To fix the UK economy requires that aggregate demand be increased. Nearly all politicians understand that. Except, the favoured way, and some might say the only way, for those on the right of the political spectrum is to create a credit bubble to encourage more private spending through more private borrowing. That’s not an option for the foreseeable future as the private sector is now saturated in debt. So saturated , in fact, that we’ll have another crash in the next couple of years unless the next government acts quickly to prevent it. That will require them to spend in a sensible fashion but nevertheless spend big time. Realistically, it is going to be a difficult sell electorally. The problem, for those politicians wishing to advocate this line, will be questions such as “where’s the money going to come from?” and comments such as we “can’t afford” to do that.
Of course, the money comes from where all money comes from in the first instance, and as Keynes said, if something can be done it can be afforded. The only danger of too much spending is too much inflation. The danger of too little spending is the recession we have now, both in the UK and, even worse, in the Eurozone.
The problem is that the electorate, and most politicians, don’t understand economics. That’s not surprising. The mainstream media don’t explain it at all correctly. To most people, the government is like a company or a household. To spend money it has first to acquire money. That’s true for a user but not at all the case with an issuer of currency.
It’s rather like living in society where everyone thinks the world is flat. If we insist the world is really round then they might not like that and vote for someone else. We, in turn, wouldn’t like that so the best approach may be to pretend we think the world is flat too, and work our way around the problem as best we can!
One way is to redefine what we mean by ‘government deficit’. As Neil Wilson has recently noticed, Ed Balls has been astute enough to use the term ‘current deficit’.
I think we all missed the inclusion of the extra word for slightly too long, so full marks to Neil for spotting that. Maybe, we gave Ed slightly more criticism than he may have deserved over his advocacy of ‘balancing the books’.
So what could be the plan? The idea is simply that we shouldn’t count capital spending, just current spending. On a personal level, current spending is our going down to the pub and drinking a few pints. We’ve nothing to show for it the morning after. Capital , or investment spending, would be on building a house or investing in a viable business. The value of that would, if we drew one up, appear on our personal balance sheet, so even if we went into the red financially we would still be in the black overall once the value of the physical assets was counted.
So how’s it going to work for government? Current spending is, amongst other things, paying out unemployment benefits. Capital spending includes electrifying all railways and building houses. The government is in a very advantageous position when it comes to doing anything in the economy. Unlike you or I, it doesn’t have to borrow money at high interest rates. It can either just create the money or borrow it via the sale of gilts at very low interest payments. Also unlike a private developer which has to pay taxes to government during the course of the development, government actually receives taxes. Therefore if a private developer can build at a profit, then government can do the same thing and make an even bigger ‘profit’.
So say it decides to build a £100 million residential development. It classes that as investment spending or capital spending so it doesn’t appear on the books as a ‘current deficit’. It hands out contracts to builders in the private sector and most of that money gets spent on wages. Either directly, on the wages and salaries of building workers, architects etc, or in the process of the labour that goes into making bricks, concrete, timber, tiles etc. So straightway some £30 million or so comes back as taxes and NI payments. The bricks, concrete etc attract VAT when they are purchased. So that’s probably another £10 million or so going back into government coffers. That revenue is classed as current revenue so it reduces the ‘current deficit’.
Then that remaining £60 million gets spent and respent in the economy. At every stage taxes are levied. 20% VAT, corporation tax, capital gains tax, fuel taxes, alcohol and tobacco taxes, yet more income tax and NI, plus lots more taxes too that we can all think of. The end result is that nearly all that £100 million goes back to government. At the same time building workers who were unemployed have now found jobs so don’t need to be paid dole money any longer.
Then government can take delivery of those £100 million worth of flats or houses , say about 400 of them at £250k each. It then sells them to a housing association or co-operative and gets all its money back. But it’s already got it back anyway! Alternatively it can rent out the residences directly, or via a lease arrangement with the co-operative, and collect the lease or rents, which at present day prices, especially in London, will pay off any interest multiple times. That way it still owns the properties and their value appears as an asset on the government’s balance sheet.
In other words it makes a tidy profit on the deal. And no it’s not necessarily inflationary, when there are unused resources available. Government will have created something extra for sale in the economy. Inflation has to be about more money chasing the same amount of goods not more money chasing extra goods.
It can repeat the same idea in lots of other ways too. For example, it can extend and modernise the Underground in London. It can start to construct Underground railways in other major cities like Manchester, Birmingham and Liverpool. The spending is classed as ‘investment’ or ‘capital.’ The revenue from the spending is classed as ‘current’. The price tag is not important, providing that the resources are available and unused, and providing we create useful jobs paying living wages, we can always afford to pay for them. By creating jobs we are not just investing in infrastructure, but we are also investing in people, enhancing their participation in society and providing them with the means to support themselves and their dependents. We can always afford that.
Is this what Ed Balls has in mind? His Bloomberg speech shows he knows enough about economics to suggest that he does.
