Money and Babies #1
Money and Babies #2
Money and Babies #3
Money and Babies #4
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.
I recently came across this comment by Steve Keen.
“This is a point on which I happily differ from most modern Post-Keynesian economists and instead concur with Keynes: credit money circulates, it is not destroyed by loan repayment. The argument that repayment destroys money made no logical sense to me when I first heard it, and was treated as absurd when I discussed it with bank accountants as well. I’ll elaborate more fully on this in future lectures.”
So is this correct?
Say, I borrow £10k to buy a car. The commercial bank creates £10k of new money simply by editing my account upwards. In other words, bank IOUs are issued. The vendor has an account at the same bank. The IOUs are transferred from my account to his, so he now has £10k of new money in his account. Later, I walk into the bank with £10k of real government BoE printed notes . I hand that over to the bank. My loan is repaid. The bank puts the government money into its reserves. The vendor still has £10k of bank created money in his account.
So the bank created credit money hasn’t been destroyed. Is this what Steve means?
Say the vendor then wants to use the £10k to pay his tax bill or pay an overseas bill for £10k. The taxman or the overseas bank won’t want bank IOUs. They’ll want real government money. So the bank will use the £10k that it now has in reserves to settle either of those payments and the IOUs created, the credit money, will then be destroyed. Alternatively he could just settle another payment with yet another customer at the same bank. In this case the newly created £10k continues to circulate.
It is important to distinguish between the IOU of the borrower held by the bank when the loan is issued, which is indeed destroyed on repayment of the loan and the credit money issued by the bank, which is not destroyed.
So Steve raises an interesting point and has to be correct. (IMO !)
Wrong. Even though those of us who argue that National Debts are not quite the huge monsters of popular neo-liberal supposition often point to Japan. Japan manages to function very effectively with a debt to GDP ratio which is over 200%, and more than double the US and UK’s national debt ratios.
All debts and deficits are caused by people, organisations, and countries wishing to save ££, $$ or Yen or whatever. If money issued by the US, UK or Japanese governments ends up being held by the central banks of the big exporters, or by their own citizens, and who don’t wish to spend it, then these countries have to be in debt in accounting terms.
The only solution, if indeed there is a problem of debts owned by foreign countries, is to go back to countries imposing tariff barriers to protect their trade zones and prevent the build up of these kinds of financial imbalances. That caused wars in the past and would again in the future. It isn’t a good option.
It is usually pointed out by supporters of the neo-liberal orthodoxy that Japan manages to have such a high state debt by also having lots of savers who lend the money to the government. It is, therefore, not external debt and so is a lesser problem True, Japan usually has a trade surplus and “pays its way” abroad.
However, internal debt can be more destabilising than external debt. If Japanese savers get spooked about a potential inflation they would all start over-spending simultaneously which could set off the problem they most fear. It would be politically very difficult for the Japanese government to control that by applying taxes on its own citizens. So whereas the debt isn’t at all a direct problem for the Japanese Government, the ownership of too many financial assets by the Japanese population could give them one.
On the other hand, if their debt were owned by a foreign country, say in the form of Japanese treasury bonds, it would be somewhat different. All that country could do , if it wanted to spend its Japanese Yen, would be to give large orders for real goods and services to Japanese industrial companies. It would boost Japanese exports tremendously. That too could be inflationary, but the situation would be more manageable. The Japanese government would be able to negotiate with its foreign creditors to spend at an agreed rate. As a last resort it could even impose a tax on its own exports.
That’s essentially the position the USA is in with regard to its Chinese creditors. If there is really a problem with debts, it is China who has the bigger one than the USA. Japan has a bigger problem too. Not so much because it has a larger debt but because it is, rather than isn’t, largely owned by its own citizens.
We understand that money is an IOU of sovereign governments , or the State, as some prefer to say. When governments spend, they create money. When they tax they destroy it. Governments often like to pretend that the ideal state of affairs is to run a surplus, which means they are destroying more money than they are creating. This may be possible for a short time, but it is obviously impossible for governments to destroy more than they create overall. So, to that extent, they always have to be in debt in terms of their currency of issue. That’s the natural state of affairs.
Even if they are not running a surplus, Governments do seem to fret, usually unnecessarily, when a part of what they issue doesn’t come back quickly enough to be destroyed. Politicians are always worried that their deficits are too large. But why do they do silly things like raising taxes and cutting spending to shrink them? They are always surprised when that never seems to work but instead they end up with high levels of unemployment and business failure.
