Daily Archives: October 25, 2013

A Fairy Story

Once upon a time, a King called Bill ruled a large island called Isla. Isla was rich in all kinds of resources: fisheries, forestry, mines, agriculture and could provide for all the islanders needs.  They bartered their produce, a fish for a coconut for example, between themselves, but gave a percentage of what they made or grew to  King Bill. King Bill was a good king who had the support and loyalty of most of his subjects.

One day King Bill had an idea. He decided to introduce a currency to bring his kingdom into the modern era. He didn’t have very much gold or silver so decided on what we now call the fiat system. He printed many banknotes, and he called the currency the Bill after himself. Kings are like that, even good ones. He issued many coins, and gave samples to all his subjects and told them that the price of a big fish should be 2 Bills a small fish would be one Bill, A loaf should be half a Bill etc. They weren’t impressed. They said they would rather keep their big fish than sell them for 2 of these so-called Bills. Some islanders drilled holes in their coins to use them as washers. They couldn’t think of anything to do with the banknotes  except mount them in picture frames to hang on their walls as they  had a nice picture of King Bill on them.

King Bill was very unhappy. He sat moping in his palace all day long. Then he remembered his fairy Godmother had always promised to grant him one wish and he had never used it. She was quickly summoned to the palace. ” Please Fairy Godmother,” he said:  “Can you cast a spell to make  my subjects  use these  Bills properly?” ” Oh,  that’s an easy one”,  she said.  “There’s no need for any spells. All you need do is demand that your taxes are paid in Bills. When I heard that you wanted a wish  I thought I was going to be up all night working on really hard spells like turning pumpkins into carriages, or frogs into beautiful princesses!”

The King was too worried about his failing currency to be thinking about beautiful princesses  at the time  and he wasn’t amused. ” Why would I want to do that said the King? I already have a warehouse full of Bills that no-one wants!”

Reluctantly,  King Bill did as his fairy Godmother had suggested and switched his tax system from one based on a percentage of  produce to one based on the new currency units. He sent out lots of tax demands. A big house would be taxed at 20 Bills. A small house 15 Bills. A big boat at 10 Bills etc He paid his tax collectors, his army, his police and all his servants in Bills too. They didn’t like that one bit and it caused a lot of resentment. They all went on strike! Everyone wanted to be paid in coconuts and bars of chocolate just like they always had been.  They all said his currency was worthless! They thought the King was going mad too. Why would he want his taxes paid in worthless pieces of paper currency when he already had a warehouse full of the stuff? He had thousands of notes and coins that no-one wanted. In any case, if he ever did run out of Bills it was easy enough to print off some more.

King Bill had to promise to pay everyone six months’ salary in advance and also promise that if it didn’t work out with his new Bills he would pay them again in bottles of the finest wines from his cellars. This convinced everyone to give the new system a try. His tax inspectors, his policemen, and all his other officials set out to the villages and towns in the four corners of the Kingdom.

Much to their surprise,  when they arrived to collect the King’s taxes they found their Bills much in demand. The islanders needed them for just those taxes. They found themselves offered much better lodgings than previously, they were offered much better food and clothing too but, of course, only if they paid in Bills!

So, thanks to the advice of his fairy Godmother everything went very well for the King. He happily spent and taxed his currency into existence. After a time everything settled down and prices become well established. He experimented with how it all worked. Sometimes he spent lots of Bills and taxed only a little. But then people would complain that the prices of fish and bread were becoming much too high. There seemed to be quite a lot of strikes too. Public opinion was divided between those who blamed the workers for being greedy and forcing up prices with excessive wage demands, and those who said the striking workers were just trying to maintain the purchasing power of their wages.

Then he went the other way and spent less and taxed more. He noticed this caused businesses to fail. They couldn’t sell everything they made. People lost their jobs and marched on his palace waving big red flags and carried placards that said things like, “power to the people”, “we demand the right to work!” They chanted slogans like ‘King Bill Out, King Bill Out King Bill OUT OUT OUT ! The king  noticed that when this happened his subjects became very intolerant of anyone who had come to live on Isla from other islands and they blamed them for taking their jobs.  If they didn’t have a job they called them ‘dole bludgers’ and said they were sponging on the hard working Islans and should go home.

Eventually the King got the hang of how to spend just enough, but not too much, and to tax just the right amount too, and became very good at what we would now call demand management. His kingdom prospered and his subjects became richer than they had ever dreamed possible.

Just as everything seemed be going marvellously well, with inflation well under control, and with nearly everyone, who wanted one, in jobs the King had an unexpected problem. His subjects suddenly got anxious when he decided to publish figures that showed he’d created 50 million Bills and all but about 1 million were out in circulation. Some of his subjects who claimed to be experts in economics,  said this meant the national debt from that alone was just about half of the annual GDP of the island.

Some people had become very wealthy. They’d saved their Bills in the King’s bank and which the King had supposedly “borrowed”. However, as he had created them all in the first place he didn’t see it as borrowing. He said he could make as many as he liked anyway so why would he need to borrow any more? He had actually chosen to pay out interest on these accounts, he said, so the holders should think themselves lucky.

Then there was a problem, or at least many people considered it to be a problem, with a neighbouring island. They weren’t so wealthy, their wage rates were low and so they could grow coconuts very cheaply. They sold lots and lots of coconuts to the people of Isla but hardly bought anything back in return. They seemed quite happy to keep all their money in King Bill’s bank. This added to the National Debt. That’s what the experts said.