Arguably, it did work reasonably well for the first few years of its public existence from 2002 onwards, but now, unarguably, it does not. Recession and high levels of unemployment is the norm, not just in the peripheral countries of Spain, Greece, Portugal, Ireland, Poland, etc but increasingly in the original group of six too. Italy and France are both experiencing double digit levels of unemployment; and the problem is now spreading to Germany itself, as its export markets in the Eurozone start to dry up. The high levels of unemployment in the peripheral regions of the Eurozone naturally leads to increased levels of migration to other areas of the EU which are performing better. Whatever we feel should be the case, our observations tell us that this is causing social and political problems too, especially in the UK, which we would be foolish to ignore.
There are many theories offered to explain the origins of the problem. The stated opinion of German right wing politicians and their ordo-liberal economic supporters is that there is nothing wrong with the Euro. If they can manage perfectly well with the Euro then so should everyone else. If they, like Germany would only just get close to balancing their budgets then all would be well.
See for example:
Furthermore, there tends to be a lot of finger pointing in the German circles directed particularly, but not exclusively, towards Greece. The criticisms generally include a past reliance on an oversized pubic sector, an inefficient system of tax collection, a past over-reliance on ‘money printing’ to fund government spending leading to higher than desirable levels of inflation and even systemic corruption. They probably do have a something of a point, no countries are ‘perfect’ not even Germany; but are the German right missing the point completely? From an understanding of just basic economics we can clearly see they are.
The fundamental problem is none of the above. There is also a widely accepted, but not necessarily correct, argument that countries need their own currency, which should be allowed to vary to allow countries to devalue or revalue their way out of economic trouble. That certainly would help but neither is it the core problem. Rather it is a problem of financial transfers, albeit an easily solved one, that is to be expected whenever two or more countries decide to share a common currency; one or more of which are large net exporters and one or more of which are large net importers. There is nothing wrong with wanting to be a net exporter, if that is what countries want to do. Of course, for every net exporter there has to be a net importer willing to buy those exports. So, we firstly have to disabuse ourselves of the idea that the net exporters, like Germany, the Netherlands, Austria, Switzerland (even though the Swiss are not in the EU) are somehow more virtuous than the USA and the UK (in the EU but not the EZ) who are net importers.
It makes sense, all round, to allow countries to choose whether to be net exporters or net importers. The alternative would mean clashes over trade, the imposition of high tariff barriers, and currency wars. It is no exaggeration to say that these clashes can lead, and have led in previous eras, to real wars too. No-one wants to see any re-occurrence of that.
How does it work when a net importer and a net exporter trade together using their own and, therefore, different currencies? Assuming that the two countries have the same trade pattern with each other as they do globally, there is an inevitable imbalance when it comes to the net importer being able to pay in its own currency. There is always going to be a ‘glut’ of that currency on the market, which if left alone would cause the currency to depreciate. That country would then be able to afford fewer imports, its exports would look more competitive, and so its trade would naturally move into balance. Neither country wants that, so the importer issues bonds which are obligingly bought by the exporter using the excess of the importer’s currency. The importer then re-issues the money obtained from the sale of those bonds into its economy by government deficit spending. In other words, the supplier lends money to its customer to be able to continue to be a good customer. The central bank of the exporter then stores the purchased bonds and just creates, or ‘prints’, extra amounts of its own currency to satisfy the need of its internal exporting companies to be paid in that currency.
So, despite all German assertions to the contrary, the policy of the Bundesbank has never been solely the minimisation of inflation. The Bundesbank was quite willing to ‘print’ as many DMs as was considered necessary to hold down its value to maintain the sales of German exports. An artificially lower exchange rate also translates into higher prices in German shops and so contributes to a higher level of inflation than may be the case otherwise.
This kind of arrangement can continue indefinitely. Of course, as the currencies are separate, they can vary over time in value in relation to each other, but, providing that inflation rates in the two countries are approximately the same, they do not need to. In principle they could be fixed, providing the exporter and importer co-operate to equalise their monetary transfers by the necessary issuance and purchase of government securities.
Therefore, if this arrangement can work with fixed exchange rates, it must be able to work with the same currency too. The process is simply same one, as before, of the exporting country lending back its surplus to the importing country so that it can continue to be a good customer. As the currencies are the same there does not have to be any bonds involved, it just needs money to be lent back, but there can be a transfer via bonds if that is mutually preferred. Money and bonds are just different forms of government IOUs in any case.
In the case of the Eurozone these would be the so-called Eurobonds which are widely being discussed, but adamantly opposed by German ordo-liberals. I fail to understand why. These are essentially the same people who were happy to lend their customers money when their currencies were different, so why do they have a problem now they are the same?
Ordo-liberals compound their mistake of not wanting to lend back the surpluses of the exporting countries in the EZ to the importing countries, by insisting that the importers should not borrow from anywhere else either. It may make sense for an exporter to have a balanced budget, but not an importer. The importer needs to sell securities and deficit spend the money received back into its economy. That deficit could be 3% of GDP, the Euro limit, but equally it could be higher. It makes no sense to even try to impose arbitrary limits on government deficits, which are also affected by the desire of populations to save financially. The deficits can, and should be, varied, as need be, to ensure the consistency of levels of inflation in different EZ economies. So a possible strategy for the ECB would be to set an inflation target of something like 3% for every EZ economy and issue Euros either via the process of quantitative easing if the exporting countries were unwilling to recycle their surpluses, or the encouragement of bond issuance or even straight lending of euros if they were, or a mixture of both.
