Last week a wrote a blog explaining why all the data being published about government borrowing is wrong. We haven't right now got government borrowing in total of about £1 trillion; we have instead, I argued, because of the Bank of England's quantitative easing programme got government borrowing of about £725 billion.
In December the UK money supply fell by 1.4%. (Table A2.1.1 here). In other words, more was being repaid to banks as loan repayment than they were lending. The consequences are painful: business has less to spend, consumers have less to spend, demand falls, and we all head for recession. That's hardly surprising given that we have relied on commercial banks to create our money supply through their lending and we know that they're failing on all their lending commitments. So, the banks would drive us into recession if we left them to the job of creating money right now, and since this fall in money supply would also lead very quickly to deflation which has the effect of reinforcing recession because people defer sending as they think things will be cheaper in the future the outcome is really pretty bleak.
Which is why, of course, more quantitative easing is inevitable. Larry Elliott reckons it will be £75 billion and very soon and I tend to agree.
Today the IFS said the government will borrow £124 billion this year. Let's assume they're right and plug that number into my forecast, also allowing for the £75 billion of QE announced in October and the £75 billion now anticipated and we get this overall borrowing data:
| Year | Net borrowing | QE | Net |
| £bn | £bn | £bn | |
| 2005 | 35,736 | - | 35,736 |
| 2006 | 35,543 | - | 35,543 |
| 2007 | 37,182 | - | 37,182 |
| 2008 | 66,368 | - | 66,368 |
| 2009 | 147,878 | 200,000 | -52,122 |
| 2010 | 147,686 | - | 147,686 |
| 2011 | 124,000 | 150,000 | -26,000 |
| Average | 7 years | 34,913 |
Remember the basis for this calculation: since the Bank of England is buying government debt which has no chance whatsoever of being resold to the market and the Bank of England is wholly owned by the government that debt is effectively cancelled once bough by the Bank of England. The only proper accounting for this debt is to recognise the government can't and does not owe itself this money and as such it should be cancelled out even if it technically still exists.
The net impact is that this year the government will not borrow at all: it will repay £26 billion of debt. And it can do that because the only effective economic activity keeping the economy going is government spending and that spending needs to be financed by the creation of new money made out of nothing by lending - as all money is made (remember that fact - if you doubt it, read this).
Now we happily live with banks creating money to fund private sector growth if it happens and don't panic about it. We should be just as relaxed if the government is doing that if inflation is unlikely as a result. And there is no chance of inflation as a result of this activity right now. That's because there is so much slack in the economy we have real wage deflation - so there is no chance of this extra money reversing that. Of course green quantitative easing would eliminate that risk entirely, but it's practically zero anyway.
So what does this mean? Well, actually government debt is falling right now: yes, I mean that.
And it also means we can afford to run a deficit. Indeed, we can't not afford to run a deficit.
And it means that because that's true the only spending that could possibly need cutting is that which we can't afford to fund net of QE, but since over the last seven years borrowing net of QE will have been less than £35 billion on average a year or less than 2.5% of current GDP and not a person thinks we can't afford to fund that we actually have no need for a programme of cuts right now. And nor will we do so until such time as employment rises and the prospect of real wage growth returns, which seems a distant prospect at present.
In that case the whole Tory economic narrative is wrong: we can afford the current deficit and must spend at current levels to ensure unemployment falls, wages rise and tax revenues increase to clear it unless we want to keep printing money for good. Since I'd rather people worked than print money I'd go for that stimulus option now. And to do that I would, I admit, have to borrow more. But when net borrowing is negative right now of course we can and should borrow more when the cost of doing so is near enough nothing: net real interest rates are about zero or even negative for the government at present.
This is the only sane economic policy option we have. All that's stopping us taking it is the completely false story that a) we're borrowing more than £100 billion a year when we're not and b) that debt is rising when this year it will not.
And yes, I'm aware how bizarre this will sound to many people. But just remember that Schopenhauer absolutely right when he said that truth goes through three stages. In the first stage, it is ridiculed. In the second stage, it is violently opposed. And in the third stage it is accepted as self-evident. We'll be at stage 1 with this idea right now. I give it a couple of years to reach stage 3.