That all added up to another 100 million Bills. So their National debt was now 150% of their total GDP. Then someone said that wasn’t counting the unfunded pensions that were due to be paid out soon.  That was much too high they said.  They said things like: “You need to be more fiscally responsible”. ” You cannot spend more than you earn”. “You need to balance your budgets”.  “Money doesn’t grow on trees, you know.” The King said that his orchard workers were paid very well and it probably would work out to be more expensive to pick the money from the trees if it did. No-one laughed at his joke.

“The end is nigh” cried the islanders. Or at least the ones who had listened to the claimed experts.  “We are bankrupt. How can we ever afford to repay such a large amount?”

“Well it’s like this, ” said the king. “Once upon a time……”

(c) Copyright 2013  Peter Martin. All Rights Reserved.

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The National debt: Is it a bad thing and is it too large?

 Conventional wisdom, and many politicians, would tell us that it is. Before we accept that to be true, we might just want to first consider the relationship between all forms of debt, and credit,  in the UK national economy. As I have ties to both the UK and Australia I’ll be British for the purposes of this post. Our currency is no longer backed by gold or anything tangible. If we look at a £5 note we see we “promise to pay the bearer on demand the sum of £5”. It is really quite a meaningless commitment. The pound, like all modern currencies, is nothing more than an IOU issued by government. If the government did not issue their IOUs, they would not have their debt but neither would any one of us have any currency in our wallets or bank accounts. We wouldn’t have any credit.
 
In other words, government debt, or national debt, is simply the mirror image of non-government credit. If one account is negative the other has to be equally positive. It cannot be anything else as all accountants who know the principles of  good bookkeeping will know.
UK_sectoral_balances_1980_2012
Non- government credit can be divided between UK owners  and overseas owners. The latter may have accumulated credit by simply selling us all sorts of goods and services and later keeping their money in £ deposits in banks which ultimately end up held mainly as UK government securities. It is just another form of bank account. What else can they do with their money? If the owners of these bank accounts wish to make a withdrawal at any time they are of course free to do so.
 
UK holders can keep their credits in their bank and building society accounts, government bonds, and even their piggy banks! They too can make a withdrawal and spend it at any time.
 
We should all be careful when extending what we all know to be true at the microeconomic level to the macroeconomic level. The common analogy that a government is like a household and has to live within its means is obviously flawed. It is a fallacy of composition. There are not many households which have a currency printing press in their basement and have computers which can credit their bank accounts at will! The government is the issuer of the currency and everyone else is a user. That makes all the difference. Users can lend government IOUs to each other; but, governments cannot borrow back their own IOUs any more than an individual person can borrow back their own IOUs from their holders. (You might want to think about that for a moment) It would be just the same as writing out another one. It is reasonable to question if the term ‘borrowing’ is really applicable.
 
As a nation the UK is richer than at any time in its history and yet in general, the population worry over much about the size of the so-called National debt. Many think we are on the verge of bankruptcy. Nothing could be further from the truth. The UK can never involuntarily default on any debt denominated in the national sovereign  currency. Government cheques will never have to bounce. They can always be honoured. That is not to say that Governments can write cheques without limit. That is not to say the size of any deficit between taxation and spending can be totally ignored. Inflation can of course be a problem. If there is too much spending or if tax collection is inadequate prices will rise and no-one with any economic knowledge would attempt to deny that. Neither is it to say that there are no economic problems for the UK to face. There are and  will increasingly be problems of energy scarcity  for example. There will always be a measure of disagreement between those who would argue that inflation should be secondary to unemployment levels and those who would favour an ultra low inflation rate. There is also a question of how resources should be shared. Economics cannot settle all political arguments.
 
It can answer the question of where the money is going to come from though. If you have followed the argument so far you should be able to answer that question yourself and, if so, you are far ahead of most politicians in understanding how our economy really works.  
(c) Copyright 2013  Peter Martin. All Rights Reserved.

MMT: The antidote to nonsensical economics.

The purpose of this blog is to promote  Modern Monetary Theory. An understanding of MMT is the best antidote to the nonsense we hear so often from the mainstream media, most politicians, and even many professional economists who ought to know better.

If you’ve ever looked at a $5 bill or a £5 note and wondered why you can use it to buy a bottle of beer or a cup of coffee, when it is just a piece of paper and not backed up by anything  obviously tangible;  or, if you have ever wondered how governments can have a debt which they have no intention of ever repaying and why their creditors seemingly are totally unconcerned about it, then you might want to look further. Similarly,  if you’ve ever had the suspicion that politicians either don’t know what they are talking about on economic matters, or deliberately want to mislead, then please read on and contribute if you can.

You may just be interested in the answers for reasons of simple curiousity. They do also however carry enormous political significance, which can divisive. Probably MMT will appeal to the political left more than the right but it is in itself quite neutral. It can be used equally by both sides of politics.

Critics of MMT  charge that the creation of money is irresponsible. Yes, it can be in certain circumstances. Equally in others it is irresponsible not to create it. Resources are being wasted in most developed economies because of insufficient purchasing power. A waste of resources is relatively easily fixed  by sensible demand management in an  economy.  A lack of resources isn’t.

Contributors are welcome to claim that some aspects of MMT are incorrect if there is also an explanation of why. But please avoid telling us that you just strongly disagree or you think we are talking rubbish!

Contributions and offers of help are welcome. Please email peter_martin_2001@hotmail.com

Sections of this blog may be quoted providing they are referenced back to their source.

(c) Copyright 2013  Peter Martin. All Rights Reserved.