Warren Mosler's Public Policy Recommendations

 From the Seven Deadly Innocent Frauds of Economics [pdf] 

The entire document is worth a look, and Mosler is one of the founders of Modern Money Theory. If you read the entire document, you'll see he's a smart cookie, and understands finance inside out. The following are his public policy prescriptions based on that understanding. 

Part III: Public Purpose

Functions of government are those that best serve the community by being done collectively. These include: The military, the legal system, international relations, police protection, public health (and disease control), public funding for education, strategic stockpiles, maintaining the payments system, and the prevention of “races to the bottom” between the states, including environmental standards, enforcement standards, regulatory standards and judicial standards.

What has made the American economy the envy of the world has been that people working for a living make sufficient take-home pay in order to be able to purchase the majority of the goods and services they desire and are produced. And what American business does is compete for those dollars with the goods and services they offer for sale. Those businesses that produce goods and services desired by consumers are often rewarded with high profits, while those that fail fall by the wayside. The responsibility of the federal government is to keep taxes low enough so that people have the dollars to spend to be able to purchase the goods and services they prefer from the businesses of their choice.

Today, unfortunately, we are being grossly overtaxed for the current level of government spending, as evidenced by the high level of unemployment and the high level of excess capacity in general. People working for a living are getting squeezed, as they are no longer taking home a large enough pay check to cover their mortgage payments, car payments and various routine expenses, never mind any extra luxuries. To address the current financial crisis and economic collapse, I recommend a number of proposals in the pages ahead.

A Payroll Tax Holiday

I recommend that an immediate “payroll tax holiday” be declared whereby the U.S. Treasury makes all FICA, Medicare and other federal payroll tax deductions for all employees and employers. This proposal will increase the take-home pay of a couple making a combined $100,000 per year by over $650 per month, restoring their ability to make their mortgage payments, meet their routine expenses, and even do a little shopping.

People with money to spend will immediately lead to a pickup in business sales, which will quickly result in millions of new jobs to serve the increased demand for goods and services. And people able to make their mortgage and loan payments is exactly what the banking system needs most to quickly return to health, not government funding that can only keeps them limping along with loans that continue to default. The only difference between a good loan and a bad loan is whether or not the borrower can
make his payment. 

Revenue sharing

My second proposal is to give the U.S. state governments an immediate, unrestricted $150 billion of revenue sharing on a per capita basis (about $500 per capita). Most of the states are in dire straits as the recession has cut into their normal revenue sources. By pushing back federal funds on a per capita basis, it will be “fair” to all and not specifically “reward bad behavior.” This distribution will give the states the immediate relief they need to sustain their essential services. As the economy recovers, their revenues will increase to pre-recession levels and beyond.

National Service Jobs

The next recommendation of mine is to fund an $8/hour [the figure is from 2010, so is low] national service job for anyone willing and able to work; this will include child care, the current federal medical coverage and all of the other standard benefits of federal employees. This is a critical step to sustain growth and foster price stability. This provides a transition from unemployment to private sector employment. Businesses tend to resist hiring the unemployed, and especially the long-term unemployed. This national service job provides a transition from unemployment to employment, and, as the economy recovers (due to my first two proposals), businesses will hire from this pool of labor to meet their needs for more workers.

Universal Health Care Coverage

My proposal regarding health care is to give everyone over the age of 18 a bank account that has, perhaps, $5,000 in it, to be used for medical purposes. $1,000 is for preventative measures and $4,000 for all other medical expenses. At the end of each year, any unspent funds remaining of the $4,000 portion are paid to that individual as a “cash rebate.” Anything above $5,000 would be covered by a form of Medicare. There would be no restrictions on purchasing private insurance policies. This proposal provides for universal health care, maximizes choice, employs competitive market forces to minimize costs, frees up physician
time previously spent in discussion with insurance companies, rewards “good behavior” and reduces insurance company participation. This will greatly reduce demands on the medical system, substantially increasing the supply of available doctor/patient time and makes sure all Americans have health care. To ensure preventative measures are taken, the year-end rebate can be dependent, for example, on the individual getting an annual checkup.And though it is federally funded, it can be administered by the states, which could also set standards and requirements.