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This is an either/or thing… if Osborne is saying we still owe the money that’s owed to the BofE despite (the general view) that we ourselves own it, perhaps this can be taken as tacit admission from the Chancellor that in fact we don’t own it and it’s only ever been nationalised in name only, remaining in actuality a private entity all along. Cat, meet pigeons. If he says we don’t owe the money as we ourselves own the BofE, well, there goes all political justification for the cuts. All of it. Pigeons, meet cat. Perhaps we should formally ask about this as either way Osborne’s in a bind whatever he answers. Tee hee 🙂
It raises an interesting question. Why does the government want to cut spending, when they know it will worsen (and yes, I think they probably do know) the economic condition?
And the Germans must surely be asking themselves the same question, vis-a-vis printing of money. Here they were worrying about hyperinflation, when the English have pulled it off right under their noses.
The answer must be : they want a recession; they want economic chaos. And we can keep asking Why?
I like this post very much. Your argument is obviously very profound in its consequences, and therefore I am interested to see how it performs under test from greater experts than I.
Presumably there are armies of conventional economists who would dispute the delightfully sensational claim “we’re not borrowing right now”? I’d be interested to see that debate.
But are there any accountants who would dispute your key claim: “since the Bank of England is buying government debt which has no chance whatsoever of being resold to the market and the Bank of England is wholly owned by the government that debt is effectively cancelled once bought by the Bank of England. The only proper accounting for this debt is to recognise the government can’t and does not owe itself this money and as such it should be cancelled out even if it technically still exists.” ?
If you presented this post to Mervyn King, what would he reply?
I have no idea what their answers would be as yet
I have a suspicion this is an Emperor’s clothes question
I’ve heard the term Fractional Reserve Banking used. Is this the system you’re referring to in your post “Money is a confidence trick”?. So for each 10,000 deposit they are allowed to lend out so many times. If this is the case, I’m just wondering why banks feel they have to borrow from other sources, i.e. overseas. They would have an enormous supply domestically wouldn’t they?
In theory – yes
In practice they need some steady deposits – that’s the £10,000 in you example
And in practice it’s not as simple as the theorists say
“Fractional Reserve Banking” is a myth. Deposits are not taken in and then lent. Banks create credit – new currency – out of fresh air when they lend or spend and this is simultaneously deposited into the system. This undated credit is not a loan – which is for a defined period -, but actually becomes the object of the loan.
Likewise ‘Tax-payers Money’ is a myth. Tax is not collected and then spent: the truth of it is that public spending comes first, and taxation retires money from circulation, thereby avoiding inflation.
Tax-payers’ money has never been anywhere near a tax-payer: it’s mainly created by private banks quite unnecessarily when they ‘fund’ public spending – as they have for 300 years – by creating credit and purchasing Treasury debt with it.
The proof of this is that for five hundred years – until 1694 when the (then private) Bank of England first began the process of privatising our sovereign credit – the Exchequer issued ‘stock’ (ie undated credit – in the form of tallies) which was returnable to the Exchequer in payment of taxes.
The very phrase ‘rate of return’ relates to the rate at which stock-holders could return stock to the exchequer in payment of taxes.
We are at the end of a 300 year aberration. While banking as a service and honourable profession is necessary, there is no need – in a world of direct instant connections – for banks to be credit intermediaries who manufacture credit on the basis of a pool of proprietary capital. In fact, a transition by banks to a role as banking service providers is actually in their interests, since the capital requirement is minimal.
The crucial role of stock in public financing has been air-brushed from economic history for far too long.
Hi Chris, I had been wondering about this. If Fractional Reserve banking is a myth and banks create credit out of thin air, then I come back to my original question – Why do banks have to find alternative sources of funding? In Australia we are constantly being told by our banks that they can’t pass on full interest rate cuts to us, because their cost of funding (overseas) has gone up. Why do they need to borrow/obtain funds from overseas if they can create credit out of thin air.
