Wednesday, June 29, 2011

Level of bank reserves wil not be the proximate cause of hyperinflation

Additional points from my comments here. Negative rate of return refers to what mainstream monetarists call return after 'expected future inflation’, which convinces people to put investments in higher risk-return investments to compensate for the higher expected inflation. This most affects money managers, who are expected to achieve minimum hurdle rates of return, which are now impossible due to the longstanding zero bound for treasuries. So it’s not the reserves of banks being put into high risk investments, but more likely the asset pools of money managers, which now have nowhere else to go (since the Fed has crowded them out of risk-free treasuries)


I can’t be sure, but perhaps Prof. Higgs uses the fractional reserve banking framework, which believes every $1 of reserves can be relent 9x. If you already believe reserves BY THEMSELVES can cause inflation, there’s no reason to not believe they cause hyperinflation. Of course, if you believe instead that loans are caused by loan demand and banks’ capital adequacy, then $1 lent by bank A does not mean that bank B, which gets it as a deposit, relends to the next person. Bank B may may capital-deficient, or may not focus all that much in loans (perhaps it likes to place money instead in commodities plays).I don’t even believe that 9x is even a useful benchmark. Banks will lend when are willing and able, regardless of existing level of reserves. The ability comes from equity capital cushion and the willingness comes from demand from creditworthy borrowers.

I believe that central banks cannot fully control the money supply at all, because private loan demand and government spending is what increases it. They can indirectly control it by increasing the cost of credit though, so private loan demand plummets, or by decreasing cost, so private loan demand increases. But at this point in time, when people are already over-indebted and the cost of credit is already at zero, there’s not much more it can do to increase loan demand, and hence to increase money supply.

It would be hard for regulation to know who is creditworthy and who isn’t. That’s the bank’s job. So regulation should always make sure that the bank does its job well, and never ever find itself in need of a bailout. That said, Yes, banks should always have skin in the game, and securitization and the rise of shadow banks which help them securitize bad loans allow them to shed risk prudence, and just go for immediate profits of booking more loans. This activity should be monitored and regulated more closely, because this has proven to be a much used loophole in the system.

I think ‘hyperinflation’ only ever happens when there is a general loss of faith in a currency, which results in mass flights out of it. Bank reserves have nothing to do with this phenomenon. ‘Helicopter drops’ of money to the general populace is more likely to do it, when done without corresponding increase in productive capacity.

Hyperinflation is not what should be bothering us. It should be that the Fed has induced investors to put more funds in higher risk-return investments, and stoking asset bubbles. QE2 most affected money managers, who are expected to achieve minimum hurdle rates of return, which are now impossible due to the longstanding zero bound for treasuries. It’s not the assumption of my article that “over time the past actions of the monetary and fiscal authorities will cause latent inflationary pressures to build significantly”, although it might for Prof Higg’s article.

I think the Fed is the wrong institution to cause anything right now, although I think they should maintain the zero rate for now to avoid any more crisis coming from more defaults by any of the remaining highly indebted parts of the economy. Low rates were meant to make lending more profitable for banks. But since it wasn’t incentivizing enough, QE2 was supposed to force them. Which means the solution being pursued is even more borrowing. It was Fed low rates for the past decade that encouraged people to get overleveraged in the first place, and I find it irresponsible that the solution being pursued to induce more spending is even more easing by the Fed. I agree that rates must be allowed to respond to market forces, and I’m just vacillating due to the possibility that quickly rising rates might bring its own problems. It’s a complicated mess,and solving it should involve reorganizing the financial and banking systems, but also having some kind of support for existing borrowers so we avoid having lot of them default, but certainly no more lending where the borrowers cannot absorb anymore.

Sunday, June 26, 2011

Do bank reserves add to risk of hyperinflation

Here's a piece by Robert Higgs, expressing doubt that the execss reserves injected by the Fed won't ever result in hyper-inflation. In a key part, Robert states:
"I'm not convinced that these gigantic sums will not, sooner or later, still become the fuel for hyperinflation, or at least for a greatly accelerating rate of general price inflation, which economists expected they would be before the recent recession and all of the government’s and the Fed’s extraordinary responses to it occurred. Second, I am not convinced that the banks will remain content forever with earning a negative real rate of return on their holdings ... If they were to realize only the difference between the rate the Fed is paying them and the rate they would earn by lending these funds exclusively to prime customers — an increase of 3 percent on their return — they would gain an additional $45 billion in income. ........ I understand, of course, that banks are seeking to repair their damaged balance sheets, in light of their recent debacle in real-estate-related investments of various sorts and in conformity with the new Basel requirements for increased bank capitalization. Still, I am not convinced that these consideration can account fully for the very curious conditions now existing in the banking industry." The rest of article is here.
My own position is: Reserves have nothing to do with how much banks will lend, and does not determine whether and how much hyperinflation can happen. Banks will lend when they want to lend, whether they already have the reserves beforehand, and even if they can’t get at any more new reserves, will securitize if they have to. Hyperinflation will not be caused by having too much reserves in the banking system per se, but by having too much demand in the general economy.

