Tag Archives: $1 billion

Where does the Money come from in a Monopoly game?

It has been some time since I last played Monopoly. The Board Game.  As I remember we have several players and a banker who assumes a similar role to government in our economy. He hands out money at the start of the game. Whenever we pass GO, or draw a lucky card from the community chest we get a bit more. He charges us tax,  super-tax, and might put us in jail from time to time.

We don’t like it when that happens, but where does the money come from in a Monopoly game? The more right wing players might argue it comes from other players when they land on the their Mayfair or Park Lane properties which have houses and hotels on them! They like to think that wealth creates money rather than the reverse. But those of us who take a wider view know it all comes from the banker originally.

The government/banker is always in debt. He has to be. His debts are the players’ monetary assets. Penny for penny. Would the game work at all if he insisted on always balancing his budget?

PS Apologies if this is a statement of the bleeding obvious! But, many of our highly educated (over-educated?)  politicians still seem to be in need of such.

Balancing the Budget !

As election time draws near in the UK , and the US presidential election campaigns start to get underway across the Atlantic,  we’ll no doubt hear a lot about this topic shortly, if we haven’t already.  Apologies if you’ve heard this all before but the political and economic mainstream still don’t grasp it. Political parties will accuse their opponents of making “unfunded promises”, and of having “black holes” in their budgets etc . Nations’ finances will be likened to a household.

Except that Sovereign Governments, like the USA and UK are issuers of currency. They aren’t at all like a household. If a household has a deficit of say £10k pa then, generally speaking, spending cuts of £5k coupled with an extra £5k of earnings will fix the problem. How many times do we see see the same logic applied to countries too? It never works. It can’t work. Governments afterwards wonder why. It isn’t difficult to understand:

Money Flow

Money coming into the Private Domestic Sector , which is essentially what we all think of as “the economy” can only be from two sources. Government spending directly into it (Gsp) , and payments from overseas for exported goods and services. How can anyone possibly think that reducing Gsp isn’t going to affect Taxes paid? Every £ or $ collected in tax originally comes from Govt spending.

The ability of the economy to deliver taxes to the government has to be directly related to its income. Reducing its income will  make us all poorer and reduce our ability to deliver those taxes.  Spending cuts won’t do anything like as much towards reducing that deficit as is usually supposed.

How much simpler could it be?

And yet if the “balanced budget” cretins get their way what will happen?  The government will makes cuts, tax revenue will fall and the deficit will end up not much different to what it was previously. The cretins will then argue they didn’t make enough cuts and that they’ll need to make more on the second round. And so it will go on, with increased levels of unemployment and business failures at every stage.

We just can’t let this happen. It’s madness.  Instead of forcing the budget to “balance”, we should should look at balancing all the money flows to maximise our economic potential.

Keeping it Simple

Many academics, and economists are no exception, rate difficulty of understanding as a virtue in itself . A look at any modern economics journal confirms this. A incomprehensible argument can bring a lot of academic kudos! The problem, though, is that when an argument appears incomprehensible, it often means the person making it doesn’t understand it either and it therefore may well turn out to be quite wrong.  I’ve seen one blog which compares economics to Quantum mechanics! Which is a load of b******s IMO!

We can often get a good insight into what is wrong with the real economy by looking at a very simple economy. For example, suppose we look at the case of a baby sitting circle which has been set up by parents of small children. They set up a club, elect a club council and issue everyone with two tokens. Straightway we can observe that the council are going to be in ‘debt’ to the number of tokens they have issued. That’s no big deal is it?

If every parent  both sits, and is sat for, regularly then the system should work very well. Those doing the sitting are paid one token. Those who are sat for have to pay one token.

But, say, after a time some parents start to like the idea of accumulating tokens which they keep in the proverbial cookie jar at home.. For whatever reason, they do more sitting than they need to cover their spending.  Maybe they are planning to have lots more children at some time in the future and they think these tokens will come in handy. Or maybe they just have a squirrel – like mentality. Who knows?

Inevitably, the number of active tokens in the club diminishes. Parents notice that there just don’t seem to be many tokens around any more. Parents still need baby sitting and other parents are willing to do the sitting but there are no tokens around to to pay for the service. Invitations to social events have to be declined because of that! So the members petition the club council to issue more tokens. Of course those with the biggest store of tokens don’t care for this idea. They say the members of the club have to learn within their means. They say its wrong for the council to issue more tokens and go even further into debt. They’ll warn that issuing more tokens is just a sure fire road to hyperinflation. They’ll ask if members of the club really want to have to pay with a wheel barrow full of tokens for just one night out!

Money, Government Bonds, and Quantitative Easing

Quantitative Easing is considered, by many, to be a euphemism for printing money. Is there just possibly a germ of truth in that statement? Why is it done?What exactly does it mean?

