The major fallacy of Positive Money (as written in Part 1) is to consider commercial bank created money as equivalent to government money, or central bank created money. Yes, commercial banks can write out IOUs or create money, in the process of creating loans, but that money doesn’t stay in the economy until the loan is repaid. It is not the repaying of loans which causes a recession it is the removal of money from the economy as that newly created money is taxed away by Government.
Statements like: “it’s almost impossible to reduce our debts without causing a recession” (1)
are at best missing the point and at worst simply wrong. Typically recessions occur just a few years after “binge” lending by banks. The 2008 crash followed after a peak of lending in 2006. The 2008 crash was not caused by those loans being repaid. There wasn’t time. Most of the lending was for property with a repayment period over, typically, 25 years. There was time though for much of that new money to be sucked out of the economy by governments’ very efficient tax collection systems. Some of them even boasted about having been able to run a surplus or at least a much reduced deficit in the years before the GFC.
Money as an IOU
To look at the nature of all money we need to look at who wrote out the IOU. An IOU written out by bank X wouldn’t be the same as one written out by bank Y. Neither of them would be the same as an IOU of government. Normally, this is not at all apparent. It would be very unlikely for any of the big banks to completely fail, but as we know from the GFC of 2008 , it is not impossible. So on an everyday basis we don’t even think about the difference. We don’t have to.
Yet, PM doesn’t consider money created by government to be an IOU. They argue for debt free government issued money. (2)
If the main fallacy of Positive Money is based on the little known truth that banks can indeed create a form of money out of thin air, the next fallacy of PM (and it is probably debatable which is the greater) is that money can be issued on a debt free basis. This fallacy, is not based on anything much at all. The much better known truth is that, if governments create money, they are creating their own debt or a liability for themselves.
On a technical note I should say that the so-called National debt doesn’t include this liability. It includes bonds and other government securities but not currency per se. If you ever hear an economist talk about how Government can pay off its National Debt any time it likes by printing money, they’ll be making use of this definition of National Debt.
Does it make any sense not to include the money base? I can’t see how. If we think of a closed economy of say 1000 people and they elect a government which issues 10 currency units to each person then the total liability of that government is 10k currency units. If each person saves , on average, 1 currency unit and the government covers the loan of those 1k currency units with bonds paying say 10% interest, the issue of those bonds would change the governments liability to 9k in currency units + 1k in bonds before any interest was paid. PM would argue that as the money base didn’t have to be financed by interest payments that therefore it wasn’t debt. Conversely, as the bonds had to be financed by interest payments it was debt. Incidentally, its not just PM who take this position. It is a broadly held view among many economists.
This argument may have some superficial appeal when interest rates are relatively high, but let us just do what all fiscally sovereign governments can do. Set our interest rates at will. We will make the interest on the bonds 1%. Are the bonds still debt but cash isn’t? What about 0.1%? The cash is not a debt but the bonds still are? What about 0.001% or the tiniest number imaginable? Say a $1 or a £1 bond paid out a cent, or a penny, of interest over the lifetime of the universe, does that 1 cent or 1 penny make that bond any different to a $1 bill or a £1 note?
Of course this is absurd, and the only logical way out of the absurdity is to consider all money, including government issued money, as debt and all bonds as debt. Cash doesn’t pay any interest but bonds or gilts do. They are both just different forms of government IOUs.