3% inflation may be too high, even if only for a limited time, for many in the more prosperous regions of the EZ to contemplate, and they have said so in no uncertain terms. See for example:
However, the alternative is to leave things as they are. It will only be a matter of time before France is ruled by their National Front. Greece ruled by Syriza, Spain by Podemos, Ireland by Sinn Fein, the UK by UKIP. There will be an upsurge in support for new Eurosceptic movements emanating from both the extremes of left and right as the EZ economies, including the now prosperous ones, go from bad to worse to disaster. It is hard to see how that could be any preferable than paying a small price by way of an acceptance of slightly higher inflation, and the issuance of as many Euros and Eurobonds as are required to fix the problem right now.
PS Another similar view
What’s the rationale of a country like Germany wishing to run a perpetual current account surplus? That desire seems to be causing a lot of trouble in the Euro Zone right now. Of course, everyone knows surpluses are good and deficits are bad. But, is that really the case?
If the Germans sell more to the UK in one year, that then gives them more ££ in their kitty to buy more stuff from the UK in the following year, which would of course be fair enough. But what is the point of their wanting to continue to do that year in year out? They are just building up large reserves of UK government securities denominated in ££ which they won’t ever spend. That is, until they decide to become a net importer, but that seems totally contrary to German economic “philosophy.” If that’s the right word!
Its the same story with America and many other countries too.The Germans like to accumulate US$ which they can never spend.
The Germans could do just as well by selling cars to the fictitious state of Atlantis. They could sell as many BMWs, Audis and as much of whatever else they make as they liked, then just dump the lot in the middle of the Atlantic ocean. They would get paid in pretend Atlantis dollars which they could never spend of course. (Except perhaps with the Chinese?) But, as they seem happy to accumulate large reserves of other currencies which they have no intention of ever spending, what would be the difference?
There needs to be a general rethink of how countries should balance their trade. It seems to make little sense to wish to have a perpetual surplus of exports for the exporters. If the importers were wise to the ways of MMT then they might not worry about their deficits, both external and internal, quite so much as they do. That doesn’t seem likely to happen any time soon, unfortunately, so the next best thing would be for everyone else to be challenge the big exporting countries like Germany, Austria, Singapore, Switzerland and China and ask them why they are so keen to earn money which they can’t or won’t spend.
Spending = Income !
I don’t know why anyone has a problem seeing that. But many of us are caught up in the thought that saving must be a good thing. That’s what the virtuous do. Spending, on the other hand, must be a bad thing. That’s what the reckless do. Except, of course, if the spending can be classed as “investment”. Then of course it might be classed as a good thing too! Income, naturally, is a good thing. At least we all agree on that. Everyone needs some income to survive.
It should be an self-evident ‘truism’ that everyone, everywhere, who’s earned any money has done so only because someone else has made a decision to spend some money. If people aren’t earning enough it is because other people aren’t spending enough. It may be “investing” in new infrastructure or, equally, it may be simply you or I just going down to the pub and buying a pint or two!
Of course, if anyone wants to put aside some of their hard earned money then there is no reason why they shouldn’t. But, as a simple matter of accountancy, it needs to be recognised, by all, that if someone is spending less than they earn someone else has to spend more otherwise our economy will spiral downwards as it has in the Eurozone. The foreign sector in the UK spend less than they earn. The spend less on importing products from the UK than they earn from sales of products to UK. That needs to be made up for.
Many baby boomers are nearing retirement. They are spending less than they earn. More generally, the private domestic sector needs to net save. That needs to be compensated for too.
So that’s down to Government. There’s no one else. It needs to spend more than it earns, ie run a deficit, to “balance the books”. It is all so simple, and so obvious, but many of us are just so conditioned to be the way we are that we are blind to the what should be apparent to an intelligent 5 year old and mess up our economies as a consequence.
The consensus being that I was wrong ! So, what’s the correct view?
Let’s make it all as simple as possible. Let’s consider the example of someone walking into the Royal Bank of Scotland to borrow one of their £10 notes. The RBS are one of those banks ‘north of the border’ who are allowed to print their own banknotes. They are essentially their IOUs . So these notes are the type of credit money we have been talking about. They tend to be well accepted in Scotland but less so in England.
So they borrow £10 and spend it on whatever! When the time comes to repay the RBS the borrower could , leaving aside the complications of fees and interest payments, give them a Bank of England £10 note, the BoE being the Central bank of the UK, and the debt is cleared. The credit money is still in circulation. It isn’t destroyed.
Alternatively, they could repay with a RBS £10 note in which case the credit money is destroyed.
I probably should have said “not necessarily” rather than “they don’t” but I think that’s all there is to the argument.