My understanding was (and correct me if I’m wrong) that FRB is used as a type of capital adequacy requirement, ie. you can have so much in loans for every deposit you have. After all if you’ve accepted a $10,000 deposit and you then loan out say $100,000 you’re not exactly lending out that money/deposit are you?
Then again maybe this doesn’t apply across every nation.
Chris Cook, I assume you didn’t develop these ideas on your own; who are you reading please?
@Anthony
When banks create credit they do so on the basis of an amount of capital specified by the Bank of International Settlements.
But in order for their books to balance once they lend credit/virtual cash they have created they have to obtain DATED (term) deposits – even if only overnight – to balance their DATED term loans which they extend to borrowers. The need to procure such dated deposits is their ‘funding’ requirement.
The point is that bank credit is not constrained by reserves (ie liquidity) but by their capital (ie solvency).
What is not generally realised is that UNDATED (demand) deposits are a completely different form of ‘liability’ to banks’ DATED loans and deposits. Demand deposits are more akin to redeemable preference shares.
@Bill Kruse
If you are interested in sovereign credit and the history of tallies etc you’ll find that the modern monetary theorists like Randy Wray have good material building upon work done 100 years ago by A Mitchell Innes.
David Graeber’s latest book on 500 years of debt also destroys the monetary myths from an anthropological perspective.
Not that I subscribe to these theories exactly – sinecI see the need for a Modern Fiscal Theory as well in respect of the BASIS of taxation/money – but they do recognise that fiat currency is in fact a CREDIT instrument, and not a DEBT instrument.
The creditary nature of money has been airbrushed from economic history for a very long time indeed as an Inconvenient Truth.
As Steve Keen is increasingly showing, if you get this fundamental point of monetary ‘polarity’ right then your forecasts may bear a passing resemblance to reality.
All conventional economics are completely worthless as forecasting tools because the foundational assumption in relation to money is wrong: it’s as though physicists assumed anti-matter is matter.
Garbage In = Garbage Out.
.
@ Chris Cook
Demand deposits are nothing like redeemable preference shares. Preference shares are a form of equity while demand depodits are the most liquid liability form.
Many banks around the world run loan to deposit ratios under 100%. A little difficult to do if you haven’t raised deposits before makling the loans
@Paul F
Equity is an undated ownership claim over assets. So is a demand deposit, except that a demand deposit is a claim over an ‘asset’ consisting only of a promissory note manufactured ex nihilo by private banks.
Loans (dated assets) will always be greater than term deposits (dated liabilities). This is a regulatory requirement.
The difference is represented by bank capital – an ownership claim over the bank’s net assets, some of which are in the form of demand deposits.
Private banks create what are essentially look-alikes of central bank promissory notes/credits, and then deposit these at the Central Bank, which acts as a title repository for this virtual cash.
The fact that this is obscured accounts for the general ignorance of the subject.
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@Chris
Thanks for all this interesting information. Sorry to be a pest. Just trying to get it clear in my mind. 🙂
What happens if banks can raise/obtain the Dated term deposits to balance their dated term loans?
And when banks get into difficulties over loans they’ve made (ex nihilo) this would be because their liabilities (deposits) are now far greater than their assets? And presumably they can’t raise the dated loans from the market quick enough to make the short-fall.
This is an interesting topic.You say Randy Wray would be a good way to follow up on it then? I imagine it’s not light reading though? 🙂
@Chris
Sorry I meant to ask “What happens if banks CAN’T raise/obtain the Dated term deposits to balance their dated term loans?
Anthony
This is where the Central Bank comes in – on a massive scale, as we have been seeing – as ‘lender of last resort’.
Banks get into difficulties because losses in respect of their loan assets which go sour must be made up out of the proprietary capital ‘cushion’ which the banking regulators insist they maintain.
The fact is that huge amounts of non-performing debt are simply being allowed to continue because the banks simply do not have the capital to declare them in default and write them off.
This means that the banks require regular transfusions of liquidity from the central bank to make good the payments which are no longer being made on non-performing loans.
This process is known as ‘forbearance’ or ‘extend and pretend’.
The banking system is essentially dead: it died in October 2008.
Hence the expression, ‘Zombie Banks’.