Fiscal Cliff Notes: The Certainty of Debt and Taxes

Written by Warren Mosler

The term Cliff Notes is used in the title in reference to the study aids used by college students.  CliffsNotes are pamphlets that contain a summary, outline and important excerpts of an entire course content.  The term is particularly appropriate for this outline which attempts to lay out the critical economic and monetary factors that relate to what has come to be called the Fiscal Cliff that the U.S. faces at midnight December 31, 2012 if no legislative actions are taken before that magic hour.

Because of inability of Congress to reach an agreement on what spending and taxes should be enacted in 2011 the country is left with an automatic expiration of past tax cuts and reductions in a number of spending appropriations, all occurring at the end of 2012.  The resulting effect of tax increases and reduced spending, should they occur, are thought to be analogous to driving the U.S. economy off of a cliff, a Fiscal Cliff.

Click on caption picture for larger image of driving off the cliff.

Here follow the notes:

• It takes a fiat currency to sustain full employment.

• And a fiat currency, like the $US and the euro, includes the certainty of debt and taxes.

• Taxation is required to allow the government to spend its otherwise worthless currency.

• And ‘debt’- some entity spending more than its income- is required to ‘offset’ an entity’s desire to spend less than its income.

• These desires to not spend are known as demand leakages.

• That means, at full employment, either a private sector entity or the government will be spending more than its income to offset the demand leakages.

• Private sector spending is, operationally, revenue constrained. It is limited by income and credit worthiness.

• Public sector spending in a currency it issues is not revenue constrained.

• The private sector, the user of the currency, must first obtain funds before it can spend.

• The public sector, the issuer of its currency, must, from inception, spend or lend first, before it can ‘collect’ taxes and/or borrow.

• The private sector is necessarily pro cyclical. In a down turn, the private sector loses credit worthiness and therefore is limited in its ability to spend more than its income.

• That leaves only the public sector to spend more than its income to fill any residual output gap and sustain full employment.

• Those claiming ‘the problem is too much debt- private sector and public sector’ are entirely missing the point.

• That includes everyone in Congress, President Obama, and Candidate Romney.

• Those now pushing for Federal deficit reduction are entirely missing the point.

• There is not Federal solvency problem, short term or long term, with any size deficit.

• There could be a long term inflation problem.

However, I have seen no credible, professional long-term forecasts of substantial inflation. That includes the Fed, the CBO, and the forecasts of the largest financial institutions, as well as the inflation rates implied by the long term inflation indexed US Treasury securities.

Last year the pre-debt ceiling war cry from all sides was that immediate deficit reduction was imperative to keep us from becoming the next Greece.

That fell by the wayside after the downgrade, that was supposed to cause interest rates to spike and find the US, Greek like, on its knees before the IMF, instead caused rates paid by the US Treasury to dramatically fall. The difference is the US government is the issuer of the $US, while Greece is but a user of the euro.

So seems to me, in this economy, federal deficit reduction should be off the table, and the burden of proof of a sufficiently high long term inflation risk should be on those who want to put it back on the table.  Anything less seems subversive, either by accident or by design.

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About the Author

Warren Mosler is co-founder and Distinguished Research Associate ofThe Center for Full Employment And Price Stability at the University of Missouri in Kansas City. CFEPS has supported economic research projects and graduate students at UMKC, the London School of Economics, the New School in NYC, Harvard University, and the University of Newcastle, Australia. He is Associate Fellow, University of Newcastle, Australia.

Warren is the founder and principal AVM, L.P., a broker/dealer that provides advanced financial services to large institutional accounts. He is also founder and principal of Illinois Income Investors (III), specializing in fixed income investment strategies for 29 years. He is presently located in the U.S. Virgin Islands where he heads Valance Co, Inc., the corporation that owns the shares of III Offshore Advisors and III Advisors, the companies that manage AVM and III.

Warren has a degree in economics from the University of Connecticut. He has 38 years of experience in a variety of fixed income markets, including derivatives. He writes at his blogmoslereconomics.com and widely in the press and blogosphere. Warren is considered to be the founder of Modern Monetary Theory (MMT). You can read a longer bio here.