When demand comes back, even if the Fed has withdrawn all excess reserves, the securitization market will have reanimated back to life, and banks will lend again. (And they will likely lend too freely if capital standards remain weak). So the best way to prevent a hyperinflation is to constrain bank lending directly with more stringent regulation. Pushing reserves into the banking system is a failed experiment by the Fed, and we should not allow ourselves to be misled as well by its efficacy. If we do, we'll miss the real problem of weak regulation. Weak regulation is what will bring us back to the conditions of 2001-2007. I posted a similar theme here.

Also, for as long as the private sector is overindebted and still deleveraging (in balance sheet recession), I believe we will be far away from the risks of having too much demand in the general economy. Better to be worrying about deflation instead for now, while also preparing for the day banks start thinking along the lines of Robert Higgs'. Your thoughts.

some more comments at Seeking Alpha

Monday, June 13, 2011

Self-induced scarcity

It's time once again for my once a year breaks, and will be posting again likely in the fall. These breaks prevent me from being too repetitive or boring, since I try to avoid posts where I don't really add much to what has already been written elsewhere.

Meanwhile, I'm sure everyone knows all the usual suspects for good readings elsewhere in the meantime. Mark Thoma still maintains the best one stop shop of all points of view in the econosphere. And if you haven't read much of this new body of thought we call MMT, New Economic Perspectives will be running primers and Q&As in the next months for those just coming into their ideas. Just in time, to hear straight from the horses' mouths, their ideas, countering the campaigns of error being propagated by some parties today.

So until next, keep safe everyone.

Sunday, June 12, 2011

More on why domestic central banks still setting interest rates are now outdated artefacts

This follows my post where I said central banks should get out of the rate-setting game. Three years ago, I wrote this in a post: Capital mobility is now global. With more inter-connectedness among nations, it is now increasingly imperative that each individual nation's monetary policies be coordinated to ensure smooth economic results system-wide.

1. With global capital mobility, if one country hikes its interest rate to contain domestic inflation, it can attract more capital from overseas, nullifying the hike. Similarly, if the country cuts rates to spur investment, capital might leave the economy for better rates elsewhere.
2. An aggressive money supply policy in one country can spill over excess liquidity into the global system, spreading inflation globally.
3. One country’s active currency management policies artificially inflates/devalues free floating currencies.
4. Because of points 1, 2, and 3, one Central Banker’s monetary policies to cure domestic unemployment might be rendered ineffective.
5. Financial crisis that start in one country can easily spread to other economies.
6. That’s because the same toxic financial security can now have multiple listings in different markets.
7. They can be placed in multiple markets, or owned, by multi-national banks looking for arbitrage opportunities created globally by, among other things, uncoordinated Central Bank policies.
8. Conversely, a domestic bank can itself own multinationally-issued investments.
9. There’s been an explosion in cross-border money laundering.
10. Multinational corporations now also cross-lend funds borrowed elsewhere among subsidiaries located in different jurisdictions.

At the time, I didn't know I was hitting on a trilemma identified much earlier by Mundell and Fleming. Mundell and Fleming’s economic trilemma posits that you can only achieve two of three objectives desired outcomes in monetary policy: open capital markets, domestic control over monetary policy, and fixed as opposed to floating exchange rates.

