The Deficit: Nine Myths We Can’t Afford


The national debate over fiscal responsibility and sustainability is entering a new, critical phase. Today, an 18-member bipartisan commission to examine the government’s fiscal problem will meet for the first time. Everything is on the table, including Social Security and Medicare.

With so much at stake, the time has come to examine our fundamental assumptions about government deficits and debt. The danger of accepting oft-repeated orthodoxies has been clearly demonstrated in the recent financial crisis. For decades, free market fundamentalism went virtually unquestioned, and we’ve all seen the result - an epic economic catastrophe. We can’t afford to make the same mistake on fiscal responsibility. It’s time to consider alternatives perspectives before we rush down potentially destructive policy paths that could compromise our future.

The Roosevelt Institute’s New Deal 2.0 asked seven economic thinkers to address what they see as the most dangerous myths currently circulating on the deficit. Several of these experts will be on hand to educate the public on April 28, 2010 at George Washington University in Washington, D.C. at a “Fiscal Sustainability Teach-In.”


Discussion of government budget deficits often begins with an analogy to a household’s budget. People say: “No household can continually spend more than its income, and neither can the federal government”. But there are big differences between a household and the federal government. You don’t have the ability to print money in your living room, do you? Well, the government does. So how it finances its own debt and spending is different from the way you do.

A government is the issuer of the currency. The household, on the other hand, is the user. Households are restricted by the need to somehow get money into their bank accounts, or their checks will bounce. The federal government, by contrast, doesn’t “have” or “not have” dollars. There is no vault or lock box where it “keeps” its money. In fact, it makes all of its payments simply by electronically crediting private bank accounts and there is no practical limit to which it can change those numbers up. Spending by the federal government always creates new money in the system, while taxation destroys it. When households and firms pay taxes, the money does not go anywhere; the government simply debits those private bank accounts by electronically reducing the amount of reserves they hold, i.e., by changing the numbers in those bank accounts down.



Myth #2: Fixing Social Security and Medicare will require “tough choices”.

A " target="_blank">new poll by the Pew Research Center suggests that nearly 80% of Americans don’t trust the federal government. Unfortunately, we appear all-too-willing to trust the government when it tells us that Social Security and Medicare are heading for bankruptcy. Indeed, the same poll shows that fewer than half of us now hold a favorable opinion of the Social Security Administration (down 13% from a decade ago). No wonder. The drumbeat over the so-called “crisis” facing Social Security and Medicare has reached a fever pitch.

The government’s message is clear: Both programs face significant trouble ahead, due primarily to the aging of our population. In order to deal with the looming problems, we will have to make “tough choices.” Not everyone can have the money they were promised.

If you’ve been around a while, you’ve heard this all before. Remember the Greenspan Commission? This is the group that President Reagan appointed to “fix” Social Security in the early 1980s, the last time the system was on the brink of “collapse.” Thanks to the “reforms” that were enacted in 1983, Americans are working longer (they raised the retirement age) and paying more (they accelerated increases in the payroll tax rate). And now we’re being told it was all for nothing — the system is broken again?

The truth is, the system was never broken in the first place, because the government’s ability to pay benefits does not in any way depend on the balance in the Social Security or Medicare Trust Funds. Benefit checks come directly from the Treasury, and, as Alan Greenspan has admitted, “[A] government cannot become insolvent with respect to obligations in its own currency.”

And so the question is not whether the government needs to make “tough choices” in order to keep these vital programs afloat. The question is, will politicians make the toughest choice of all and tell the American people the truth: Social Security and Medicare face no financial crisis now or in the future.



Most people don’t realize that government debt — Treasury securities — are nothing more than savings accounts at the Federal Reserve Bank in Washington.

There are about 13 trillion dollars in Treasury securities at the Fed. Collectively, these savings accounts are known as the national debt. The national debt represents a portion of the combined savings of US residents, corporations, banks, and foreign governments. And most folks probably don’t know that when a person buys them, the Fed simply transfers the dollars from her checking account to a savings account at the Fed called a “Treasury security.”

Tens of billions of dollars of these Treasury securities come due every week. When that happens, the Fed pays off that “debt” simply by transferring the dollars, plus interest, out of these savings accounts and back to the holders’ checking accounts.




MYTH #4: What we don’t tax we have to borrow from the likes of China for our children to pay back.

