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The Washington idiocracy is buzzing with the "fiscal cliff" terrors and predictions of doom and gloom if we "don't get our economic house in order" - whatever that is supposed to mean. It's all rather confusing since both sides say that going over the cliff will destroy the economy because of the imposed austerity, so we need to make a deal to impose austerity. The only agreement seems to be the confusing (and confused) message that, while absolutely necessary, austerity must be avoided at all costs, even as we enter into it.

So both sides are trying to sell us some of the same stuff but with different window dressing. In essence, there is bipartisan agreement that what the 99% needs now is a good slap of austerity. The only questions remaining are how much and how cruel? Bipartisan agreement. When that happens, usually it's we the people who get fucked. You could almost declare that any bipartisan consensus is wrong by definition. Certainly, that was true for the bipartisan consensus that Iraq had WMD, and it is true today for austerity and its anticipated implementation in the American economy. And, of course, this present consensus, much like that of the Iraqi WMD, is based entirely on lies, distortions and myths promulgated by those best positioned to gain from the proposed actions.

Certainly it is true that even a stopped clock approaches 99% accuracy 1% of the time and is instantaneously perfect once or twice a day depending on its design. So it is with our voices in Washington. Both the Republicans and Democrats are advocating for a few policy elements that would actually help the economy. But much of the rest of their proposals would be either harmful or ineffectual. Many of these harmful proposals stem from a profound misunderstanding of how a modern monetary system actually operates, and a faulty characterization of the nature of money itself. In a modern monetary economy the sovereign currency issuer is not constrained in spending by limitations in either tax revenues or securities (bond) sales. Thus, federal spending cuts in the face of a weak economy, low output, and high unemployment are actually contractionary, and potentially deflationary and very damaging.  By definition, deficit reduction by the federal government is deficit creation in the private sector. Deficit spending by the government is the government's (which is We the People) contribution to the economic growth of the private sector (which is us). It is the only means by which net financial assets (net savings) can accumulate in the private sector. Democrats want to retain the safety net and public purpose spending that currently exists, and increase infrastructure investment. They have this part right, though they do not go far enough.

Public policy already enshrined in law (Federal Reserve Act) calls for the Federal Reserve Board of Governors and the Federal Open Market Committee “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” It's just that with the simultaneous adoption of Milton Friedman's neoliberal doctrine in the 70's and 80's, employment and output became of secondary, then tertiary and finally of lip service concern. In the neoliberal world, it is financial assets, not industrial ones, that rule. And, sadly, most progressive pundits (I'm talking to you, Howard Dean, and you, Andy Stern, and Robert Reich, Rachael Maddow, Ezra Klein, Chris Hayes) have bought neoliberal economic dogma lock, stock and barrel, even though its every prediction has been falsified in the recent past. Proof is abundant in the renewed recession/depression in Greece, Italy, Portugal and Spain (currency users at the mercy of the rest of the EU) and in the UK, which is a currency issuer and thus reentered recession for purely gratuitous reasons, as we in America are about to do for our own similarly gratuitous reasons.

UPDATE: (h/t to katiec) China is portrayed as our greatest competitor and adversary on the world stage. Like us, China is a currency issuer, and it uses that power to keep it's exchange value down in foreign trade to enhance its export-driven economy. On December 27, it was reported that China will again use the power of its fiat money to spur its domestic economy. China plans to expand it 2013 contribution to the domestic Chinese economy by 50% - that being the real meaning of what we Americans call, "OMG a 50% increase in deficit spending." In other news, Ezra Klein reported that the fiscal cliff will contract the US Economy by 5.1% of GDP in 2013. That's how we compete in America? That's how we create jobs?? We shrink from the world???

On the issue of taxation, Democrats and progressives are far less cogent than those on the right. The idea of "fairness" that pervades progressive thought on taxes seems to be rooted in a fundamental misunderstanding of the function of taxes in a fiat money regime. Republicans, on the other hand, are consumed with their disdain for taxes. They are adamant in their opposition to raising rates, and the unspoken wish of many conservatives seems to be that taxes didn't exist at all. They do not understand that all of their beloved money would be worthless were it not for driving power of taxes. After all, you can barter most things. but never taxes. Uncle Sam takes only dollars - if you don't have them you better get them, or learn to enjoy misery.