In normal times, central banks try to increase the amount of lending and activity in the economy  by cutting interest rates which encourages people to spend, not save. However, when interest rates are close to zero and can go no lower, another  option for a central bank is to lend money into the economy, by which they usually mean the commercial banks, directly. That is  supposed to be the motivation for quantitative easing (QE).

The way the central bank does this is by buying assets – usually government bonds – using money it has simply created “out of thin air” .The institutions selling those bonds , either commercial banks or other financial institutions, will then have extra money in their accounts, so boosting the money supply. That is the mainstream theory

It was used first by  in Japan to help it out of a period of deflation following an asset bubble collapse in the 1990s.

Let us just go through the steps of what happens when a government issues, say, $1 billion of new bonds and then re-purchases them. That in a nutshell is QE – although usually just the last step is considered. A government issues (prints!) the bonds. They are sold for $1 billion at auction. The government can then claim, somewhat dubiously as we will see, their $1 billion is real and hasn’t been printed. The financial institutions have their bonds. The government decides to buy them back. There would be no point in using the original $1 billion so
Government prints another $1 billion. The government gets back the bonds. As they are an IOU all they can do is tear them up. The financial institutions then have back their $1 billion, plus no doubt a little extra to keep them
sweet, so there’s no net change as far as they are concerned. The bonds no longer exist and all that is apparent is the government, somewhat to their embarrassment, have funded their deficit by printing money after all!

But is all what it seems?

Let’s start from the beginning with our understanding of what money is. Nearly all modern money is fiat based. It is not backed by anything tangible like Gold or silver. It isn’t pegged to any foreign currency and can be worth more or less against other currencies one day than the next. It has a value because of the power of governments to impose taxation and insist on payment in that currency.

All money is printed. Or, it is an electronic version of that. So the term ‘printed’ can mean either one or the other. Look in your wallet and you’ll possible have a $100 dollars or so of printed government money. They are just IOUs. You’ll maybe have a thousand dollars or so in your bank account. They are just electronic government IOUs. Basically they are the same thing.

So what is a bond? Anyone can issue a bond which is just an IOU with interest included. If the issuer sells a bond, there will be a promise to pay a certain amount at some future date. Depending on the credit worthiness of the issuer and the prevailing, and anticipated future,level of interest rates at the time, the bond will have some value which is less than the face value of the bond.For instance, I could issue a ten year bond for $200 and maybe expect to sell it for $100. That would give my creditors approximately a 7% return on their investment. That bond would be trade able during its lifetime and at some intermediate point will have a value of $150.

Governments too issue bonds. The more credit worthy the government, the less risk of their defaulting on their commitment and so the higher price they can expect to receive on issue. These are usually decided by a process of auction. When governments are in full control of their own sovereign currencies there is zero risk of involuntary default. There isn’t zero risk of inflation though, and so the issue price will probably still be less than the face value of the bond. Although there have been instances of that not being the case. It is possible to have negative interest rates. In that case investors are effectively paying a fee for someone else to look after their money.

Government bonds are still known as ‘Gilt-edged securities’ in the UK. At one time they were printed pieces of paper with golden edges. On some bonds, coupons were attached which could be handed in for the payment of interest.
The term coupon is still used for payment of interest on a bond.

The conventional wisdom is that it would be highly irresponsible for Governments to finance their budget deficits by printing money. It is not considered acceptable for Governments to spend new money into existence. There is a different argument when it comes to lending money into existence. That’s different of course! We may come back to how commercial banks by arrangement with reserve banks can create money ‘out of thin air’ in a later posting.

That argument does, of course, depend on whether bonds are not just another form of money. If we look at one piece of paper which is a bond, we have to ask if it is really different from another piece which is in the form of a banknote. One will have an interest rate associated with it but what if that interest rate is very low as would be the case presently? What if that interest rate were so close to zero that it hardly mattered? In that case it can be seen there is no functional difference between a bond and a banknote.If one is printed money then they are both printed money. The level of interest is just a detail.

Quantitative easing, the buying of bonds, and other securities by Government, is just an exchange of one form of money for another. Its all done in bank accounts in reality. There are probably no pieces of paper involved. A customer of a central bank has money in bonds when it is in one type of bank account. The process of QE means shifting out the money to another account which is currency based. The process will tend to reduce the level of interest rates but if they are near zero to start with, probably not by much. The overall effect on the economy will be small. Especially when the financial institutions choose to sit on their assets, rather than lend them out,  as they previously decided to do. Contrary to initial fears QE has not led to runaway inflation in countries where it is being used.

Yes, printing money has occurred: it happened when the bonds were first issued, which is considered quite normal, not when they are being re-bought.