StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

Fiscal Cliff Showing Many GOP Budget Beliefs To Be Myths

28 Nov 2012
Posted by Stan Collender

My column from today's Roll Call explains how the debate over the fiscal cliff is proving many of the (largely GOP-driven) beliefs that have dominated the federal budget debate for the past decade are nothing but myths.

Fiscal Cliff Should Alter Budget Debate

Other than the fact that we’re now two weeks closer to its tax increases and spending cuts going into effect, not much has really changed about the fiscal cliff since my last column was published two weeks ago.

Yes, we’ve heard reports about staff discussions. Yes, four Republican senators — Saxby Chambliss of Georgia, John McCain of Arizona, Lindsey Graham of South Carolina and Bob Corker of Tennessee — said publicly that they’re willing to break the no-tax-increase pledge, although doing it by raising rates — the administration’s preference — still doesn’t seem to be acceptable. Yes, some CEOs of companies whose customers will have less to spend if the tax increases go into effect said the fiscal cliff should be prevented. And, yes, a number of Republican and Democratic governors whose states will lose some of the federal financial support they receive have said it would be a terrible thing.

All of that is largely irrelevant. Without the White House and House Republicans seeing eye to eye — and they still definitely don’t — we’re no closer to a deal to stop the fiscal cliff than we were before the start of the Thanksgiving recess.

But that doesn’t mean the budget debate hasn’t been substantially changed by what’s already happened. To the contrary, some of the most commonly held budget beliefs and fiscal fish tales have now been shown to be deceptive, disingenuous, misleading and just plain wrong.

The most obvious of all the now clearly disproven common budget wisdom is that the federal deficit is always bad and therefore must always be reduced. The whole discussion about the fiscal cliff — indeed the creation of the phrase itself — is all based on what should now be considered absolutely incontrovertible: There are times — like now — when a federal budget deficit is a good thing and efforts to reduce it make no sense whatsoever.

This comes as an absolute shock to those who keep being told and have a religious-like belief that a deficit is a sign of corruption inside the Washington Beltway and a reason the other political party can’t be trusted with the economy. The fiscal cliff debate has demonstrated that the presidents, representatives, senators, and Federal Reserve Board chairmen who fight for a deficit — or a higher deficit — when the economic situation calls for it are far more valuable than those who demand it always be reduced.

The second myth the fiscal cliff has exploded is that Wall Street understands what’s happening with the federal budget. That’s the only conclusion that can be drawn from the extraordinarily positive overreaction that took place on Nov. 16, when because congressional leaders emerged from a White House meeting on the fiscal cliff and used the word “constructive” to describe the session, the Dow Jones industrial average rallied by more than 100 points and went from negative to positive territory.

If Wall Street was so taken in by a statement that had no real meaning and very likely was choreographed to hide the fact that nothing was agreed on at the largely ceremonial meeting, it doesn’t deserve its long-held reputation for being so all-knowing when it comes to fiscal policy politics.

Wall Street also no longer deserves its reputation for wanting deficit reduction all the time. The “bond market vigilantes” that were evident during the Clinton administration now have become the Bigfoots of the U.S. economic debate — much talked about but without any proof of existence.

On the contrary, the Wall Street CEOs who issued an open letter to the White House a few weeks ago demanding that the fiscal cliff be avoided and the deficit be higher than it otherwise will be under current law, as well as the investors who caused the market to rally Nov. 16, have made it clear that, if they ever actually existed, the bond market vigilantes of the 1990s were an exceedingly rare species.

The third budget fairy tale the fiscal cliff has now shown to be make-believe is the much- repeated concept that federal spending isn’t good for the economy and spending cuts will have no negative consequences.

Much of the debate over the fiscal cliff has been about how the spending cuts that are scheduled to occur on Jan. 2 will result in thousands of private and public sector layoffs. We also have projections from the Congressional Budget Office and Wall Street that unemployment will increase to more than 9 percent. That’s the opposite of the benign or even positive economic effect some have been saying federal budget cuts have no matter when or how they are made.

The sad part is that there’s been very little admission by those involved in or commenting on the fiscal cliff about how it has shown many of the previous assumptions about the federal budget to be wrong. No matter what happens, changing this should be one of the goals of the debate. Otherwise, whenever this crisis has passed, the debate will go back to being dominated by the same lies that have made the current situation so difficult to deal with.


Yes, say it again and again and again. It amazes me that people who want a balanced budget amendment also say we can't go off the fiscal cliff. The Republicans on my TV are are making two diametrically opposed arguments in the same sentence and no one is calling them out and pinning them down.

Cognitive Dissonance

Yes. It's called Cognitive Dissonance and it happens very commonly. People commonly hold beliefs that are mutually contradictory. How does this happen? People compartmentalize their beliefs as "Facts" but never explore the consequences of those beliefs or make the connection between them.

We have many politicians and media folks who memorize a set of talking points and rules without a deeper understanding of their beliefs. This is the result of an anti-science ideology that refuses to question authority.