Wikipedia mentions that Paul Krugman has stated: "The point is that you can't have it all: A country must pick two out of three. It can fix its exchange rate without emasculating its central bank, but only by maintaining controls on capital flows (like China today); it can leave capital movement free but retain monetary autonomy, but only by letting the exchange rate fluctuate (like Britain – or Canada); or it can choose to leave capital free and stabilize the currency, but only by abandoning any ability to adjust interest rates to fight inflation or recession (like Argentina today, or for that matter most of Europe). "

Three years ago, I wondered whether we needed a global central bank. But now I'm thinking that with a global free market, a domestic central bank still setting interest rates is already an outdated artefact, and sure to cause more harm than beneficial results. If a Central banker really doesn't fully control his domestic monetary policy, whatever he does is sure to cause unintended effects, both for his domestic situation and for those abroad. With global capital mobility, a central banker needs to either give up control over interest rates, or give up all pretension that he has any relevant control over domestic policy. At best, given that whatever a domestic central banker of a nation like the US does affects the international capital markets, whether rate-setting or non-traditional quantitative easing, such as QE2, monetary policy and rate-setting is only useful as a trade war weapon. Just witness what's happening to China's economy now, as it tries to maintain a fixed peg.

Here is a still relevant related discussion on central banks over at David Smith's EconomicsUK.

Friday, June 10, 2011

Focus should be on income creation, as a consequence of creating jobs that produce sellable goods

Comments at Seeking Alpha are a veritable mine of new material. Some more comments and my answers over there:

Commenter: "money creation has never created wealth. heck, if it did, counterfeiting should be protected in the constitution.the author is entirely focused on growing the GDP number rather than meaningful production and real wealth. this is the very problem of GDP that econ 101 talks about."

You're right. Income creation, as a consequence of creating jobs that produce sellable goods does. Income creates the demand for the goods being produced by the jobs created. In contra to what commenters here claim, I'm not focused on GDP. In fact, everybody else in the comments are, focusing too much too much on output and production and plating crops to feed their family. The fact is, I'm focused on income creation, as a consequence of creating jobs that produce sellable goods. If you just print money ala QE2, well...see this next comment.

Commenter:"If this author's comments had even a shred of merit, Zimbabwe would have the most vibrant economy on Earth."

Zimbabwe did not spend to develop its citizen's capability to become self-sufficient. Zimbabwe printed money to give to everyone, even though there were no productive capacities to absorb the money. So the money just bid up the prices. What would have happened if Zimbabwe instead built cooperatives and supported grassroots businesses that would provide employment and income to the citizens. The income these citizens earn will give them the capability to buy the new goods they will be all creating. But if the government will just give money to the citizens all of who do not end up producing more, but will just all bid up the few remaining supplies in the economy... well, you get Zimbabwe.

"It is not a given that all of us need to save to pay down our debts. Some actually save to create wealth."

Who then funds the saving? All of us want to save in order to create wealth. That is why there should be a default spender otherwise, when we all do this simultaneously, we all stop earning income from one another

Commenter:"A growing GDP is supposedly a sign of growing societal wealth, do you agree? Wealth is created by human labor and innovation, not debt."

A growing GDP is just a sign of growing spending. To the extent that it leads to income for someone else in the economy, then yes, it's a sign of wealth for that person

"Let's say I start growing crops. I work my butt off for hours a day every day. After a few months, I have enough crops grown that I can feed my family. Who went into debt for that? Nobody. Was wealth created? Yes, I created enough wealth to feed a family for a year."

Let's say grew crops. You fed your family. Is that wealth for you? Yes. Did it grow the GDP? No, you did not sell it to anyone, so no one is counting that. If you sell that to someone in exchange for money, that person probably borrowed it. If he didn't, someone who paid his his income probably did. Or probably government originally spent that money into existence. Yet in your example, you planted and fed it to your family. If you didn't report a sale to the government, how can it be counted as GDP?(and why would you want to report it and be taxed for planting for your family?)

It's truly unfortunate the income tax was ever invented, since it continues to this day. It's a relic of the gold standard, a time when governments could only spend whatever money can be backed by their gold reserves. So when facing a a truly expensive undertaking, they need to confiscate from the people, and hence the income tax was born during a time of war.

Now that national governments are out of they gold standard, they can print money as necessary to spend. Nowadays, taxing people actually takes demand away from the private sector because when government takes money from the people, the people are out of money. Nowadays, only municipalities truly need to tax in order to raise funds.

Commenter:"This article is absurd and those who follow this line of thinking are not dealing with reality, rather they view reality through a socialist prism where government is all powerful and brings to the masses all that is good. A quick glance out the window would bring all the but the most delusional back to their senses."

