Dr. Thomas Swan has doctorates in physics and psychology. He applies the same scientific approach to his study of macroeconomics.
Five years ago, I realized that everything I believed about economics was wrong. My beliefs were built on assumptions, hearsay, and intuition, and reinforced by decades of political commentators treating the financial responsibility they learned as adults as the bedrock of economics.
Like these other "adults in the room," I was mightily concerned with how the government would pay for things, what taxes or cuts were needed, and whether debt would be accrued. Yet, for all my fiscal responsibility, my beliefs were based on intuition rather than reason: the intuition that government finances were like my own.
The Household Analogy
When you intuit that the government is "like a big household," you are assuming that:
- It can only spend what it receives in income (i.e., taxes).
- It can go into debt and become bankrupt if it spends more than its income.
- It should "save for a rainy day" and hoard the limited supply of money.
- There are terrible consequences for trying to create more money (i.e., inflation).
The household analogy is familiar. It is intuitive. It causes you to believe a politician who says that the government can "take out a credit card from the Bank of China." The remainder of this article will demonstrate that it is also entirely incorrect.
The Government Can Never Go Broke
Taking the United States as our example, you may be surprised to learn that every U.S. dollar in existence was created by the U.S. government (or by banks with permission). The first dollar was created in 1792 and trillions have been created since then.
This fact shouldn't be surprising (who else is going to do it?). Indeed, this exclusive right to create the dollar is enshrined in the Constitution. As the St. Louis Fed makes clear, this means that the government can never run out of money.
As the sole manufacturer of dollars, whose debt is denominated in dollars, the U.S. government can never become insolvent, i.e., unable to pay its bills.
— Federal Reserve Bank of St. Louis
Furthermore, Alan Greenspan (chairman of the Federal Reserve from 1987–2006) said the following under oath in front of Congress (see the video below for context).
There is nothing to prevent the federal government from creating as much money as it wants and paying it to somebody.
— Alan Greenspan
The truth is that most national governments have this power, including the U.K., Australia, Canada, and New Zealand, although some have given it up (e.g., European Union states such as Greece). Localities such as U.S. states also do not create currency and require some form of income.
This power to create money means that every statement from a politician, economist, or media personality about the government "running out of money" or being "unable to pay its bills" is a lie. The household analogy means that the lie is rarely questioned (i.e., you can run out of money, so why not the government?).
Taxes Do Not Fund Spending at the National Level
Most people believe that there is a limited and constant amount of money in the world and that governments need to get hold of it before they can spend. The absurd implication is that the current money supply has always existed.
In reality, the money supply is nearly always growing, and the number of U.S. dollars in 2022 was more than five times what it was in 1992 (see graph below). Although much of the new money is bank credit, the rest is created when Congress passes bills that include spending (e.g., on new aircraft carriers for the military).
The common belief that taxes fund Congressional spending is therefore incorrect. Rather, governments create money every time they spend because it makes no practical sense to wait until they have accumulated enough in taxes.
Or did you think the government was waiting to receive your grandma's crumpled tax dollars to pay Raytheon for an aircraft carrier?
The proceeds from taxation and bond sales are technically incapable of financing government spending [...] modern governments actually finance all of their spending through the direct creation of high-powered money.
— Professor Stephanie Kelton
This new money is not "printed" either. The government is not storing your tax dollars in a safe somewhere and sending crates of them to weapon manufacturers.
Rather, the government makes payments by instructing the Federal Reserve to increase the number of dollars in their bank accounts. This happens electronically by keystrokes on a computer (see video below). Only about 10% of money is cash or coin.
Money Creation Does Not Cause Inflation
With all this new money, shouldn't we be in an inflationary death spiral? Thankfully, no. Creating money does not cause a proportional reduction in its value, or did you think the first dollar ever created was as valuable as the collective trillions in existence today?
The conventional wisdom that printing money causes inflation is not true.
— Professor John T. Harvey
If you are like me, you had this patently false view about inflation because you saw a photograph of a wheelbarrow of money in a 7th grade history class about Weimar Germany and you assumed that correlation equals causation.
Although money creation can cause inflation, it usually doesn't, and it was not the cause of the historical examples that most people cite (Weimar Germany, Zimbabwe, etc.). Rather, supply shortages or foreign debt caused the inflation, and money was created after to give public sector workers an incentive to keep working.
Inflation may occur when production is limited by a lack of resources or labor, which is why it's usually a supply-side issue, and why quintupling the money supply in the past 30 years has not brought about Armageddon.
Taxes Are Destroyed but Taxation Is Necessary
Money is deleted as easily as it's created, and this is essentially what happens to your federal taxes. Although it seems counterintuitive that your "hard-earned tax dollars" are unceremoniously deleted, the government doesn't need them and doesn't consider them part of the money supply after their receipt by the Treasury.
Governments create money by spending and extinguish it via taxation.
— Professor James K. Galbraith (former executive director of the Joint Economic Committee of Congress)
However, taxation is necessary. When the government creates and gives you dollars to work (e.g., as a teacher or soldier) or provide it with resources (e.g., books or aircraft carriers), it needs you to want, value, and accept those dollars. The government does this by forcing you to pay taxes that are only payable in dollars.
