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?

Understanding the nature of our economy doesn’t imply an ultra -left political stance any more than does an understanding of the nature of the solar system. ie Knowing that the Sun doesn’t orbit the Earth!


19 responses to “Hey there, Deficit Denier, climb down out of that Magic Money Tree!

  1. The term deficit denier is used to deride people who understand how deficits work (as opposed to actually arguing with them which would defeat the object by bringing what they’re discussing to the attention of a startled and angry broader community) just as the term currency cranks was used for much the same ends back in the 1940s. Plus ca change, then, except this time… social media 🙂

  2. You’re missing the elephant in the room – government borrowing/treasury bonds – and in the process obfuscating what is “government debt”. Yes we need an adequate supply of debt-free money appropriate to the size of the economy but currently we are lumbered with 97% of our money having been borrowed from commercial banks who have usurped sovereignty in order to create it out of thin air. In 1970 this was only 50 % and yes there is a place for banks to create “extra money” as debt to themselves – especially for private and SME funding but not 97% and not just focused on funding obscene salaries and inappropriate bonuses and actually programmed to create Boom and Bust.

    • Peter, In 1970 there was hardly any any digital money about in general circulation. There was written cheques and BoE cash. Credit cards required paper imprints. Banks in England weren’t allowed to print their own banknotes.

      All that has happened is that the use of BoE paper notes has to a large extent been displaced by commercial bank digital money. Does it make any difference to the economy? Why would it? Why does changing paper for digital make any difference?

      That’s not to say the lending of money by banks doesn’t make a difference. The banks are putting that money into the hands of someone who wants to spend it. So when we see lending occur initially there is a boost to the economy. But as the lending slows down and the debts accumulate we see the bust. So the banks can’t create new assets in the economy. Only Govt can do that. They can only create asset liability pairs. Just like you and I can.

      • Para 3 is a good paraphrase of the last 40 years. Banks frantically creating money and raking in profits and bonuses then when it all goes pear-shaped as the debt levels start to extrapolate exponentially the banks desperately haul in the loans and destroy the money; a basically dysfunctional system.
        Para 1 The 1844 bank act barred banks from printing money. They got round this by creating credits and allowing cheques to be written against them – same as digital. In 1970 M3 was c £100billion of which £50 billion was notes and coins provided as an asset by BOE and £50 billion was digital/credits created as debt to themselves by the banks.
        Para 2 beggars belief! “does changing paper [debt-free] for digital [debt to banks] make any difference?” You answered it yourself in para 3 by saying “the debts accumulate [and] we see bust.” Over the past 40 years BOE has injected £50bn new money into the system. Over the same time span commercial banks have created c.£1,700 billion as debt to themselves – Ok that is now £375bn less – i.e. only £1,350 billion – since BOE through QE has given them that amount of debt-free real money in exchange for some of the now toxic debt. The system is broken and needs to be completely revamped. PQE is a step in the right direction but the BOE/Treasury/Maastricht accounting rules need to be upended. Just as a state economy isn’t a household budget nor is double entry accounting appropriate for a sovereign currency.

      • You’re getting off the point of the blog which is about so-called “deficit deniers” and “magic money trees”. If the Greek private banks had replaced 30 million of assets in my example with 30 million of their own new assets nothing changes because they also have to assume 30 million of new liabilities too. Net assets is still 30 million.

      • Peter your reply below is nonsensical to me! I must be thick so I’ll post all my degree qualifications back to Cambridge.

  3. reallyniceguy2014

    The real deficit deniers are deficit dunces!

    Does that make us deficit wizards, adepts or masters? Technicians, scientists, logicians, accountants?

    Maybe simply deficit realists?

    Comparing deficits and holocausts is obscenely, dishonestly wrong. They aren’t aren’t mparable or like for like, apples and pears.

    • I wouldn’t say that anyone using the word ‘denier’ is necessarily invoking a comparison with the holocaust. A ‘denier’ (literally) denies the existence of. It could be dangerous climate change. So we’d have dangerous climate change denier. It could be the danger of smoking cigarettes or taking hard drugs for example. So we’d have harmful substances denier. The word has to be used in a way that does at least make some sense, but as I tried to explain in the post it doesn’t make any sense at all even for those who would argue that the deficit might be a problem – which of course it could be if inflation started to get out of hand.

  4. Wait a minute. How does the German Central Bank end up with the 10 million? Surely the money either gets converted in a Greek or German private bank. If it’s done in a German Bank don’t they rather than the CB end up holding the Greek currency?

    • There will be lots of currency trading in Greek and German and other banks as you suggest. If all countries left the exchange rates of their currencies to the workings of the market, all currency flows and trade would be approximately balance, except to the extent that anyone would voluntarily want to hold some US$ (for example) as cash or in the form of bonds could cause some small imbalance.

      But, if a country wishes to run a trade surplus it has to systematically suppress the value of its own currency. There is always going to be a shortage of its own currency and a surplus of the currency of its trading partners which run deficits. So if I’d chosen China rather than Germany the process would have involved the People’s Bank of China being instructed by its government not to sell too many New Drachma on the open market but instead buy Greek securities with those surplus ND. They wind up with the surplus ND mainly in ND securites ( they pay some interest) but some will be in cash. Just like they do right now with US$. The PBoC then just create extra Chinese Yuan (Renminbi) to satisfy their local exporters. In accountancy terms the PBoC break even because , although it has just created (some would say printed) extra currency (a liability) it has the ND securities on its books.