I am not a socialist, just because I advocate that someone should step in when the private sector is not spending. In fact, I would much prefer a private sector solution, but what do you do when no one wants to step up. 2 and a half years, in the midst of the crisis, I wondered whether there could actually be a private sector solution. Can there be a private sector solution I concluded, yes there is. But it would entail massive bartering program on a global scale to take the place of the broken capitalist system. We can still have this, that is, if someone can operationalize it. Now if you still think this private sector alternative is absurd, I'd like to hear someone suggest options on how we can jumpstart this economy. Who buys the first million to start the recovery? You?

Commenter: "Some of us don't have any debt other than those incurred by the Gov't. So how did we get debt free? People sold us things because we had to buy things to continue our existence. We borrowed only for absolute necessities...We earn more than what we need by selling our skills and talents for a higher price than is required for a minimum existence."

Where did you get the money you used to buy your stuff. And where did the guy who gave you the money get his money? Who is creating this? A hundred years ago, there was just enough money going around as needed, give or take, a few million people going hungry. Now, we have billions of people, trillions of money circulating around the world economy. Where did all this money magically come from?

Commenter: "The growth comes from the growth of skills and talents anything beyond that is negation of the law of survival of the fittest"

But how does all this growing skills get paid if nobody has the money to buy them? Income creates the demand for the goods being produced by the jobs created. 3 questions to ask to check whether it is worth spending on:

1. Does this create productive jobs for those who would be otherwise unemployed?
2. Will the newly hired workers have meaningful income that they can spend back in the economy?
3. Is the output of the jobs adding to capacity of goods/services demanded?

If it generates income for the unemployed, aggregate demand will go up. If it adds to demanded capacity, there will be no inflation. If the output is demanded by people, there will be no wastage.
Commenter: "How do we know that government is printing just enough?"

Perhaps the best indication is that 100% of those looking for jobs found jobs- key word is LOOKING. And the jobs don't necessarily mean jobs that they have to like paying at exorbitant salaries, but jobs at the decent minimum wage at a close enough location doing community jobs. I think Billy blog has mentioned teaching, filling up service-intensive government agencies, cleaning parks, etc. Enough to keep them and their families fed without having to ask for handouts.

Commenter:"If you are so certain that we can't go broke then does it really matter what politicians spend the fiat money on?"

Yes, it matters because if politicians spend the money on useless things, we will have malinvestment, and we will end up with the bad driving out the good. While a government borrowing in its own currency cannot go broke, it is possible it prints too much to discourage people from holding it.

Commenter:"How did you decide that it wasn't enough? What would have been enough? If that had been squandered also (input was significant greater than the utility of the output), how much more should have been spent?"

Perhaps the best indication enough was spent is if 100% of those looking for jobs found jobs- key word is LOOKING. Enough to keep them and their families fed without having to ask for handouts. If previous spending been squandered, then we should vote the politicians who did so out of office. The recent bailouts are evidence of this. If some money had already been squandered, then that squandering should stop immediately, but it should not stop you from starting on the right path that leads to recovery- which is restoring aggregate demand via jobs, even if it would means more spending again. It is the recovery that will pay for both the right type of spending and the also for what has been squandered before.

Commenter: "How are you going to get all of the economists singing off of the same sheet of music so that the President's Council of Economic Advisers presents the same story of responsible spending (i.e. sound investment) as you and I agree on? "

I doubt you can ever be able to tell all economists singing the same sheet. Just look at all the comments on this thread so far, everyone has his own idea, and thinks it is what will solve the solution. All you can really do is make sure the most powerful elected politicians (the president, the heads of congress) understand and sing the same tune, and everybody else will have to follow. Right now, the politicians all have the idea that solving a demand deficiency is by pulling out government demand, hoping someone from the private sector will be brave enough to take its place.

Commenter: "Didn't a country called the USSR and its communist leaders try that?

Yes, but the USSR completely wiped out capitalism. What we are proposing is to augment capitalism, when it is being weak or not working.

Comment: " I still maintain Austerity in the long run is less painful than ruinous Squandering that leads to Zimbabwe"

Okay, this is the retired Mises talking. But a Mises who's only starting to get into industry, but has been unable to for the past 3 years, will feel otherwise. Let me give a simplified example. Rogue, Keynes, and Mises comprise an economy. Rogue wants to save more income today so he can spend more tomorrow. This leaves Keynes, who usually sells his service to Rogue, with no income to buy his meal from Mises. Therefore, both Keynes and Mises go incomeless today and all spending in the economy comes to a halt. It may not even come back tomorrow when Rogue plans to spend because he's now afraid to part with his money, now that he's seen the lack of spending by anyone else. It is now up to the government to buy Keynes' goods so he can buy from Mises, and he can buy from Rogue, and the cycle can go on.