There is no economic school of thought that would suggest health care should be what’s called a “marginal cost of production” means that it is bad for the economy and our entire standard of living to have business pay for health care. This proposal eliminates that problem for the American economy in a way that provides health care for everyone, saves real costs, puts the right incentives in place, promotes choice and directs competitive forces to work in favor of public purpose.

Proposals for the Monetary System

First, the Federal Reserve should immediately lend to its member banks on an unsecured basis, rather than demanding collateral for its loans. Demanding collateral is both redundant and obstructive. It is redundant
because member banks can already raise government-insured deposits and issue government-insured securities in unlimited quantities without pledging specific collateral to secure those borrowings. In return, banks are subject to strict government regulation regarding what they can do with those insured funds they raise, and the government continuously examines and supervises all of its member banks for compliance. 

With the government already insuring bank deposits and making sure only solvent banks continue to function, the government is taking no additional risk by allowing the Federal Reserve to lend to its member banks on an unsecured basis. With the Federal Reserve lending unsecured to its member banks, liquidity would immediately be normalized and no longer be a factor contributing to the current financial crisis or any future financial crisis. 

Second, the government should also remove the $250,000 cap on insured bank deposits, as well as remove regulations pertaining to bank liquidity, at the same time that it allows the Federal Reserve to lend unsecured to member banks. The Federal Reserve should lower the discount rate to the fed funds rate (and, as above, remove the current collateral requirements). The notion of a “penalty” rate is inapplicable with today’s nonconvertible currency and floating exchange rate policy.

Third, an interbank market serves no public purpose. It can be eliminated by having the Federal Reserve offer loans to member banks for up to 6 months, with the FOMC (Federal Open Market Committee, the collection of Fed officials who meet and vote on monetary policy) setting the term structure of rates at its regular meetings. This would also replace many of the various other lending facilities the FOMC has been experimenting with.

Fourth, have the Treasury directly fund the debt of the FHLB (Federal Home Loan Bank) and FNMA (the Federal National Mortgage Association), the U.S. Federal housing agencies. This will reduce their funding costs, and this savings will be directly passed on to qualifying home buyers. There is no reason to give investors today’s excess funding costs currently paid by those federal housing agencies when the full faith
and credit of the US government is backing them.

Fifth, have FNMA and the FHLB “originate and hold” any mortgages they make, and thereby eliminate that portion of the secondary mortgage market. With Treasury funding, secondary markets do not serve public purpose.

Sixth, increase and vigorously enforce mortgage fraud penalties with Federal agencies.

Strategic Stockpiles

When families live on remote farms, for example, it makes sense to store perhaps a year or more of food for crop failures and other potential disruptions of the food supply. However, families living in cities, as a practical matter, instead can only save U.S. dollars. Unfortunately, in the event of actual shortages of food and other strategic supplies, numbers in bank accounts obviously will not do the trick. It is therefore a matter of public purpose to insure that there are actual strategic reserves for emergency consumption. Currently we have a strategic oil reserve. This should be extended to stores of other necessities for the purpose of emergency consumption. The purpose should not be to support special interest groups, but to provide the consumer with real supplies of actual consumables for rainy days.

A Housing Proposal for the Financial Crisis:

1. If the owner of a house about to be foreclosed wants to remain in the house, he notifies the government, which then buys the house during the foreclosure sale period from the bank at the lower of fair market value or the remaining mortgage balance.
2. The government rents the house to the former owner at a fair market rent.
3. After two years, the house is offered for sale and the former owner/renter has the right of first refusal to buy it. 

While this requires a lot of direct government involvement and expense, and while there is room for dishonesty at many levels, it is far superior to any of the proposed plans regarding public purpose, which includes:

a. Keeping people in their homes via affordable rents;

b. Not interfering with existing contract law for mortgage contracts;

c. Minimizing government disruption of outcomes for mortgage backed securities holders;

d. Minimizing the moral hazard issue.

With this proposal, the foreclosure process is allowed to function according to law, so no contracts are violated. And renting to the former owner at a fair market rent is not a subsidy, nor is the repurchase option at market price a subsidy.

