Want to reduce your deficit, Mr Osborne? Stop your boys burning those £50 notes* !

* Or at least ask them to tell you about it!

The Oxford University based Bullingdon club has attracted controversy of late, in large part  due to certain unsavoury practices  indulged in by its young, privileged, elitist but poorly behaved members. Their current initiation ceremony is reported to include the burning of a  £50 note in front of a beggar or homeless person.


Former members of the club are now a well ensconced part of the UK political establishment. These include the current Prime Minister Mr David Cameron (In photo, second from the left standing) , the Chancellor of the Exchequer Mr George Osborne, and the Mayor of London Mr Boris Johnson (far right sitting)

A key source of worry for our worthy politicians is the UK’s government budget deficit which now runs at approximately 4% of GDP. This is the gap between what the government spends into the economy and what it receives back in taxation.  The budget deficit is often referenced in support of their argument that we are all “living beyond our means”,  that our “credit card is maxed out”, and that cutbacks in spending  and increases in taxes are unfortunately necessary to “cut our coat according to our cloth” etc etc.

So in this context, we might ask just what macroeconomic impact the burning of our currency might have? It is course illegal to deface or destroy currency. Why should that be?

It does have an effect. If these wealthy young men had chosen to give £50 to a homeless person that money would no doubt have been quickly spent. It would have been a stimulus to the economy.  The destruction of £50 has the opposite effect. It is exactly the same as if we had handed that £50 note over to the government in taxation, where the government routinely puts old notes through the shredder.  If Mr Osborne knows of specific instances where currency has been deliberately destroyed he is quite entitled to count that as voluntary taxation. His deficit would be reduced commensurately.

As he can’t know just what happens to our currency he has to assume it still exists and that it is just being saved somewhere. The net effect is still the same. To keep the economy functioning,  at full capacity,  any money which has been taken out of circulation either by its destruction or because it is being stored in a safe or bank account has to be respent back into the economy by government on our behalf. It’s neither here nor there  whether the budget is in deficit or in surplus.

We don’t need to know how much is being burnt and how much is just being stored. If any government overdoes the spending, relative to the levels of taxation, we’ll have too much inflation, but if it underdoes it , like now, we’ll have deflation and high levels of unemployment and underemployment.

Hey there, Deficit Denier, climb down out of that Magic Money Tree!

“Deficit Denier” ??

The accusation of being a ‘deficit denier’ seems to cause real problems for many progressives.  We should meet this accusation head-on.  WTF is a ‘deficit denier’ anyway?  This is the obvious question that needs to be asked. Is anyone denying the UK and US governments spend more back into their economies than they receive in taxation revenue? No-one is. Neither is anyone denying,  during the very rare  times the government is in surplus, the reality that everyone else is then in deficit themselves. Someone has always to be in deficit. What is there to deny?

We try to be deficit comprehenders. Just like Stephanie Kelton’s deficit owls. We try to understand and explain why a sovereign government like the UK can be in deficit for an extended period of time and why the bailiffs aren’t knocking on the door demanding an immediate repayment of all loans.

“Magic Money Tree” ??

This is rather a silly phrase that betrays a lack of capability for even simple lateral thinking by its user. Mrs Thatcher was fond of comparing Government to her father’s retail business. It leads to the wrong answers. We can’t understand Government  economics on this basis.

We need to be thinking about the nature of economics from a government’s POV. It’s not the same as our POV! Once we accept that,  it all becomes easy enough.

Say a  government, perhaps the Greeks,  issues a new currency. They issue 100 million currency units into the economy to pay their workers and other expenses.  Where does it come from? Nowhere. It is just created in a computer or printed on a press. There’s no need to even pick it from the “magic money tree”. A few taps on the keyboard is all that’s required!

In the first year the govt receives back 60 million in taxes. So the Government now have a debt of 40 million. Where has it gone? Well the people have 30 million in  their wallets and piggy banks. They’ve bought some imports from Germany so the Germans have 10 million in their central bank.

So Govt Debts = Assets(Monetary) of Domestic Sector + Assets(Monetary) of Overseas Sector.

No Government debts means no-one else has any assets! The Government of a sovereign currency issuing country has to be in debt!

It really is that simple!

The government then issue another 100 million in the next year and collect back 110 million in taxes. Yippee! They are in surplus! But just look at where that surplus has to come from.