There’s a concept in Physics known as the half-life, which is commonly applied to the decay of radioactive materials. Say there are 1000 atoms of an unstable isotope, to start with, they will decay to 500 atoms after a time and release radioactive emissions in the process. Then, again after the same time, the 500 atoms will decay to 250. Then 125 and so on. The radioactivity is decaying over time, but never quite decays to zero. But mathematically we can say it tends to zero as time progresses. The shorter the half-life the quicker the decay.
This concept can be applied to the way taxes act on every financial transaction, starting when governments first spend their created money. If Income taxes are involved the rates can be very high. Up to 75% in France for example. On the other hand some transactions are tax free, (even in France!) and we have to consider a weighted average tax rate per transaction. If that average is 5% then it will take 14 transactions, per unit of issued currency, before half of it is returned to government and is therefore destroyed. Increase that to 7% and it becomes only 11 transactions. 10% takes 8 transactions, 20% takes just 5 transactions. 30% takes 3 transactions.
Providing the transactions keep occurring, governments will always get the same amount of revenue regardless of the level of taxes, so long as they are finite. Increasing taxes won’t therefore increase revenue in the way that may be initially supposed. Considerations by economists such as Arthur Laffer on what are the optimal level of taxes to maximise revenue can be seen to be unnecessary. Governments shouldn’t want all taxes to be optimised. Other, usually more social, considerations should apply. For example, cigarettes could be optimally taxed to maximise revenue or they could be highly taxed to discourage smoking. The less than optimal tax which is then raised from sales of cigarettes leaves more money in the economy to enable extra transactions to take place. Those transactions then yield the extra revenue that may appear to have been lost.
So, from a government’s perspective, increasing taxation, and/or reducing spending, should be associated with the need to reduce the amount of financial transactions which occur overall in the economy. If there are too many transactions, the real resources to support them may be insufficient and higher than acceptable levels of inflation will occur. Conversely, reducing taxes, and/or increasing spending, should be associated with the need to increase the number of transactions occurring, so increasing business activity and therefore reducing unemployment levels.
MMT is becoming to be generally well regarded on the political left. Part of that acceptance is due to MMT’s insistence that unemployment isn’t an insoluble problem and that deficits don’t matter, or at least not in the way the neoliberals claim they do. There’s an obvious way for the left to find their spending money, once basic economic principles are grasped, to fund their social programs and at the same time fix the unemployment problem which plagues nearly all western economies.
That may not have quite the same appeal to the right, but nevertheless, there is something in MMT for them too. MMT in itself isn’t a prescription for what Governments should do, but rather an economic theory which explains how real economies function and therefore how they react to applied fiscal and monetary policies. So, if MMT is right, and the evidence is very much in its favour, it would make sense to look at how it could help all shades of the political spectrum.
One of the major questions to answer , from all political viewpoints, is ‘how big should the State be’? Hardly anyone is saying 0% of GDP. Hardly anyone is saying 100%. So there is really no correct answer. Everyone has their own opinion. I’d be happy with a State sector which was about 40% of GDP. Others, on the left, may prefer 50% or more. On the right they may prefer 25% or less.
So, using MMT how should anyone argue for a State sector of only 25%? Typically that would be only half the size of the State sector in present day European countries. For a start, considerations on the size of government should be decoupled from considerations of deficit reduction. It’s possible to have any combination of small or large government, and small or large government deficit or even surplus. If there’s an argument for smaller government then the political right just needs to make that argument.
This should run along the lines of ‘Yes, we are going to cut government spending by removing or reducing various services, but we are also going to cut taxation too to help everyone to pay for those services which will no longer be provided by Government.’ A sort of Super- Reaganomics! The Government deficit shouldn’t be mentioned. A high deficit did not seem to unduly worry President Reagan, who was astute enough to realise that money to expand the economy had to come from government. He just favoured leaving it in the economy longer by taxing less rather than spending more.
Any attempt at a forced reduction in the deficit is likely to be counterproductive from a rightward perspective. It would lead to not only increased unemployment but also a failure of many businesses in the private sector. It would lead to increasing claims that capitalism was failing. There would be increased calls, as there are in the UK now, for more nationalisations to fix the problems of a failing system.
The Governement’s deficit, which incidentally has to equal the non-government’s surplus, as shown in the previous posting, has also to equal the level of the net savings of the private sector plus the payment for net imports into the economy. These are largely outside the direct control of government in a free society and the equation is just as true for an economy with a smaller government sector as it is for a larger one.
PS If you have a political representative who is of a rightish persuasion, please, if you agree with it, forward this article to them. These days that could include Labour MPs and Democratic Congress persons too! I’ll retract any comments if they can prove any flaws in the argument.