Re: On Budget Deficits

From: cantueso (cantueso_at_dieznet.com)
Date: 08/15/04 

Date: 15 Aug 2004 11:05:02 -0700

William F Hummel <wfhummel@comcast.net> wrote in message news:<90ksh0h445drjb6rftfn6bm34r9n7lcp7a@4ax.com>...
> On 14 Aug 2004 00:22:16 -0700, cantueso@dieznet.com (cantueso) wrote:
>
> >William F Hummel <wfhummel@comcast.net> wrote in message news:<d8rph0pcm7ac9nr3ph0cllbikfn7j6c2r6@4ax.com>...
> >>
> >> WHAT the government taxes is a function of how it chooses to
> >> distribute the tax burden. WHY the government taxes is an entirely
> >> different matter. I'll give you an analogy that should explain why
> >> taxes are necessary.
> >>
> >> Imagine a hydraulic loop representing the flow of fiat money between
> >> the government and the banking system. We start with a reservoir of
> >> bank reserves created by government spending that contains both
> >> required reserves and excess reserves. The excess reserves must be
> >> continually drained. Otherwise the Fed could not maintain control of
> >> the Fed funds rate, which is the interbank lending rate on reserves.
> >>
> >> The government can drain excess reserves in one of two ways, by taxing
> >> or borrowing. Borrowing depends on the willingness of the public to
> >> lend, and is therefore voluntary. However taxes are not voluntary.
> >> They act as the pump in the hydraulic loop. Take away the pump and
> >> there is nothing to ensure the excess reserves can be drained. Note
> >> that the pump only needs to drain what borrowing fails to drain. Thus
> >> the flow through the pump can be a fraction of the total spending by
> >> the government.
> >>
> >> To the extent that the government borrows, the public will build up a
> >> separate reservoir of government securities. The financial wealth of
> >> the public increases as the reservoir of securities increases. There
> >> is no practical limit as to how large that reservoir can be, which is
> >> equivalent to saying there is no practical limit to how much the
> >> government can spend.
> >> >
> >> >and could you tell me whether in this regard the US currency is
> >> >different from other currencies?
> >>
> >> I don't know of any example of a major currency in which taxes are not
> >> an essential part of the system. However there may be some countries
> >> that can avoid taxes by riding piggy back on the US monetary system,
> >> i.e. pegging their own currency to the dollar.
> >
> >it is very hard to see things like that.
> >
> >not too long ago, in some Swiss towns, the taxes were voted by the
> >inhabitants, and most of the tax money was to be spent by the town
> >government. ("do you want a new road? in this case the tax will be 1%
> >more. should the teacher get a raise? in this case we'd have to
> >postpone the acquisition of a new church bell." etc)
>
> Don't confuse local government entities like cities and states with
> the national government. Cities and states do not create the national
> currency. Unlike the national government, they can only spend what
> they receive in tax revenues. They may carry some debt to finance
> capital investments, but that debt must be serviced out of tax
> revenues. If they borrow too much and can't service their debts, they
> will be bankrupt just as a private firm or household would be
> bankrupt. However because the political and economic implications of
> a bankrupt city or state are so dire, they are usually bailed out at
> general taxpayer expense.
> >
> >now I will have to see how what you say fits in. you say there is no
> >practical limit on how much the government can spend. the government
> >spending turns into assets that people keep in their drawers.
>
> You should read my article again. Government spending does not turn
> into assets that people keep in their drawers. All of its spending
> is recaptured through taxes, and the sale of bonds if necessary. That
> balanced reciprocal flow is what enables the central bank to control
> the price of bank reserves. The public, not the government,
> determines how much cash it holds instead of bank deposits.
>
> There may be a limit to (national) government borrowing but we haven't
> found it yet. Obviously the more borrowing, the more government
> securities the private sector holds. Those securities represent net
> financial wealth of the public. That financial wealth will increase
> aggregate demand. If you hold a million dollars in T-bills, you are
> likely to feel no different about your spending power than if you are
> holding a million dollars in a checking account.
>
> If the demand for consumption due to the wealth effect grows too fast
> relative to national investment and output, the result will be price
> inflation. Thus the ultimate limit on government deficit spending
> should be its effect on inflation. Nevertheless during the period of
> the Reagan and Bush presidencies (1980-1992), the inflation rate
> declined, even as the national debt held by the public quadrupled.
> >
> >seen like that, what happened in Germany at the end of the war? people
> >had tons of money and could not buy anything with it. would you say
> >that the government had gone beyond the "practical limit"? stated in
> > terms of your hydraulic loop analogy, what went wrong?
>
> I assume you are referring to the hyperinflation in Germany after
> World War I. What went wrong in financial terms should be clear from
> my article. Quoting: " .... the government cannot spend without
> borrowing or taxing, and it cannot borrow or tax without spending.
> This balanced reciprocal flow of funds between the government and the
> banking system is key to managing the cost of money to banks, and thus
> to the economy at large."
>
> The German economy was in shambles after the war, its production
> facilities devastated, and very little income to pay for the huge war
> reparations imposed by the victors. The government could neither
> borrow nor collected taxes to cover its own spending, so it simply
> printed money to spend. The result was an exponential inflation of
> paper money. As noted, the enforcement of tax collection is essential
> in maintaining the public's confidence in what is intrinsically
> worthless fiat money.

I have just discovered your page at

http://wfhummel.net/seigniorage.html

that is what I will read.

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