Once we understand that we can see that the Government’s debt or deficit is no problem to it at all. Just as it is no problem for the ‘banker’ (who should perhaps be called the government) in a game of Monopoly  (as in the board game) to be in debt. There would be no point playing if he hung on to all his cash and started fretting about his deficit! It can be a problem for the players in the economy though.  If there’s too much spending there can be too much inflation of prices and that’s the time to think about taxing some money back into the bankers infinite ‘coffers’.  The ‘banker’ doesn’t need it – he might just want to keep prices stable.

I don’t believe these are difficult concepts. There’s over four years to the next general election. It is understandable that politicians are more concerned with picking up easy votes than explaining macro-economic principles, but when it is all this simple why not call out the neoliberals, if they really do believe this nonsense,  for the dim-wits they are?

Is Government Spending Already by PQE?

We can think that all spending by government is already by the creation of new money, which is the general understanding of PQE (otherwise known as  Overt Monetary Financing of Government), using the concept that money is an IOU of a sovereign currency issuing government.

So, just as you or I have no use for our own IOUs, we tear them up when we get them back, neither has government. All money collected  in the form of taxation or in bond sales is simply shredded. Destroyed -either physically or digitally. When govt spends, it does so by issuing new IOUs. ie Issuing new money.

So what is the point of taxation? It’s to prevent high inflation as has already been mentioned in previous posts.

And the point of selling gilts (bonds)? It is to set longer term interest rates. Generally speaking: The more that are sold by auction, the lower their price, and the higher their yield. The higher their yield the higher are longer term interest rates.

If Government wants lower interest rates in the longer term it should sell fewer gilts, yet still create as many new IOUs, as many new ££, as it needs for spending purposes. Its spending decisions have to be such that they won’t produce too much inflation, of course,  which would require the raising of taxes. The balance between spending and taxation remains the subject of political debate as always.

A better idea might be to stop selling gilts completely and allow savers, ie the hitherto bond purchasers, to put their money on account with the BoE ( which is best considered as part of Treasury) and set the interest rate payable just as a high street bank would set the interest to us on our longer term savings. Short term interest rates are already set this way so the concept, and practice, just needs to be extended to include all savings. The interest rate would probably be higher for a longer deposit period, again as we might expect from our own bank.

And what about the exchange rate?

If the government offers lower interest rates the £ might be expected to fall, and higher rates will probably cause it to rise. If we stay with the idea of selling gilts, and stick with the concept that PQE  is somehow different,  we can say there will be less need for the government to ‘borrow’  and therefore less need to pay out interest.

This will have the same effect on the exchange rate as directly reducing interest rates.  It is just looking at the process from a different perspective.

PQE, as is conventionally understood, could be part of the government’s exchange rate strategy. That is if it wants one, and that could be the subject of another discussion! If it wants a lower pound, it does more PQE. A higher £ means less PQE. It depends on what sort of trade deficit we want to run. If we are happy to run a high deficit, and there is no reason why we shouldn’t, we can keep the pound high, but if we want to reduce it we will need a lower £.

Goodbye to £5 and £10 notes?

The  Bank of England’s chief economist Andy Haldane’s speech. caused some raised  eyebrows recently. It sounds like he knows we’re in for some tough economic times ahead. Things are so desperate that it  might require the abolition of cash in the economy!  People will be forced to hold money in banks and see its value dwindle.

As Andy Haldane has put it “A more radical proposal still would be to remove the ZLB (zero lower bound) constraint entirely by abolishing paper currency.”

We could perhaps begrudgingly say Andy Haldane has shown political and economic courage in saying this. If we are being charitable we could credit Mr Haldane for highlighting the intellectual bankruptcy of most mainstream modern economic thinking. If we wished to be less charitable we’d have to say the idea of abolishing cash is about as stupid as it gets!

I hope it is the former and that cash won’t be abolished. But this isn’t the first time we’ve heard this silly argument argument from monetarist economists and in particular from Kenneth Rogoff. See  here  and  here. That they feel the need to make it shows they still haven’t really grasped that interest rates can’t have the controlling  effect they think they have on the wider economy.