One constantly hears that the Chinese (and other external creditors) “fund” our deficit. The folklore is that when China finally sells off its US bond holdings, those yields will sky-rocket. The dollar will then crash, no one else will want the debt, and it will be the end of America as we know it.

To debunk this myth, you need to know two things. First, all foreign governments have checking accounts at the Federal Reserve Bank called “reserve accounts.” Second, US Treasury securities are nothing more than savings accounts at the same Federal Reserve Bank.

How does China get its dollars? It sells things to us. And when China gets paid, those dollars go into China’s checking account at the Federal Reserve Bank.

And when China buys US Treasury securities, what happens? The Fed transfers China’s dollars in its checking account at the Fed to its savings account at the Fed. We call that “borrowing from China” and “going into debt to China.” But it’s not really “borrowing” in the sense of creating an external constraint whereby we have to defer spending to “pay back” China. The Fed simply pays off China’s “debt” by transferring the dollars, plus interest, back to the holder’s checking account, which it can create at the stroke of a keyboard as the monopoly issuer of dollars.

The dollars are nothing more than data entry on the Fed’s computer. They have no other existence. And it has no impact on the government’s ability to spend as to whether China’s dollars are in their checking account or savings account.



Reality: Government spending is not constrained by revenue.

As explained above, the Federal government neither “has” nor “doesn’t have” dollars. The government spends by creating new money and taxes by destroying money, which simply involves changing numbers in bank accounts. Suppose the government pays Social Security benefits to a retired teacher, Mrs. Jones, in the amount of $1,500 a month. At the end of the month, the checking account of Mrs. Jones is credited by $1,500. Did the government need your tax revenue to pay Mrs. Jones? No! It simply changed the numbers up in Mrs. Jones’s bank account, basically creating new money. On April 15 Mrs. Jones sends a check to the IRS to pay her taxes. When the government gets the check, what does it do? It simply changes numbers down in Mrs. Jones’s bank account, destroying the money.


So if the government doesn’t need to tax to be able to spend, why does it tax at all? There are two reasons. First, the government creates demand for its currency through taxation. If the public didn’t need the dollars to pay its taxes, it wouldn’t be willing to sell goods and services to the government in return for pieces of paper (or numbers in a checking account). Taxes, then, are what give value to money. Second, the government uses taxes to control the public’s spending power. When the public has too much spending power, government taxes some of it away to avoid inflation. When there is too little spending so that unemployment results, it lowers taxes to boost private spending.

Any and all financial constraints on government spending such as issuing government bonds dollar for dollar against deficit spending, debt ceilings, and restrictions on the Fed’s ability to buy treasury securities are purely political and necessarily self imposed, because they are imposed on us by our chosen institutional arrangements and not by something inherent in our economic system.


Myth #6: Deficits and government borrowing takes away savings.
Reality: Deficits add to income and savings.

The truth is that deficits add to the total monetary savings held outside of government. To the penny. That’s right, if the government deficit was 1 trillion dollars last year, then total net savings of everyone outside of government went up by 1 trillion. Not a penny more or a penny less.






~Warren Mosler, President, Valance Co.

Myth #7: We’ll end up just like Weimar Germany or Zimbabwe.

The minute you challenge the assumption that the government should not spend when it has a large deficit, out comes the charge that we’ll get some horrible hyperinflationary outcome like Weimar Germany or Zimbabwe.


In Zimbabwe, the situation is also very different from ours. There, the conditions for hyperinflation were caused by the destruction of nearly half of the country’s domestic food production via misguided land reforms, plus a civil war which eliminated much of the economy’s productive manufacturing capacity. In response to food shortages, the Bank of Zimbabwe used valuable foreign exchange reserves to buy imported food, leading to a lack of foreign currency to purchase essential raw materials. Manufacturing output collapsed, but the government used much of the remaining foreign exchange to dole out political favors, rather than adding to the country’s productive capacity. The end result was inflation and then hyperinflation.



MYTH #8: Government spending increases interest rates and ‘crowds out’ valuable private sector investment.

Ask an economist what determines the interest rate, and she’ll probably mutter something about supply and demand or “market forces.” Ask the same economist what determines the level of saving and investment, and the answer probably won’t change very much. This is because most economists were trained using textbooks that have not been rewritten since the United States went off the gold standard after WWII.






Conclusion: Interest on the debt is not currently an obstacle to increased federal spending and/or tax cuts. And it’s a very simple matter to bring interest payments down to 0 in any case.