How We Can All Benefit from the Trade Deficit

The current trade gap is a reflection of the rest of the world’s desires to save U.S. financial assets. The only way the foreign sector can do this is to net export to the U.S. and keep U.S. dollars as some form of dollar financial assets (cash, securities, stocks, etc.). So the trade deficit is not a matter of the U.S. being dependent on borrowing offshore, as pundits proclaim daily, but a case of offshore investors desiring to hold U.S. financial assets. To accomplish their savings desires, foreigners vigorously compete in U.S. markets by selling at the lowest possible prices. They go so far as to force down their own domestic wages and consumption in their drive for “competitiveness,” all to our advantage. If they lose their desire to hold
U.S. dollars, they will either spend them here or not sell us products to begin with, in which case that will mean a balanced trade position. While this process could mean an adjustment in the foreign currency markets, it does NOT cause a financial crisis for the U.S. The trade deficit is a boon to the US. There need not be a “jobs issue” associated with it. Appropriate fiscal policy can always result in Americans having enough spending power to purchase both our own full employment output and anything the foreign sector may wish to sell us. The right fiscal policy works to optimize our output, employment and standard of living, given any size trade gap.

Industries with Strategic Purpose

Our steel industry is an example of a domestic industry with important national security considerations. Therefore, I would suggest that rather than continuing with the general steel tariffs recently implemented, defense contractors should be ordered to use only domestic steel. This will ensure a domestic steel industry capable of meeting our defense needs, with defense contractors paying a bit extra for domestically-produced steel, while at the same time lowering the price for non-strategic steel consumption for general use.

Using a Labor Buffer Stock to let Markets Decide the Optimum Deficit

To optimize output, substantially reduce unemployment, promote price stability and use market forces to immediately promote health-care insurance nationally, the government can offer an $8 per hour job to anyone willing and able to work that includes full federal health-care benefits. To execute this program, the government can first inform its existing agencies that anyone hired at $8 per hour “doesn’t count” for annual budget expenditures. Additionally, these agencies can advertise their need for $8 per hour employees with the local government unemployment office, where anyone willing and able to work can be dispatched to the available job openings. This job will include full benefits, including health care, vacation, etc. These positions will form a national labor “buffer stock” in the sense that it will be expected that these employees will be prone to being hired away by the private sector when the economy improves. As a buffer stock program, this is highly countercyclical anti-inflationary in a recovery, and anti-deflationary in a slowdown. Furthermore, it allows the market to determine the government deficit, which automatically sets it at a near “neutral” level. In addition to the direct benefits of more output from more workers, the indirect benefits of full employment should be very high as well. These include increased family coherence, reduced domestic violence, less crime, and reduced incarcerations. In particular, teen and minority employment should increase dramatically, hopefully, substantially reducing the current costly levels of unemployment.

Interest Rates and Monetary Policy

It is the realm of the Federal Reserve to decide the nation’s interest rates. I see every reason to keep the “risk free” interest rate at a minimum, and let the market decide the subsequent credit spreads as it assesses risk. Since government securities function to support interest rates, and not to finance expenditure, they are not necessary for the operation of government. Therefore, I would instruct the Treasury to immediately cease issuing securities longer than 90 days. This will serve to lower long-term rates and support investment, including housing. Note, the Treasury issuing long term securities and the Fed subsequently buying them, as recently proposed, is functionally identical to the Treasury simply not issuing those securities in the first place.

I would also instruct the Federal Reserve to maintain a Japan like 0% fed funds rate. This is not inflationary nor is it the cause of currency depreciation, as Japan has demonstrated for over 10 years. Remember, for every $ borrowed in the banking system, there is a $ saved. Therefore, changing rates shifts income from one group to another. The net income effect is zero. Additionally, the non-government sector is a net holder of government securities, which means there are that many more dollars saved than borrowed. Lower interest rates mean lower interest income for the non-government sector. Thus, it is only if the borrower’s propensity to consume is substantially higher than that of savers does the effect of lower interest rates become expansionary in any undesirable way. And history has shown this never to be the case. Lower long term rates support investment, which encourages productivity and growth. High risk-free interest rates support those living off of interest payments (called rentiers), thereby reducing the size of the labor force and consequently reducing real national output.

The Role of Government Securities

It is clear that government securities are not needed to “fund” expenditures, as all spending is but the process of crediting a private bank account at the Fed. Nor does the selling of government securities remove wealth, as someone buying them takes funds from his bank account (which is a U.S. financial asset) to pay for them, and receives a government security (which is also a U.S. financial asset). Your net wealth is the same whether you have $1 million in a bank account or a $1 million Treasury security. In fact, a Treasury security is functionally nothing more than a time deposit at the Fed.