When intelligent men like Rogoff and Haldane have silly ideas, political ideology is usually to blame. The main argument for banning cash, other than to hinder criminals and tax-dodgers, which is no stronger an argument now than it has ever been, is to facilitate sharply negative interest rates. But if we want to stimulate the economy, as we do right now, there’s an obvious and much easier alternative: ie loosen fiscal policy. Increase government spending and reduce levels of taxation.

The only reason to suggest something as outlandish as banning printed currency is that you believe this alternative to be impossible. Or, rather impossible according to one’s own political ideology.

Monetarism all sounds fine – superficially. When times are good interest rates are increased to slow the economy down. When times are bad they are lowered to stimulate lending and get it moving again. There’s no need for government to be involved at all. They can concentrate on balancing the books like any good business should.

Except that every stimulus leads to the build up of private debt in the economy. This build up slows down economic activity, and so we later have to have another reduction in interest rates. Then another and yet another after that . If we get it all wrong then there can even be a giant crash in the economy when those who’ve taken on too much private debt go bust and cause their creditors to go bust too.

So, eventually we arrive at the situation, as we have now, where interest rates in much of the western world  are close to zero and they need to go negative according to the theory to stimulate the economy again. Economists with more intelligence are saying “Whoa! There must be something wrong with the theory”. Others with less insight are saying “But this is just the special case of the zero lower bound” and those with no insight at all, or are stupefied by their own political ideology, are ploughing on regardless and calling for the abolition of cash!

Leaving aside the argument that many of us quite like the convenience of using cash, it’s much quicker than messing about with credit cards at the petrol station for example, it is a genuinely bad idea to go down the road of negative interest rates which will lead to an ever increasing build up of private debt in the economy.

Mainstream (ie Neo -Classical and Monetarist in outlook) economists didn’t spot the onset of the GFC because they didn’t  know where to look for the warning signals. The role of private debt in leading to booms and busts was denied. Expanding the “money supply” was the only standard remedy for stimulating economic activity and the risk of creating asset bubbles was largely ignored with disastrous consequences.

I may come back to the question of private debt in the economy later but for now I’ll just reference Prof Steve Keen’s excellent blog on the perils of debt deflation.

We can’t legislate to change the value of PI nor to reduce the deficit.

The question of the deficit is regularly popping up again and again in the news. Yes the government’s deficit not our jobs deficit! Even Jeremy Corbyn hasn’t quite got it right with his calls for deficit reduction but at least his heart is in the right place. He’s been called a deficit denier. I’m not sure what that means exactly- but he should probably take it as a compliment.

Labour and the Tories weren’t much different in May on the question of the deficit. Arguably Labour was even worse. Labour’s  promise to “cut the deficit every year” ignored economic reality. The difference between what the Government spends and what it gets back in taxes is simply what is saved in the economy by the users of the currency. ie the pound sterling. That saving could be you and I putting some money into National Savings certificates or it could be the Chinese or Germans not wanting to spend all the currency they earned selling us stuff.

That saving is the source of government deficit and debt. The savers end up owning government debt by choice in other words. It’s the same story in all other countries too. All the world’s National Debts total to something like $60 trillion, or the equivalent in different currencies. We don’t owe that to Mars! We owe it to all those who have chosen to save in different currencies.

Since when has it ever been possible for any UK government to tell you or I or the Chinese that we shouldn’t save our money in pounds?

Anyone who thinks that is economically illiterate. Crazy even. These kind of pledges makes no sense whatsoever. They are on a par with wanting to legally redefine the value of PI to be some more convenient and rational number, 3.2,  as some tried to do in Indiana 1897.

Wiser counsel  prevailed at the time and that law was never passed.  Sometimes we do have to be deniers. If PI = 3.14159265359… we do have to deny that it is really 3.2 . Just as we have to deny the possibility that any sovereign currency issuing government has direct control over its budget deficit.

What is People’s Quantitative Easing?

PQE,  sometimes known as Overt Monetary Financing, is the process of creating new money, issued by the central bank in exchange for government bonds. This is then directly spent into the economy to stimulate economic activity. Whereas conventional Quantitative Easing is primarily to provide liquidity to banks and other financial institutions – Some might say it is to give them money which can create asset price bubbles, and other price distortions! – PQE is much simpler and free of many complications.  PQE  can be part of powerful fiscal policy to remedy the  problems of recession and depression.

