The MMT Fallacy · Rebel Economist (Free)

The MMT Fallacy

For those that don't want to read this entire post, let's not bury the lead:

MMT is wrong:

The U.S. does not have a spend and then tax system, we have a tax then spend system
The U.S. Treasury does not issue the U.S Dollar
The Fed does not issue reserves for the Treasury to spend
The Fed does not issue new reserves to pay the Gov's bills directly
The Gov cannot spend before receiving tax receipts or revenue from bond sales

Below I explain in detail exactly why. Please let me know if you think I made any mistakes.

After many, many hours of discussions with friends here and elsewhere, I think it’s finally becoming clear, I have finally gotten to the bottom of the MMT debate, so please let me know if you agree.

We can have a tax and spend system, which many people believe we have today, and under a tax and spend system in 2024, the USG would have taxed roughly $5T and spent roughly $7T, showing a roughly $2T deficit, and the Gov would have had to borrow roughly $2T to cover the deficit spending.

Or we can have a spend then tax system, which MMT believes we have today, and in 2024 the USG would have issued and spent $7T and taxed back $5T, showing a $2T deficit, as the USG spent $2T more than they received back in tax revenue.

Two different systems that in practice don’t matter much until you have a deficit. Under a tax and spend model, to cover deficit spending the Gov has to borrow, because desired spending exceeds tax receipts. Under a spend first then tax back model, the Gov already spent the $, so the deficit is covered by issuing money, no borrowing or debt, the deficit is created because tax receipts are lower than currency issued and already spent, so all the money issued is not all taxed back.

Which model we have is the heart of the MMT debate.

A currency issuer always has a liability for the currency they issue, which means when they issue their currency they increase their Liabilities on their Balance Sheet, and when they receive their currency back as payment, they reduce their Liabilities. If they receive 100% of the currency they issued back as payment, their Liabilities go to zero and all currency is removed form circulation.

Many people call the currency the U.S. Federal Reserve issues ‘fiat currency,’ high powered money or Government money, reserve account credits aka ‘reserves.’ What we know for certain is only the Fed can issue reserve account credits or ‘reserves’, which are IOUs from the Fed to the receiver, and are Fed Liabilities. For this example, we are going to set aside any discussion that the Fed is not part of the government, and assume for the time being that it is.

MMT says:

“The Government can spend prior to receiving tax receipts or revenue from bond sales.”

Is this true? Luckily, this question does have an exact answer, so let’s find it!

How does the Government receive reserve account credits or ‘reserves’ to spend?

Only the Fed can adjust their ledger and issue new reserves. Functionally, what are all the ways in theory the Gov could receive new reserves to spend?

1. The Fed can credit the TGA with new reserves to spend

2. The Fed can buy a bond from the US Treasury and credit the TGA reserves equal to the purchase price of the bond

3. The Fed could credit the reserve account of the bank of Gov payees, which is completing Gov payments on the Treasury’s behalf

4. The Fed can buy a Gov bond from a bank

5. Any other ways the Gov can receive new reserves to spend?

Here’s the problem with each:

#5 - I don’t see any other ways the Gov can receive reserves to spend, but please let me know if I forgot one or if you can think of one. Thx!

#4 – The problem with #4 is the Gov does not receive any revenue or reserves when the Fed buys a Gov bond from a bank, only the selling bank receives the reserves.

#3 – The problem with #3 is if the Fed issues new reserves to pay Treasury or Gov or Fed bills, every new liability the Fed issues, every new reserve account credit, mathematically results in a one to one decrease in the Fed’s equity.

Fed Equity = Fed Assets – Fed Liabilities

· 40 = 540 – 500

If the fed issues 40 new reserves to pay bills, it results in a decrease of 40 in the Fed’s equity:

· 0 = 540 – (500 + 40)

If the Fed did this, they would soon be insolvent, their liabilities would exceed their assets and equity, and the Fed would be bankrupt in a week or so, which means I hope we can all agree, this never happens.

#2 – The problem with #2 is under current U.S. law, the Fed cannot buy bonds directly from the U.S. Treasury, and thus cannot directly finance deficit spending.

#1 – The problem with #1 is the same problem as with #3, the Fed does not spend its equity or it would go bankrupt, the Fed only issues new reserves to buy assets, or lend against assets, which increase the Fed's balance sheet but does not change the Fed’s equity. If the Fed buys 40 in new bonds:

· +A (40 in bonds)

· +L (40 in reserves)

· 40 = (500 +40) + (500 = 40)

Bank Asset Swaps Creates New Reserves

· -A (bond)

· +A (+reserves)

Banks swapping bonds for reserves with the Fed increases the Fed’s Balance sheet without increasing or decreasing Fed equity, and has no change on bak total assets or bank equity.

This also means the first reserve account credit was not crediting the TGA, or the Fed would have negative equity. It means the first reserve, and all other reserves, are only issued when a bank swaps an asset (-bond, +reserves) with the Fed in order to increase their reserve account credits to increase bank liquidity, so the bank has enough reserves to settle their payment obligations with other banks. The Fed does not issue new reserves to spend and pay bills, the Fed only issues reserves to buy assets.

By law all Gov payments must originate from the Treasury General Account TGA, and unless there is enough revenue or reserves in the TGA to cover the payment, the Gov cannot make the payment. This is the origin of the debt ceiling crisis, if the Gov does not have enough reserves on deposit to complete the Gov’s payments, the Gov has to sell more bonds and increase the Gov debt in order to complete payments previously approved by Congress. And if they hit the debt ceiling, the Gov cannot sell more bonds, so they do not have any reserves to complete payments, and the Gov forced to default on the Gov Liabilities.

If we look at the Balance Sheet of the U.S. Treasury, they do not have any liabilities for issuing $7T in currency in 2024, but they do have $2T in new liabilities for borrowing by selling bonds in 2024. The U.S. deficit spending has accumulated $30T in debt borrowed from the public (an additional $6.4T in debt bought from banks and the public is now owned by the Fed). That’s pretty strong evidence that we have a tax and spend model, not a spend then tax model.

The U.S. Government COULD choose to issue money as new Liabilities on the U.S. Treasury ledger, spend then tax, which is a new third monetary circuit (banks one & Fed two), which I modeled that on medium (link below). *

So, is MMT right? Does the Gov issue money to spend today?

Unfortunately for MMT, reason and logic dictate that unless someone can show a way the TGA can receive reserve account credits to spend prior to receiving tax receipts or revenues from bond sales, we are forced to conclude:

MMT is wrong:

The U.S. does not have a spend and then tax system, we have a tax then spend system
The U.S. Treasury does not issue the U.S Dollar
The Fed does not issue reserves for the Treasury to spend
The Fed does not issue new reserves to pay the Gov's bills directly
The Gov cannot spend before receiving tax receipts or revenue from bond sales

Please don’t shoot the fellow rebel messenger!

If anyone thinks I have made a mistake somewhere, please let me know where!

Thank you! Happy 4th!

https://medium.com/@wunderwood11/trumps-rare-and-short-lived-opportunity-for-a-5t-grand-bargain-69921b8fc7c6

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