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.

MMT is gaining followers!

John Kelly, who writes for the Australian Independent Media Network blog posted a couple of very good articles in the last week.

John writes:

“I am not pretending to be an economist. But I am smart enough to see the difference between the government’s management of the economy and the way it should be managed. Either they don’t know how to do it, or they don’t want to, which is the more likely, and that means we, the 90% who feed the economy, are being played for fools by the 10% who feed off us and stay rich, because of us.”

Do Taxes Fund Spending

The Ridiculous Debt and Deficit Scam

If Dollars and Pounds are Really IOUs it Must Logically Follow that Government Debts Need Never be Repaid!

One common argument made by neoliberals is that government debts, and the interest payments that go with them, are potentially a burden to the next generation. You’ll hear that sort of thing all the time from politicians. Of course there is no empirical evidence for this assertion. The immediate post war generation don’t seem to have suffered from a collective war debt burden. That generation has been lucky and has done remarkably well, on the whole.

But why should this be? Let’s start from the understanding that dollars and pounds are no more than government IOUs. This view is now held right across the political spectrum. There is no real controversy. There’s no gold , no silver backing them up they are just government IOUs as described by the Bank of England.

So let’s just think about our own IOUs. Suppose we have run out of sugar and ‘buy’ a kilo from our neighbour by issuing an IOU. So our neighbour gives us the sugar and we give out an IOU. That’s how governments buy things of course.  Suppose we use up that sugar and need some more. What can we do? We can write out another IOU and give that to another neighbour and get some more sugar.

From a government’s perspective that would correspond to printing more money. After a while our neighbours lose confidence in these written IOUs , so the conventional argument goes, and therefore responsible governments should borrow funds in the market rather than just keep on printing new money. So how do we borrow back these IOUs? It’s really not possible. All we can do is offer to swap them for new IOUs called bonds. So we write out a new IOU to one of our neighbours promising that we will repay not just one kilo but two kilos of sugar but the catch is that our good neighbour has to wait 10 years to get them. If you do the arithmetic our neighbour will get approximately 3.5% interest on his bond over the ten year period. In return we get back our original IOU which we can then spend, responsibly, with a new neighbour.  Responsibly? Because we haven’t printed new money :-)  But we have printed a new bond :-(   Its better not to mention that!

So the first logical conclusion to be drawn is that there is really no such thing as government borrowing. More correctly, it should be described as government issuing. Governments issue either currency ( one form of IOU) directly or issue bonds (another form of IOU with interest) in order to get back their currency IOUs to be able to respend them.

Incidentally, if they do it the other way around from normal, and issue currency IOUs and swap them for bond IOUs the process is then known as Quantitative Easing! That’s another story!

So governments are in this odd position of never having anything except their own IOUs, so how can they possibly ever properly repay the holders of these IOUs? Governments can’t create any sugar (real wealth)  directly, how can they? So how can they ever repay their debts in any meaningful way? They can’t. They can forcibly confiscate IOUs through the process of taxation but that is not at all the same thing as repaying debts.

That all needs a bit of thinking about, but logically it must mean that no matter what governments borrow today there is no need for our children to worry about ever repaying our debts at some future time. If the government of the future time tries to impose a too high regime of taxation, in relation to what it spends back into the economy, and thereby creating recession and excessive unemployment, our grown-up-by-then children will vote them out at the next future election. At least they will if they have any sense and don’t succumb to the neoliberals of their future time who will be spinning them a yarn about debt burdens to future generations!

It is that simple.