Great Leap Forward

Yes, Virginia, Taxes Do Drive Money: Confirmation from a Money Manager

Yet another money manager “bites the dust”, falling for the MMT view that “taxes drive money”. See his piece, “The good you do for the dollar when you pay your taxes”, by Jon Shayne April 3, 2014;

I wonder why this is relatively easy for those who work in financial markets, but almost impossible for economists of any stripe to “get it”? Some might say that financial markets people are just smarter—but I doubt that explains it. A lot of economists are fairly bright. But they are not used to thinking about “money” as anything but what Friedman’s helicopters drop into an otherwise well-functioning economy, screwing things up and causing inflation. In any case, read this excerpt and judge for yourself. I think Jon Shayne has provided a pretty good summary of the “TDM” (taxes drive money) view. Note he cites Jamie Galbraith (no surprise) but also one of my favorite economists, Zvi Bodie who knows of our work but is outside the loop.

Here’s Shayne:

Have you ever wondered why the U.S. dollar has value? It is not because of the gold in Fort Knox. There used to be gold behind the dollar, but not now. President Richard Nixon cut the last ties in 1971, effectively ending the foundation of the Bretton Woods international monetary system. Rather, the ultimate reason that the U.S. dollar has value, at least in the opinion of some economists, and in my own, is that no one likes being in jail. And dollars are a get-out-of-jail-free card. April 15, when Uncle Sam collects taxes on our incomes, is right around the corner. We must pay those taxes in dollars, and there are penalties for not paying them, which can include time in prison…. Court opinions, like dollars, are words on paper, but they are not just words on paper. If a final court decision condemns you to years in prison, you will, in fact, have to do time.

So, a court opinion, despite consisting only of words, means a lot more than a greeting card. And courts, interpreting the law, are what give the dollar its power to satisfy financial obligations. Beyond the court system, there is a social component to the value of a paper currency. The purchasing power of the dollar will change in response to inflation, as more dollars get created, and in response to the value of other currencies. Those changes are generally going to be gradual, however. I am not claiming that the extra-legal influences on the value of the U.S. dollar are insignificant. It is just that the need to come up with some cash to pay taxes is, practically speaking, absolute. Only the amount might be subject to a court’s interpretation. You could be arguing with the IRS about, say, how much the nursing care you bartered for with your homegrown vegetables is worth, but there would be no successful dispute about your owing something.

To understand the value of the dollar, it is instructive to consider how U.S. dollars are different from bitcoins. We do not need bitcoins to stay out of prison, and U.S. law is unlikely to ever recognize them as legal tender. Granted, bitcoins are elegant and, in their wonky way, beautiful. But many things are beautiful. Bitcoin is not even the only crypto-currency. Few people, in my experience, consider taxes to be the grounding for the dollar’s value. Most people just don’t think about it. However, Paul Solman, the master of the bits on this page, touched on the idea last year in an interview with Boston University finance professor Zvi Bodie….

These days, the easiest place to stumble upon the idea that taxation is the basis of money’s value is in a somewhat obscure school of economics called Modern Monetary Theory. MMT is, I think it is fair to say, just left of mainstream, and builds upon this idea as it makes a case for greater government spending. One prominent proponent is Jamie Galbraith, an economist at the University of Texas. I am not sure why the idea of the dollar as a get-out-of-jail-card gets so little, um, circulation. But I have found it helpful, myself, as a money manager. It keeps me from freaking out at the necessity of, sometimes, holding cash in a portfolio while looking for other investments. There is still the possibility that the government – the “prince,” as Adam Smith put it in the passage above — will print too much, and that purchasing power will erode quickly. Still, dollars are better than bitcoins because like death, as Benjamin Franklin taught us, taxes are unavoidable. If the government were weak, we might worry, but ours is very strong….

4 Responses to “Yes, Virginia, Taxes Do Drive Money: Confirmation from a Money Manager”

cwmayer2004April 22nd, 2014 at 1:03 pm

As to why MMT is easier for people who work in financial markets, I have a guess – as someone who works in the field. Investors are always holding an inventory of cash, bonds, stocks, etc. And they are always valuing these things against each other. So, naturally they fret about the value of the dollar. Most have no good answer for why it has value. It’s accepted on faith and that’s uncomfortable.

Then along comes MMT with this logical, rigorous and yet elegantly simple explanation. It clicks. And it clicks, too, because investors are very aware of tax liabilities – a powerful real world consideration they live with every day.

So, that’s my guess. Most of the rest of MMT, in my opinion, follows pretty easily from building on this simple insight that “taxes drive money.” I can’t tell you how many times I’ve told the story about the parents and the coupons (from Mosler). It’s quite effective – and when they get that, they get why deficits are a normal outcome stemming from a desire to save, etc., etc. The rest falls into place.


L. Randall Wray L. Randall WrayApril 22nd, 2014 at 1:36 pm

thx chris, makes sense. And note how Shayne finishes the piece, worrying about inflation! He almost goes monetarist on us. However, of course, I agree that too much spending (keystrokes, not “printing money”) will be inflationary. But we are a “strong” economy and production would normally rise to the challenge: spend and they will produce. So I am not an inflation worrier.

cwmayer2004April 23rd, 2014 at 12:42 pm

I am not an inflation worrier either because MMT has given me a better understanding of the macroeconomy. But I was an inflation worrier not all that long ago. I think most investors and money manager types know or have seen the chart/anecdote that the US dollar has lost 95% of its purchasing power since 1913 or whatever. And that freaks them out and makes them think of the dollar like a perishable item.

Besides that, I also think that monetarism has been a successful school of thought in terms of getting their ideas out there, at least in financial circles. Many finance types are knee-jerk monetarists on the inflation question.

But MMT is up and coming…


DismayedApril 24th, 2014 at 4:34 pm

I usually ask people who fret about the long-term decline in the dollar's value if they would prefer 1913 dollars and the market basket of goods available then, or today's dollars and goods. I'll take today myself!