Fiscal cliff

Let's go over the cliff! Spending cuts and tax increase for all sounds good to me! What's not fair about that!.... Oh I got it the losers who have been sucking all the money will have to pay their. " fair share" lol.....

bond vigilantes

The US government never has to worry about 'bond vigilantes' because unlike Europeans who gave up their monetary sovereignty and now use euro that those nations are not allowed to issue themselves, the US government borrows money in its own currency. The government writes the legislation that controls the operation of the US banking and money system. The central bank sets the interest rates to encourage or discourage people and governments from borrowing from commercial banks. This is the exercise of "monetary policy". The commercial banks create the circulating money supply by making loans to private sector borrowers and by buying government bonds. So it is actually the banks isuing credit money who create and distribute the nation's money supply. When a bank buys a new government bond, it pays for the bond by creating a credit in the US Treasury's account at that bank. Treasury then transfers the credit to its accounts at the regional Federal Reserve banks that the government uses as its checking accounts. The credit creating banks, not "the government", create our money.

There are 21 big banks, American and international, who have been given "primary dealer" status, which authorizes them to directly bid on new issues of Treasury debt (bonds). International banking protocol (Basel I, II and III) has deemed government debt "zero risk", so banks are not constrained by capital adequacy laws from buying and holding unlimited quantities of government debt. To retain their primary dealer privilege the PD banks are required to buy at least a minimal amount of newly issued Treasury debt. So PD banks "have to" provide funding to buy new government debt. And banks can't "run out of money" because banks "create" the money that they use to fund loans and bond purchases. Bank loans "create" bank deposits.

Most people assume that the deposits have to be made BEFORE a bank can lend, but this is not how the system works. I suppose it is a case of cognitive disonance that those people never wonder where all the money comes from in the first place. They assume, if they ever think about this at all, that "the gubm'nt" creates the money, so they accuse the government of "causing inflation", when in fact it is excessive money creation and lending by commercial banks that causes inflation. If the government creates its own money and spends so much that it causes inflation, why is the goverment "in debt"? Why does the US government owe $16 trillion of US dollar debt if that same government is "issuing", not "borrowing" the US dollars? The anti-gubm'nt crowd never seems to put 2 and 2 together to see that commercial banks, not the government, create and issue the US$ money supply every time they make a loan or buy a bond. Making a loan creates a new bank deposit, new additional money. Repaying the loan destroys that bank deposit, destroys that money.

Our money is created and extinguished on banking system balance sheets, not in government print shops. And the banks who create the money to buy government debt have to keep doing so or they lose their primary dealer status. I suppose it's possible that the PD banks could stage a coup d'etat and refuse to buy any more government debt, in defiance of the government's laws that require them to do so. But short of that kind of revolutionary maneuver, the 'bond vigilantes' have very little power over US government borrowing.

Congress has arbittraily imposed debt ceilings on itself, which is another issue. And primary dealer banks sell a lot of their new Treasury bonds into the secondary markets where other banks, or foreign governments, or pension funds and private money pools, or private buyers, can choose whether or not they want to buy government debt at current interest yields. But before the bonds ever reach the secondary market the primary dealers have already paid the government for the bonds and the government has the money; money newly created as a new bank deposit. It is only in the secondary market that non-bank buyers purchase Treasury debt with money that already exists as their "savings".

If another bank buys the debt from a primary dealer, the other bank pays for the bond by creating new money and transferring that credit to the bank account of the primary dealer who sold the bond. That credit, that money, now becomes the PD bank's "asset". The PD traded an interest bearing asset, the bond, for a non-interest bearing asset, cash. Then the primary dealer uses that credit/asset to extinguish the deposit liabilility it had created on its balance sheet when it initially bought the newly issued Treasury bond. So the PD bank sold an asset (the interest bearing bond) off its balance sheet, and used the proceeds of the bond sale to extinguish the deposit liability it had created at the time it "paid for" it purchase of the new bond. So both the asset side and the liability side of the PD bank's balance sheet are reduced by the amount of the bond sale, as if it had never created a new deposit and bought the bond in the first place. Except the PD sells the bond for more than it paid, leaving the PD bank some profit.

The only factor constraining any bank from creating unlimited credit money to buy and holding unlimited government debt and collecting the "free" interest income, is that banking legislation requires banks to keep their balance sheets balanced. Assets (interest bearing loans that the banks hold) must equal liabilities. Customers' bank deposit balances are a bank's major liability, as banks have to "pay" interest to attract enough deposits to balance their balance sheets. A bank that has too much low interest government debt on the asset side of its balance sheet, may suffer losses if it has to pay higher interest to attract enough deposits to balance its balance sheet.

But again, this balance sheet law is simply an arbitrary protocol. China, whose government owns and controls its banking and money system, can play fast and loose with its banking legislation. So China is free to use its control of its money system to implement bank lending policies that support China's real economy. The government controls its macro economy. In the US and most of the world, macro control of national economies has been transferred into the hands of their accountants, their private banking systems. In our nations the economy serves our money system. China uses its money system to serve its economy. Which do you think is the smarter system?

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