Mention PQE, however, a term coined I believe by Richard Murphy, and it won’t be long before Zimbabwe and the Weimar Republic will be used as examples of why it’s not a good idea! That’s OTT, but nevertheless the objection of possible inflation needs to be addressed.

PQE could possibly cause inflation. All government spending, as with all spending, deficit or otherwise, carries an inflationary potential .

Deficit spending is necessary to keep the economy functioning when users of the currency wish to save some of it. Those who doubt that might just like to consider the very simple economy of a baby sitting circle. If everyone in the circle readily spent a token and received a night’s baby sitting in equal measure to their willingness to do a night’s baby sitting to receive a token, there’d be no problem at all. But, say, for whatever reason, some of the sitters decided to accumulate tokens. Fairly quickly there would be a shortage and the system would cease to function. There would be a demand, from those without tokens, that the baby sitting council should issue extra ones. Those with a stockpile of tokens would object, saying the “printing” of new tokens would devalue their existing tokens.

If the hoarders lent the tokens back to the council they could be pacified with some reward. Just as lenders of pounds to the government are pacified with a reward of extra pounds. But if the hoarders of the tokens saved them in a piggy bank and refused to lend them back, all the council could do would be to create new tokens and inject them into the system. This would be the equivalent of PQE.

Is one method more or less inflationary than the other? There’s not much in it. Arguably PQE would be less inflationary because there are no extra rewards needed. If the issuing of new tokens, by either method, was just enough to restart the system, not too much and not too little, then neither method would be inflationary.

So who are the hoarders in the real economy? The central banks of the big exporters are the biggest. The big exporters don’t want to spend all they earn by selling goods and services into the British economy. So they buy Government bonds and so effectively lend back their surplus tokens, or ££. The wealthy are the other main ‘culprits’. They tend to accumulate more ££ than they need.

But what if not everyone recycled their extra tokens back through the banking system? Suppose they kept hoards of cash in safes or bank deposit boxes? The government can’t borrow those back. All it can do is create some new tokens. PQE in other words.

The government can’t know just how fast money is moving or if lots of it is being stored this way. What it can expect is the combination of low interest rates and low inflation will make it more attractive for many users of currency who may be engaging in illegal, or borderline, transactions and so wish to hide their finances, will  to store their cash this way.  However, Government can easily monitor inflation. If it is engaging in PQE and inflation starts to be a problem it needs to back off. Alternatively if it’s not a problem it can do a bit more. The government needs to be careful, but shouldn’t be so scared of the idea that it doesn’t even try it out.

Corbynomics or Leslienomics?

The leadership debate in the British Labour Party seems finally to have swung around to a discussion on economic theory. The Labour Shadow chancellor Chris Leslie has recently weighed into the discussion with a claim that:

Jeremy Corbyn’s anti-austerity agenda will harm the poor

Really? What planet is Chris Leslie living on? Back on Earth the empirical evidence from around the place is that harm to the poor occurs from the application  of austerity economics rather than sensible economics.

The Labour right’s economic mumbo jumbo means that they are forcing Labour Party members who may not be of the left themselves to ally themselves with the  left. Many may not want to leave NATO, or want to nationalise all the leading industrial companies, or want to live in a society which is over-controlled by government. The do, though, want sensible macro-economic polices and they, albeit in slightly imperfect form,  aren’t on offer from anyone except the left.

The Labour Right needs to get a grip.

They could start by looking at the nature of deficit spending by government. This is one way of getting more money into the economy. Generally to reflate it. Taxation is one way of removing money. This has a deflationary effect. But, they aren’t the only ways. There is export inward spending by overseas customers which is reflationary. And, spending on imports by home consumers which removes money from the economy and so is deflationary. Then there is saving which is deflationary and de-saving, or private  borrowing, which is reflationary. Too much deflation leads to recession. Too much reflation leads to inflation.

We have to consider all money flows. Germany, being a net exporter, has inward money flows from trade and so a balanced or even a surplus budget is required over the trade cycle. The UK is a net importer so requires a deficit -on average over the trade cycle.

So, if the Labour Right wish to reduce the government’s budget deficit, they need to understand what they are doing and understand the nature of those money flows. They need to understand the need to move trade into balance too -probably with the help of a significant £ devaluation. Otherwise they will just end up incompetently crashing the economy and having 20% plus unemployment.