MMT Humour – Money and Babies

  Money and Babies #1


  Money and Babies #2

budget def

  Money and Babies #3

budget def2

 Money and Babies #4

budget def3








Loan repayments destroy credit money. Right? Wrong. They don’t. (Part2)

Part 1 on this topic seemed to generate a lot of discussion both on the comments section  here  and  here

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.

The Japanese own their own debt so they don’t have a problem. Right?

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.

The Half-Life of Money

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.