This is the core reason for taxes, but there are other reasons, such as to reduce the money supply and to punish problematic industries (e.g., polluters). Funding government spending is not one of the reasons. Indeed, governments have to create and spend money before anyone can even pay their taxes.
Professor Randall Wray Explains Taxes and Borrowing
The "National Debt" Is Not Debt
If the federal government can create its own money, why is there a national debt of ~$30 trillion? It's because this isn't debt. The government does not need the money, and the holders of government "debt" do not want it paid back any time soon.
Much of this "debt" is bonds and treasuries. Countries like China and Japan put the dollars they earn through trade into bonds because they want the interest, just like you do at your local bank with a savings account. Your bank is not in debt to you any more than the U.S. is in debt to China.
Every dollar that China has accumulated through trade and invested in U.S. "debt" had to have first been created by the U.S. government some time earlier.
If the government wants to eliminate this "debt" it can close the savings accounts (bonds) and move the money to checking accounts. If China wants to withdraw their savings altogether, the government can create/print the amount they withdraw (see video below).
These savings accounts are called debt so that you use the household analogy, believe the country is in financial peril, and do not argue for the government to spend on public services like healthcare and housing. This allows businesses to sell these services to you for a profit, and banks to make more money from loans and mortgages (i.e., actual debt).
Fear-mongering about the "debt" has persisted for at least 85 years, when it was a thousand times smaller (see video below). Normally, when people predict the apocalypse, they are discredited when their prediction fails.
A Budget Surplus Is Not a Good Thing
A budget deficit means that the government has created and spent more money into the economy than it has removed in taxes. Broadly speaking, this means that a budget deficit puts more money into your pocket than it takes out.
The national debt is more than bonds. It is the total of every budget deficit in history. It is the money supply. Eliminating the national debt with budget surpluses would eliminate the money supply.
A budget surplus is when the government taxes more money out of your pocket than it spends into it. Such attempts to "balance the budget" therefore cause people and businesses to go into private debt (e.g., 1998–2001; see graph below), which usually triggers a recession (shaded areas of the graph).
In other words, a government deficit is a private sector surplus. It is basic accounting that every dollar spent by the government has to go somewhere and be balanced by a surplus elsewhere. Proof of this is provided in the graph below.
We are told that deficits are bad and surpluses are good because politicians do not want you to argue for government spending that would make your life better. They are able to manipulate you about these concepts because "deficit" sounds negative and "surplus" sounds positive. Your intuition is your own worst enemy.
Why Learning Macroeconomics Is Important
Every time a policy is proposed that could save lives, such as universal healthcare, climate protection, or a job program (involuntary unemployment is a significant cause of suicide), it is killed with the following eight words: "how are you going to pay for it?"
Liberals, whose "Robin Hood politics" reinforces the tax-and-spend falsehoods described above, propose taxes or cuts that conservatives disagree with, and the two sides have fought on these terms for decades while millions have died.
Politics today is like two paramedics refusing to drive you to the hospital because they want to settle an argument about whether to pursue the person who stabbed you. Liberal or conservative, both put a barrier in the way of helping you.
The truth is that the government can help you now. It has no financial constraints. It only has resource constraints and the risk that its spending might cause a demand for some resources that exceeds the economy's productive capacity (i.e., inflation). Money is not your savior. Doctors, ambulances, and well-equipped hospitals are.
People Are Starting to Learn
In recent years, Modern Monetary Theory (MMT) and its advocates have popularized and informed millions of people about the economic truths set out in this article.
Eventually, these ideas could transform society by causing a profound and irreversible shift in our understanding of money and government. Such a society would focus less on the importance of money and more on what we can achieve with the real resources at our disposal.
It is no coincidence that every modern historical triumph, from reaching space to defeating the Nazis, acknowledged the triviality of money. We did not say "we can't afford to fight the Nazis." Rather, we looked at what we could do with the resources we had and used money to incentivize people to contribute. A government can create as much incentive as it wants.
In my view, our collective understanding of these paradigm-changing ideas will bring about the greatest societal change of the 21st century. All of the artificial financial constraints that our leadership class knowingly or unknowingly places upon itself will be removed. Instead of “we can’t afford that” we will say “how do we resource that?” and reduce suffering on a massive scale.
The Critics of MMT
Modern Monetary Theory already has its critics. Typically, these critics either do not understand the theory or do not want you to understand it. They create straw man versions of MMT to make it appear unreasonable, uncomplicated, and not the work of highly-credentialed academics and economists.
For example, you may have heard that MMT is "just about printing money,” that the theory does not consider inflation, or that it can only work if the dollar remains the world's currency.
Many of these critics have careers or ideologies that have been sustained by their support for economic models that cause a recession every ten years. Other critics have reservations about what will happen to human society if these ideas become popular, regardless of whether they are true.
Dispensing with the intuitive economic falsehoods that you have grown up with should not be entrusted to people who are invested in the falsehoods being true. Rather MMT should be learned from the academics who developed the theory, such as those listed below.
- Kelton, S. (2020). The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy. John Murray.
- Mitchell, W., Wray, L. R., & Watts, M. (2019). Macroeconomics. Bloomsbury Academic.
- Wray, L. R. (2022). Making Money Work for Us: How MMT Can Save America. Polity.
This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.
© 2022 Thomas Swan