In the real economy, the saving can go on because people are trying to pay down their debt. In which case, this is not new money that can be spent in the economy because it just extinguishes something that had already been previously spent. For example, Rogue is saving to pay down his debt to the bank because he previously speculated on gold. The bank doesn't earn new income here because essentially it's just getting its money back. Neither would it lend new money to Keynes and Mises to spend given that it now knows they are jobless bad credits with no way to pay back any new debt. Now: is government spending to take rogue's place still unnecessary?

Recession is a fall in production, because businesses overproduced in a previous cycle. A fall in demand is a fall in demand because people want to conserve their money. A recesion ends when the business' unsold inventory gets sold. A fall in demand doesn't end unless someone suddenly takes the place of the fallen demand.

Okay, 'complete stop of the economy' may be overstating it. But say the economy went to 10% unemployment because that is now the only sustainable employment for the new level of demand. The economy still goes on for the lucky 90%, but the 10% unemployed should abandon all hope. For them, the economy already went to a complete stop.

Wednesday, June 8, 2011

More on why a growing government debt always accompanies a growth in GDP

My previous post generated healthy and serious discussion over at SA. Here are a few more related points that arose from my discussions there (Naturally, this post again 100% leaning towards MMT).

When GDP is growing while government debt is going down, it might be that private sector is increasing debt. If private sector debt isn't growing either, then the country is likely incurring trade surplus, therefore, their savings are being funded by some other country's government spending or private sector debt.

In any case, the question to always ask is where is the money to grow the GDP coming from. It has to come from someplace. Always, someone has to be spending more than saving, for there to be more spending going on in the aggregate economy. This statement is alluding to to the macro where all money has to come from somewhere. If funds are borrowed from someone who is already wealthy, his wealth must have come from somewhere. Someone spent money that gave him wealth in the first place.

1) A commenter said "People sold us things because we had to buy things to continue our existence."

Where do you get the money you use to buy your stuff. And where did the guy who gave you the money get his money? Where did all this money going around the economy come from? Somebody is willing to spend to buy someone else's service. Where did that first buyer's wealth come from? If he's Bill Gates, he earned it selling software. Now where did the people who bought his software get their money from? Surely, a hundred years ago, there wasn't enough money going around the economy to pay for all the software that Bill Gates and co. have sold us, and are still selling us. Where is all this new money coming from? Who is creating this? A hundred years ago, there was just enough money going around as needed, give or take, a few million people going hungry. Now, we have billions of people, and trillions of money circulating around the world economy.

If you say from banks giving credit, you are almost there. But given that banks do not lend to anyone they don't think will pay them back, where does the bank think their borrowers will get their repayment money from? Don't they get afraid that money will eventually run out, and ALL their borrowers will default? How is it that the economy, after growing into the trillions, still hasn't melted down completely? If all this new money is debt-based, isn't it inevitable that we get back to the size of the world economy 200 years ago, or some point when most people and businesses did not have debt?

Yes, this growing money base is backed by a growing productivity base, but the demand for this productivity base can disappear all of a sudden. If most of the financing for this growing productivity base was debt, a key sector withdrawing its demand can cascade to more demand disappearing from its proximate sectors as well. Don't you think a rising government spending should accompany a rising private debt so at least some of that debt has an adequate backing of stable demand? In the demand-deficient economy, government should spend it on people who will readily turn around and buy services from others in the economy. This means government buying services from the individuals who would have otherwise had no income because of those hoarding their income.

2) A commenter said "Those skills and talents were leveraged by our employer in conjunction with the skills and talents of other employees to produce profitable product for which there was a demand."

Again, if all the money your employer paid you came from his credit line, or the credit of his customers, don't you think everything would eventually come crashing down? Don't you think at least some of that demand for your company (which probably did not exist 100 years ago) is due to new spending that did not actually result from someone getting into debt?

3) commenter said: "Wealth is created by human labor and innovation, not debt.Let's say I start growing crops. I work my butt off for hours a day every day. After a few months, I have enough crops grown that I can feed my family. Who went into debt for that? Nobody. Was wealth created? Yes, I created enough wealth to feed a family for a year."

Let's say you grew crops. You fed your family. Is that wealth for you? Yes. Did it grow the GDP? No, You did not sell it to anyone, so no one is counting that. But if you sell that to someone in exchange for money, that person probably borrowed it. If he didn't, then someone who paid his income probably did. Or probably government originally spent that money into existence.

