Daily Archives: June 12, 2014

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.