Nearly 20 years ago, Soft Currency Economics was written to reveal that government securities function to support interest rates, and not to fund expenditures as generally perceived. It goes through the debits and credits of reserve accounting in detail, including an explanation of how government, when the Fed and Treasury are considered together, is best thought of as spending first, and then offering securities for sale. 

Government spending adds funds to member bank reserve accounts. If Govt. securities are not offered for sale, it’s not that government checks would bounce, but that interest rates would remain at the interest rate paid on those reserve balances.

In the real world, we know this must be true. Look at how Turkey functioned for over a decade—quadrillions of liras of deficit spending, interest rate targets often at 100%, inflation nearly the same, continuous currency depreciation and no confidence whatsoever. Yet government “finance” in lira was never an issue. Government lira checks never bounced. If they had been relying on borrowing from the markets to sustain spending, as the mainstream presumed they did, they would have been shut down long ago. Same with Japan – over 200% total government debt to GDP, 7% annual deficits, downgraded below Botswana, and yet government yen checks never bounced, and 3-month government securities fund near 0%. Again, clearly, funding is not the imperative. 

The U.S. is often labeled “the world’s largest debtor.” But what does it actually owe? For example, assume the U.S. government bought a foreign car for $50,000. The government has the car, and a non-resident has a U.S. dollar bank account with $50,000 in it, mirroring the $50,000 his bank has in its account at the Fed that it received for the sale of the car. The nonresident now decides that instead of the non-interest bearing demand deposit, he’d rather have a $50,000 Treasury security, which he buys from the government. Bottom line: the US government gets the car and the nonresident holds the government security. Now what exactly does the U.S.government owe? When the $50,000 security matures, all the government
has promised is to replace the security held at the Fed with a $50,000 (plus interest) credit to a member bank reserve account at the Fed. One financial asset is exchanged for another. The Fed exchanges an interest bearing financial asset (the security) with a non-interest bearing asset. That is the ENTIRE obligation of the U.S. government regarding its securities. That’s why debt outstanding in a government’s currency of issue is never a solvency issue.

Children as an Investment Rather than an Expense

Anyone who pauses to think about it will realize that our children are our fundamental real investment for the future. It should be obvious to all that without children, there won’t be much human life left in 100 years. However, our current institutional structure—the tax code and other laws and incentives on the books—have made our children an expense rather than an investment. And a lot of behavior most of us would like to see not happen, including deficiencies in education, child neglect and abuse and high rates of abortion, could be addressed by modifying the incentives built into our financial system.

Public Purpose

For me, all federal public policy begins and ends with public purpose. I begin with a brief list of the functions of government, all of which comprise what can be called public infrastructure, that in my estimation do serve public purpose and should be provisioned accordingly. 

The first is defense. It is my strong belief that without adequate military defenses, the world’s democracies (a word I’ll use for most forms of representative governments) are at risk of physical invasion and domination by nations with dictatorships and other related forms of totalitarianism.

While democracies will move to defend themselves, in today’s world, it is most often the dictatorships that move militarily to attack other nations without the provocation of a military threat. Examples include Pakistan threatening India, North Korea threatening not only South Korea but others in the region, Russia supporting military actions against most any western democracy, Israel under constant threat of attack by all the region’s dictatorships and the Taliban attempting to take control of Afghanistan and disrupt any attempt at establishing representative government. It is evident to me that if the western democracies decided to abandon all defense measures they would immediately become subject to hostile invasion on
multiple fronts. Therefore, there is a critical public purpose being served by allocating real resources to national defense. The next step is to set the objectives of our defense effort. At one time this included “the ability to fight a prolonged war on two fronts” much like the European and Pacific fronts of World War II. Other objectives have included the ability to strike mostly anywhere in the world within a certain number of hours with a force of a pre-determined size, to maintain air superiority and to be able to deliver
nuclear weapons against the Soviet Union and other potentially hostile nations which can direct nuclear weapons at the U.S. and, more recently, to have the capability of using drones to assassinate hostile individuals remotely anywhere in the world.