This is not an ideological position, but a practical one. For those who think otherwise, I have a real world question. Given that all of us need to save to pay down our debts, how does anybody get to sell anything in our current economic arrangement? Remember that the basis of all business is to make money. And the basis of all jobs is to support a business' objectives. Given that all of us are trying to be net sellers and avoid being net buyers, since as a commenter said "we postpone gratification and avoid borrowing", how does anyone of us still earn what we need to, and as he also said "satisfy our needs and the needs of those who are hurting around us"?

Thursday, June 2, 2011

Why government deficits are healthy and normal, especially after a fall in demand

Not a day passes by when we don't encounter someone writing that government should cut its budget and start balancing it. This post will add to the body of posts arguing that a government committing to austerity is exactly the wrong policy to enact during a deleveraging and during a general fall in aggregate demand. Since posts calling for austerity and balanced budgets are just reiterating the same points again and again, I will reiterate points I've already made earlier. This post leans 100% MMT.

All income in the economy is money that has been borrowed into existence by someone lese, or else spent into the economy by government. There's no other way for fiat money to come out of thin air. Nobody in the private sector suddenly becomes wealthy, without having gained his wealth from somewhere. Trace every unit of this money all the way to its origin, and you eventually get to a point where it was either created by someone's debt, or by an act of government spending. Government spends money in paying citizens to defend its borders, police its citizens, teach its children, and the various other duties in running the state. Someone takes out a loan from a bank, with a promise to pay it back at some future date, and the bank raises this money from the central bank, which credits the fiat.

A growing economy creates the credit and demand growth necessary to sustain itself without government deficit spending. Conversely, in a depressionary environment, where people are conserving income, credit is withdrawn, and demand is therefore withheld from the economy, we need government to step in and fill the spending void left by the private sector saving. Not to do so would lead to private incomes being destroyed, due to withheld demand, which leads to a vicious spiral of more people not spending, and more demand being withheld from the economy.

And yet, experience shows us that government spends more during a boom than on a depression. They do so because they think of themselves as merely sharers of the currency with the private sector, rather than its issuer. So they spend when they think they have the tax funds, and refuse to spend when they lose the tax base (Though by jumpstarting spending in the economy is precisely how they will recharge the tax base).

There is a stable level of government deficit that promotes growth. It's a deficit level just large enough to create private incomes to make private businesses stable, and willing to hire more people, and thus leading to a positive spending multiplier. Since government spending becomes part of GDP, every $1 of government spending leads to at least $1 of GDP. In order that debt does not grow faster as a percentage of GDP, there should be a positive multiplier effect. So government needs to be careful what it spends money on. A good expenditure would be giving jobs to the jobless providing community services that are currently lacking. This is not a handout, because those not willing to work will not get anything (Thus no inequitable distribution of society's bounty). Without government spending, where would the growing incomes to power private spending initally come from? The state's option to be able to spend more, in place of disappearing private spenders during times of escalating private sector desire to save, is an invaluable lifeline during a severe depression.

Without a growing government debt, there can't be growth in GDP. Government debt constantly grows because when government spends more than it takes in revenues, as during recessions, it's always forced by law or charter to borrow. This is a relic of the time when all its payments in currency need to be backed by gold. Now that the gold standard is long gone, this charter is obsolete. The mechanism to fund deficits could be by purely printing fiat money. If Treasury just credits the bank accounts of fiscal beneficiaries, it can spend without having to raise money via borrowing through the Treasury market.No more need to decide whether to borrow, because the borrowing issue just muddles the issue, and gets people to focus on the debt level rather the efficacy of what the government is spending on. Once countries had decided to let go of the gold standard, they acquired the capability fund government spending by merely issuing more currency. What's now left is for the law, and custom, to recognize this.

P.S. I just want to add this point, for those who fear that increasing government spending will lead to inflation. The point is that there would be no inflation if the private sector is avoiding to spend. Inflation will only arise if there was already a lot of private sector demand, and the government is stepping in to add even more to it. If there's no demand, there'll be no inflation. In fact, if the demand is falling, there would be deflation. Unless someone steps in to fill the void. Same goes for those who fear a crowing our of private sector. No private sector demand, nothing to crowd out. Would that it were true that there was something to crowd out, we wouldn't even be talking about the need for more government deficits.

follow up posts here and here.