      It’s slightly more complicated in Germany (so probably not a good example) which shares a currency with its neighbours which would no longer include Greece if they had their own currency. Germany uses the economic weakness of it partners in the EZ to keep its currency down which causes all sorts of problems for them, incidentally. But, ultimately, if there was an imbalance of trade between the EZ and Greece someone in the EZ (either the Bundesbank or the ECB) would have to be willing to hold Greek securities denominated in ND.

      • Ah, of course. Governments are players in the FX market. Thank you. I’ll have to re-read this a few times to understand it properly.

  5. This is full of confusions. there’s a difference between a financial asset and netting a sector’s financial assets and liabilities with every other sector. Every financial asset has a corresponding financial liability. If the federal government has no financial liabilities outstanding then every other sector has no federal government financial assets. But there are plainly many financial assets that exist.

    Saying that since a bank when making a loan doesn’t increase the amount of financial liabilities the government has outstanding (which isn’t strictly true in the case of FDIC banks where deposits are always a contingent liability of the government. the contingency being the bank’s insolvency/under capitalization), it doesn’t increase financial assets at all doesn’t make sense.

    Financial assets do clearly increase as evidenced by the balance in your deposit going up and the bank having your promise to pay. It is both important to deal with the net figures to know the deficit and surplus each sector is running as well as their overall financial net worth. However, net worth is not everything. the gross proportions are also important.

    This of course goes back to a conversation a few months ago on facebook where I was telling you about my research area and you were telling me I was wrong about my research area. The federal government paid off its public debt in 1837 and its only obligations outstanding was the obligation to accept gold and silver coins in payment of taxes and public lands (most of those coins outstanding being battered spanish silver coins). Its not coherent to say there were no financial assets except for gold and silver – net financial debts to the rest of the world in the country when they paid off the public debt. what we can say is that the financial net worth of the domestic non-federal government sector (netting out all state, local, corporate and private sector financial liabilities with their corresponding financial assets held by others) was gold and silver acceptable in payment of taxes minus the net financial debts owed to the rest of the world.

    This was possible at all because most of what was “money” was bank notes issued at the state level which were acceptable in payment of taxes at the state level (and certain notes were acceptable in payment of federal taxes and public lands). State governments (and to a lesser extent local governments, as well as possible state chartered corporations that weren’t banks) ran deficits and had accumulated large debt levels.

    The point is that net worth and the deficit/surplus positions of each sector are important but so are gross positions. The Gross financial liabilities and Gross financial assets of the banking sector are of course hugely important. As Keen points out gross financial sector debts are extremely correlated with the prices of key financial assets, home prices and unemployment.

  6. *gross private sector debts are extremely correlated

    • Hi Nathan,

      Thanks for dropping by. I do try to avoid telling anyone they’re just plain wrong. All I can do is explain it as I understand it, and I do accept that it’s possible that my understanding is wrong.

      But I can’t see where I’m wrong is saying that:

      “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. ………..
      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.

      Which I’d say is the core of my argument. By assets I do mean net assets. So I guess I could include that word in more often to remove any doubt on that point.

      So we can complicate the picture and have every one in the economy with a mixture of monetary assets and liabilities which still nets to 30 million or, keep it simple and have everyone with no liabilities and just monetary assets which total to 30 million. But does that make any difference to the overall thrust of the article which is lambasting the neolibs for their talk of ‘magic money trees’ and ‘deficit deniers’?

      As I understand the sectoral financial balance theory, net assets sums to zero. But, doesn’t this only apply to a fiat currency? So at least one of three sectors has to be in deficit. Once we add in gold reserves, or any other real asset with a real value, and start counting that, then the summation doesn’t equal zero. It must equal the real value of whatever we’ve included. So if we define a unit of account as equal to the weight of a certain amount of gold and actually have the gold in the vaults, or circulating as coins in the economy, then wouldn’t it be theoretically possible for all sectors to be in surplus simultaneously? That was what I was getting at in our earlier discussion.

  7. If you mean net financial assets you should say net financial assets. there is an important distinction. saying that a bank loan doesn’t create a financial asset will prima facie get strange looks and quick dismissals from people (including neo-chartalist economists).

    Further, you must always be clear about net financial assets from whose point of view. In the above case of the antebellum economy this logic could easily be turned around. I could easily say that the financial net worth of the non New York state government sectors was equal to the financial net worth of the New York state government. There’s no inherit reason why we must say net financial assets from the federal government sector perspective. the accounting is just the same in each case. If you’re bringing these ideas to a new audience (which presumably is your purpose in writing this blog post) you have to be clear you mean from the federal government point of view before deploying the concept. otherwise you end up in a mass of confusion.

    *in the New York case you might object because New York couldn’t issue tax receivable money. The same is “strictly” true of the federal government. Yet this is acceptable because the federal reserve conducts monetary policy in such a way as to always ensure there is a market for U.S. treasuries. While this wasn’t totally true of New York state, it did charter saving banks who could only invest in government debt. once the federal government paid off its public debt, they shifted mostly into new york state and city debt as well as ohio debt. chartered banks were also required to keep bonds on deposit with state regulators.

    There were also in various times and places requirements for chartered banks to provide large lines of credit to state governments at administered interest rates. Thus the state (and many other states) used various government powers to make a market in its debt that in certain times and places came to resemble deficit spending by the federal government.

    It is this historical reason (and the institutional analysis it implies) as well as the pedagogical reason why I’d suggest you use always use the term net financial assets and say explicitly whose perspective financial assets net out from.

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