These are all military objectives. Some are general, some very specific. In the United States, they are ultimately political choices. For me this means the President, as Commander in Chief, submitting these types of high-level military objectives to Congress for approval, and then working to achieve those objectives by proposing more specific military options to accomplish our national goals. The President proposes objectives and what is needed to accomplish those objectives, and the Congress reviews, debates, and modifies the objectives and proposals to meet those objectives, and appropriates the resources it decides necessary to meet what it decides best serves the nation’s military objectives.

Most of the world’s democracies (and particularly those with a U.S. military presence) have, however, come to rely on the assumption that the U.S. would ultimately defend them. Often, though not always, this is through formal alliances. This ultimate reliance on the U.S. military has resulted in these nations not allocating what would otherwise be substantial portions of their real wealth to their national defense. One option for addressing this issue would be to meet with the world’s democracies and establish what a “fair contribution” to the U.S. defense effort would be for these nations, and then go so far as to publish a “non-defense” pledge for those who refuse to contribute their fair share of real goods and services to
the common defense.

The ‘right sized’ defense has everything to do with actual defense needs, and nothing to do with the total expenditures of dollars necessary to meet the nation’s defense needs. Nor need there any mention of “how are we going to pay for it” as taxes function to regulate aggregate demand and not to raise revenue per se. The way we, the current generation, always “pay for I”’ is by the real resources—goods and services—that are allocated to the military that could have remained in the private sector for private consumption. That real cost includes all the people serving in the military who could have been working and producing goods and services in the private sector for private consumption. That includes everything from auto
workers to tennis instructors, lawyers, doctors, and stock brokers.

The “right size” and “right type” of defense can change dramatically over relatively short periods of time. China’s capability of shooting down satellites and Iranian medium range nuclear missiles that could threaten our shipping are but two examples of how the advance of military technology can very quickly make prior technologies instantly obsolete. Both objectives and options must be under continuous review, and there can be no let up in advancing new technologies to do all we can to stay on the leading edge of military effectiveness.

About 10 years ago I was discussing the military with a member of the Pentagon. He said that we needed to increase the size of the military. I said that if we wanted to do that we should have done it ten years ago (1990) when we were in a recession with high unemployment and excess capacity in general. Back then, with all that excess capacity, a buildup of the military would not have been taking as many productive resources away from the private sector as it would have done during a period of full employment. He
responded, “Yes, but back then we couldn’t afford it, the nation was running a budget deficit; while today with a budget surplus, we can afford it’. This is completely backwards! The government never has nor doesn’t have any dollars. The right amount of spending has nothing to do with whether the budget is in surplus or deficit. They use the monetary system which provides no information for all their information.

Inflation!

OK, so the risk of running a deficit that is too large is not insolvency—the government can’t go broke—but excess aggregate demand (spending power) that can be inflationary. While this is something I’ve never seen in the U.S. in my 60- year lifetime, it is theoretically possible. But then again, this can only happen if the government doesn’t limit its spending by the prices it is willing to pay, and, instead, is willing to pay ever higher prices even as it’s spending drives up those prices, as would probably the case.

And now here is a good place to review what I first wrote back in 1992 for Soft Currency Economics which came out in 1993:

Inflation vs. Price Increases

Bottom line, the currency itself is a public monopoly, which means the price level is necessarily a function of prices paid by the government when it spends, and/or collateral demanded when it lends. The last part means that if the Fed simply lent without limit and without demanding collateral we would all borrow like crazy and drive prices to the moon. Hence, bank assets need to be regulated because otherwise, with FDIC-insured deposits, bankers could and probably would borrow like crazy to pay themselves unlimited salaries at taxpayer expense. And that’s pretty much what happened in the S & L crisis of the 1980’s, which also helped drive the Reagan boom until it was discovered. Much like the subprime boom drove the Bush expansion until it was discovered. So it now goes without saying that bank assets and capital ratios need to be regulated.

But let’s return to the first part of the statement—“the price level is a function of prices paid by govt. when it spends.” What does this mean? It means that since the economy needs the government spending to get the dollars it needs to pay taxes, the government can, as a point of logic decide what it wants to pay for things, and the economy has no choice but to sell to the government at the prices set by government in order to get the dollars it needs to pay taxes, and save however many dollar financial assets it wants to. Let me give you an extreme example of how this works: Suppose the government said it wasn’t going to pay a penny more for anything this year than it paid last year, and was going to leave taxes as they are in any case.

