The National Debt Deception
Updated: Nov 10, 2021
"Government spending is out of control! We can’t afford new government programs to rebuild infrastructure, mitigate climate change, or provide health care, child care, or ensure a college education for all. The US national debt is rapidly approaching $90,000 per person. This is a debt that eventually either we, our children, grandchildren, and future generations of Americans will have to pay." This is the conventional wisdom, even among economists. But it is simply not true!
In her best-selling book, The Deficit Myth, economist Stephanie Kelton explains Modern Monetary Theory, and proclaims “the birth of the people’s economy.” She exposes the common myth that the government’s budget is like a household budget and that it is irresponsible for the government to spend more money that it collects in taxes. The federal deficit is simply the difference between government spending and tax collections in a given year. She points out that government deficits always create private sector surpluses that stimulate new private sector spending and investments, which in turn increase future government tax revenues.
Kelton explains why Americans shouldn’t be concerned about government deficits, as long as inflation in consumer prices remains under control. Deficit spending makes new money available for private sector spending or saving and investing. Deficit government spending results in consumer price inflation only if increases in production of the things consumers buy fails to keep pace with the increases in new money available to spend. This typically means that the economy is approaching or has reached its current maximum productive capacity—which apparently has not been the case for the past 30 years. The new large budget deficits since 2008 have inflated prices of corporate stocks and prime real estate rather than prices of consumer goods and services.
The national “debt deception” is related to, but different from, the federal “deficit myth.” The “national debt” is the total accumulation of all past and present “budget deficits.” As Kelton points out, the national debt also is different from household debt because the US government has the ability to create enough new money to pay down or pay off the national debt at any time. However, the debt deception is even more profound than the deficit myth. I believe it is more than a simple misunderstanding. It is an attempt to deprive the federal government of its ability to ensure that the economy serves both the public and private interests of society.
The Federal Reserve System, called the FED, is a network of 12 large banks that function as the nations’ central bank. The Federal Reserve Banks are not owned by the government, but the Board of Governors of the FED is an agency of the federal government that reports to and is directly accountable to the US Congress. So, Congress is ultimately responsible for actions taken by the FED. Whenever the US Government needs money to finance deficit spending, the government sells US Treasury Securities. A Treasury Bill, Treasury Bond or other government security constitutes a loan made to the US Government. The Treasury may choose to sell securities to, and thus borrow money from, individual investors, commercial banks or from the FED.
Whenever government securities are sold to banks or individual investors, money is simply shifted from the purchasers’ accounts (the private sector of the economy) to the US Treasury’s bank accounts (the public sector of the economy). The Treasury uses these new deposits to cover the costs of budget deficits. These transfers add to federal budget deficits and to the national debt, but no new money is created or added to the total supply of money in circulation.
Alternatively, the FED’s Board of Governors can instruct the FED to buy US Treasury Securities and deposit the proceeds in US Treasury accounts at the FED to be used to cover the government’s deficit spending. These deposits represent new money because no money was borrowed or taken out of circulation elsewhere to create the deposits. The FED may later sell the newly acquired securities to one of its member banks or to commercial depositors. Regardless, the additional money created by the FED to finance the deficit remains in circulation in the US economy.
The FED can also add to the total money supply by loaning money to member banks and creating new deposits in the banks’ accounts to offset the loans. These new deposits can be used as reserves to secure new loans made by banks to commercial customers. Proceeds from new loans are deposited in commercial borrowers accounts, much as proceeds from FED sales of government securities are deposited in Treasury accounts.
Because of something called fractional reserve banking, each new deposit created by the FED can support a series of commercial bank loans totaling ten times the amount of the initial deposit, sometimes even more. The FED can influence the total amount of money placed in circulation in the private sector by changing that amount of reserves required to secure new loans or by changing interest rates for funds loaned to or borrowed from the FED. However, the FED can’t force private investors or consumers to borrow or spend money to stimulate the economy.
The only significant difference between new money created by the FED and new money created by commercial banks is that the FED puts new money in circulation through government spending and commercial banks puts new money in circulation through private sector spending. Once the money is spent in either sector, it ends up as new deposits in commercial bank accounts—in the private sector. After the initial round of spending, additional lending and spending takes place in the private sector. The bottom line is there is no more need for the FED to pay down or pay off the national debt than for commercial banks to reduce their deposits or close out customers’ accounts. Deposits in US commercial bank (~$20 trillion) and outstanding US corporate bonds (~$10 trillion) total more than the national debt (~$27 trillion).
The debt deception an apparent strategy devised by political and fiscal conservatives to diminish public trust and confidence in the federal government. Many conservatives apparently have become convinced that "Government is not the solution to our problem, government is the problem"—to quote former President Ronald Reagan. The US Constitution gives the Congress responsibility for creating and maintaining the value of the nation’s currency. To carry out this responsibility, the federal government must have the ability to manage the total amount of money in circulation.
A balanced budget requirement, as proposed by conservatives, would prevent the government from increasing spending to respond to economic crises such as the COVID pandemic of 2020-2021, the Great Recession of 2008-2009, or the Great Depression of the 1930s. Increasing taxes to balance the budget during times of crisis would only make bad situations worse. Commercial banks can’t respond to economic crises because investors and consumers are reluctant to borrow, and bankers are reluctant to lend during times of economic recession. However, the government can create and spend new money anytime it is needed to stimulate consumer spending, employment and economic recoveries, as it has done during economic crises of the past.
The government also needs enough money to fulfill its constitutional responsibilities, “to establish justice, ensure domestic tranquility, provide for the common defense, and promote the general welfare”—as is spelled out in the Preamble to the US Constitution. These responsibilities were given to the government because they are essential to the security and well-being of the nation, and because individual economic incentives are either absent or inadequate to ensure their fulfillment. The private and public sectors are both critical to the health and well-being of the economy and society. The government has the responsibility, and thus must also have the ability, to maintain an appropriate balance between the two.
The US monetary system is extremely complex. Most people have not had an opportunity to learn about it and simply cannot be expected to understand how it functions, or is supposed to function. Economists who advise elected representatives have no such excuses. The only logical conclusion is that the deficit myth and debt deception are strategic and intentional attempts to undermine the strength and effectiveness of the US Government.