Taxes are essential to a monetary economy, giving the monetary token its value. Nevertheless, we do tax stupidly, aligning incentives in non-economic ways as I will discuss below. When the Republicans say we don't have a revenue problem they are actually correct from the modern monetary theory (MMT) perspective, since the real function of taxes is to regulate economic activity, not to finance government investment. This is a critical distinction of MMT, which, at its core is an operational description of the monetary system as it exists. Operationally, taxes and borrowing do not finance spending. Taxing regulates economic flows and should be used to control inflationary pressures and politically for shaping various incentives that presumably benefit society as a whole. The borrowing side is a relic of the gold standard and, at the level of bank reserves, continues as the primary means by which the Fed (not the bond vigilantes) controls interest rates directly in the interbank market and indirectly in the private sector economy.

So I can find some grounds for agreement with Republicans on rejecting tax increases because increasing poorly implemented taxes in a fragile economy would be predictably counterproductive. The real inequity in the tax structure is the failure to tax unearned income. On this aspect I'm sure I'll meet vigorous condemnation from the right, and probably some from the left where neoliberalism has also sunk its tentacles. But when the Republicans go on to say we have a "spending problem" they are being ironic. They are right for exactly the wrong reason. They are upside down and backwards. We do indeed have a spending problem: we spend too damn little! We spend too little on advancing public purpose and we spend too damn much on stupid things like maintaining 5113 nuclear warheads, or a $1.1Trillion joint strike fighter program to counter the threat of the defunct Soviet Union. But overall, it is the former, inadequate public purpose spending, that is allowing our economy to languish. It is not the deficit that keeps us down. It is the deficit of deficits.

Returning now to taxation, consider how the system is presently implemented. The American economy is about 70% consumer driven. The production-consumption cycle is the main engine of economic activity and growth, yet that is exactly where the majority of taxation is directed. That's like crafting a fine bucket to haul water, and then drilling it full of holes to make sure it leaks well. Income and payroll taxes are leakages, and now we're talking about increasing them - drilling more holes in the bucket. Foreign trade deficits are also leakages that we now encourage under the rubric of "free trade." We used to try to avoid that leakage with tariffs to protect domestic producers. That's called protectionism today and it's supposed to be bad. This from the same paranoids that bring you the second amendment and suggest mandatory arming of elementary school teachers. But it really is bad for those producers who want to protect themselves from paying domestic wages and benefits, yet wish to continue earning domestic prices. The other leakage is savings - particularly the type of savings that diverts money into economic rents and unearned income, such as capital gains, that tax policy largely overlooks.

Money set aside to grow at compound interest is a wonderful thing for the individual. However, if there is a lot of that happening in a society, it becomes problematical. It is the Paradox of Thrift wherein if we all save then we all don't spend and the economy tanks. The other issue is that exponential growth from compound interest is a debit on someone else's balance sheet. So the debt side of the equation is also growing exponentially. For a user of currency, like you, me, Iowa or Greece, this is obviously self limiting as the debtor grows insolvent and the creditor says "no mas!" This happens not only to the individual, but also to the economic aggregates. The debt eats the productive capital like a cancer. We saw it in 1929, we saw it in 2008, we've seen it throughout history which is why the concept of jubilee with its universal pardons and remissions exists. The neoliberal economic paradigm does not acknowledge the deleterious effects of debt at compound interest to the soundness of the economy over time. This is a fatal flaw that has changed the meaning of "free markets" from markets free of the parasitism of the rentier, to markets free of the protective influences of regulation and the rule of law. From industry to usury. A new prescription is desperately needed. But, as I have written before, the simple truth is we have the wrong doctors.

(updated with additional info and correction of a bit of terribly clumsy language for which I apologize)

Originally posted to Old Surgeon on Mon Dec 31, 2012 at 07:05 AM PST.

Also republished by Money and Public Purpose.

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