And then suppose this year all prices went up by more than that. In that case, with its policy of not paying a penny more for anything, government would decide that spending would go from last year’s $3.5 trillion to 0.

That would leave the private sector trillions of dollars short of the funds it needs to pay the taxes. To get the funds needed to pay its taxes, prices would start falling in the economy as people offered their unsold goods and services at lower and lower prices until they got back to last year’s prices and the government then bought them. While that’s a completely impractical way to keep prices going up, in a market economy, the government would only have to do that with one price, and let market forces adjust all other prices to reflect relative values. Historically, this type of arrangement has been applied in what are called “buffer stock” policies, and were mainly done with agricultural products, whereby the government
might set a prices for wheat at which it will buy or sell. The gold standard is also an example of a buffer stock policy.

Today’s governments unofficially use unemployment as their buffer stock policy. The theory is that the price level in general is a function of the level of unemployment, and the way to control inflation is through the employment rate. The tradeoff becomes higher unemployment vs. higher inflation. To say this policy is problematic is a gross understatement, but no one seems to have any alternative that’s worthy of debate.

All the problematic inflation I’ve seen has been caused by rising energy prices, which begins as a relative value story but soon gets passed through to most everything and turns into an inflation story. The “pass through” mechanism, the way I see it, comes from government paying higher prices for what it buys, including indexing government wages to the CPI (Consumer Price Index), which is how we as a nation have chosen to define inflation. And every time the government pays more for the same thing, it is redefining its currency downward.

It is like the parents with the kids who need to do chores to earn the coupons they need to pay the monthly tax to their parents. What is the value of those coupons? If the parents pay one coupon for an hour’s worth of work (and all the work is about equally difficult and equally “unpleasant”), then one coupon will be worth an hour’s worth of child labor. And if the children were to exchange coupons with each other, that’s how they would value them. Now suppose that the parents paid two coupons for an hour’s worth of work. In that case, each coupon is only worth a half hour’s worth of work. By paying twice as many coupons for the same amount of work, the parents caused the value of the coupons to drop in half. 

But what we have is a government that doesn’t understand its own monetary operations, so, in America, the seven deadly innocent frauds rule. Our leaders think they need to tax to get the dollars to spend, and what they don’t tax they have to borrow from the likes of China and stick our children with the tab. And they think they have to pay market prices. So from there the policy becomes one of not letting the economy get too good, not letting unemployment get too low, or else we risk a sudden hyperinflation like the Weimar Republic in Germany 100 years or so ago. Sad but true. So today, we sit with unemployment pushing 20% if you count people who can’t find full-time work, maybe 1/3 of our productive capacity going idle, and with a bit of very modest GDP growth—barely enough to keep unemployment from going up. And no one in Washington thinks it’s unreasonable for the Fed to be on guard over inflation and ready to hike rates to keep things from overheating (not that rate hikes do that, but that’s another story).

And what is the mainstream theory about inflation? It’s called “expectations theory.” For all but a few of us, inflation is caused entirely by rising inflation expectations. It works this way: when people think there is going to be inflation, they demand pay increases and rush out to buy things before the price goes up. And that’s what causes inflation. What’s called a “falling output gap,” which means falling unemployment for all practical purposes, is what causes inflation expectations to rise. And foreign monopolists hiking oil prices can make inflation expectations rise, as can people getting scared over budget deficits, or getting scared by the Fed getting scared. So the job of the Fed regarding inflation control becomes managing inflation expectations. That’s why with every Fed speech there’s a section about how they are working hard to control inflation, and how important that is. They also believe that the direction of the economy is dependent on expectations, so they will always forecast “modest growth” or better, which they believe helps to cause that outcome. And they will never publicly forecast a collapse, because they believe that that could cause a collapse all by itself.
 

So for me, our biggest inflation risk now, as in the 1970’s, is energy prices (particularly gasoline). Inflation will come through the cost side, from a price-setting group of producers, and not from market forces or excess demand. Strictly speaking, it’s a relative value story and not an inflation story, at least initially, which then becomes an inflation story as the higher imported costs work their way through our price structure with government doing more than its share of paying those higher prices and
thereby redefining its currency downward in the process.