I am bored, mightily bored, with the argument that goes along the lines of a commentator here this morning who said:
Every penny spent on public sector salary must first be taken, on pain of violence, from the purse and wallet of a private sector worker, under the name of tax.
I am equally bored by the argument that is made time and again that in order to spend when tax revenues do not cover state costs the state must borrow and be subject to the whims of the market.
These statements are not true. Not only are they not true, they are profoundly incorrect and reveal a shocking level of ignorance on the part of those making them about the nature of government, money and econoMICS.
As evidence I’ll quote Galbraith again — from the piece I referred to yesterday — because it is so good:
The U.S. government spends (and the Federal Reserve lends) in a very simple way. It does so by writing checks — in fact simply by marking up numbers in a computer. Those numbers then appear in the bank accounts of the payees, who may be government employees, private contractors, or the recipients of federal transfer programs.
The effect of government check-writing is to create a deposit in the banking system. This is a “free reserve.” Banks of course prefer to earn interest on their reserves. Thus they demand a US Treasury bond, which pays more interest without incurring any form of credit or default risk. (This is like moving a deposit from a checking to a savings account.) The Treasury can meet that demand, or not, at its option — it can permit, or not permit, the stock of US Treasury bonds in circulation to increase.
So long as U.S. banks are required to accept U.S. government checks — which is to say so long as the Republic exists — then the government can and does spend without borrowing, if it chooses to do so. And if it chooses to issue Treasuries to meet the demand, it can do that as well. There is never a shortfall of demand for Treasury bonds; Treasury auctions do not fail.
In the real world, the government creates demand for bonds by spending above the level drained by taxation from the system. The extent to which those bonds are held locally, or abroad (another common source of worry) depends on the US current account deficit. This also has nothing to do with approval or disapproval by foreign bankers, central bankers, or their governments of American deficit policy. A foreign country cannot acquire a US Treasury bond unless someone outside the United States has acquired dollars to pay for them, which is generally done by running a trade surplus with the United States. And when foreigners do acquire those dollars, then like domestic banks they prefer to earn interest, which is why they buy Treasury bonds.
Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks to this system. The actual risks in this system are (to a minor degree) inflation, and to a larger degree, depreciation of the dollar.
And that’s it.
And that’s why everything the ConDems are doing is completely and utterly unnecessary. Because as Galbraith goes on to say, we don’t need to repay the deficit. But if we do we’ll make things a lot worse.
Despite which we’re wasting a generation of people because the Tories can’t be bothered to learn how money works.
No wonder some of us are angry.
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“Every penny spent on public sector salary must first be taken, on pain of violence, from the purse and wallet of a private sector worker, under the name of tax.”
Public Sector workers pay the same tax as everyone else (barring those wealthy enough to make other arrangements).
@ Richard
Much as I try to decipher the verbiage that comes from these clever chaps that you quote, I still cannot see how we can go on spending more money than we have every year by borrowing more and more against the future ad infinitum with no apparent intention ever to pay it back.
I do however think that in this instance the cat comes out of the bag in the very last sentence. I quote “The actual risks in this system are (to a minor degree) inflation, and to a larger degree, depreciation of the dollar.” So it follows that ultimately the currency will be worth nothing and that is exactly what I would expect to happen to an economy run in this way. Is that a good investment in the future?
From the (admittedly fairly execrable) Dominic Lawson in the Independent recently:
“Nations are not like individuals, they [Keynesians] argue: for a start, they can always borrow at a good rate from international markets. The sudden threat of a lenders’ strike to the sovereign state of Greece is allegedly what shocked the Liberal Democrats into supporting the Tories’ plans for immediate deficit reduction; but the former Chancellor Alistair Darling had sensed this possibility before the general election. He was reported to have told his Cabinet colleagues that no one can tell for certain when a sovereign debt crisis would start, but when it happens, it is sudden and precipitate: “The ice seems solid the moment before it cracks.””
@woolley
The point is that you can spend to keep employment going at almost no cost at all – or even with reducing deficits (as we saw in late 2009 and early 2010 in the UK when borrowing requirements were falling) if you spend on investment that leads to growth which eventually gets the private sector to pick up which then leads to the revenue creation which in turn then supports the currency and which reduces the deficit
And you can do all this by either borrowing or just issuing money when there is substantial slack in the economy because there is no inflationary pressure – as now
Of course yo then have to act counter cyclically when the boom arrives
But the progression to failure you project does not happen – because keeping people in employment pays for itself and when the whole world is in recession all move broadly in parallel so the chance of one major currency sinking is very very very low indeed
@mad foetus
But you assume governments have to borrow
As Galbraith shows, they don’t
In other words a sovereign debt crisis exists only so long as governments think they must borrow and not for as long as they have to borrow
It is the misunderstanding and not the reality that holds governments, Dominic Lawson and others over a supposed barrel
Get heads round the reality and in this case the crisis goes away
An interesting reflection on
Deficits and depressions here
The ‘home economics’ drivel seems to have superseded the ‘uk plc run the country like a business’ drivel that held sway for so long. (Though I heard Martin Sorrell regurgitating that line on Newsnight recently, sounded rather quaint).
I suggest we run a national economy as a national economy, not some thing else.
Strangely, through the debt boom, households have been encouraged to act like governments, without understanding the unique qualities required to act this way (credit creation and taxation = counterfeiting and extortion at the individual level).
People who can’t differentiate between national, business and household accounts should have nothing to do with any of them.
You have only demonstrated, or rather Galbraith has demonstrated, that government borrowing uses made-up money; so by definition dilutes the existing money held in circulation – which is simply legalised theft from existing holders of the currency.
That it does not measurably do this during a recession is simply shows that other factors may overwhelmingly hold down prices during the downturn. However, that made-up money *is* out there, and such a government is left with a higher debt to pay. When the recession does end, inflation then will return faster than it otherwise would, because of the increased money in circulation.
Your love of Galbraith’s big words is sweet, but the macro world does have to play by the same rules as the micro in the long run. Your proposal is equivalent to suggesting struggling UK individuals should rush out and take massive fixed-rate loans to pay their debts due this year, because interests rates are so low. That might be true, and it might even be possible, with a friendly or daft bank manager, but you are still left with a massive loan to repay, with interest. And these are struggling individuals that we already know cannot afford these repayments…
Martin Audley: “Quote You have only demonstrated, or rather Galbraith has demonstrated, that government borrowing uses made-up money; so by definition dilutes the existing money held in circulation – which is simply legalised theft from existing holders of the currency.”
I find describing it as theft a bit strong, but it hints at what funding by inflation is – a tax. The difference when compared to other taxes is that instead of taking the money directly from people, it takes a fraction of the value of all the money in circulation.
One of the often overlooked issues is that, as a tax, it is relatively regressive. People at the lower end of the wealth scale will tend to have the majority of their savings in cash and accounts denominated in Sterling, whereas those who are wealthier are more likely to diversify into other investments.
@Martin Audley
Your analysis is very sweet
Where do you think “real” money comes from?
And do you really think the UK is the same as a household? It’s a delusion Thatcher suffered from, Surely you don’t too
Because let me assure you – if you do, you’re very, very wrong
Start with the fact that households do not issue currency and countries do if you haven’t noticed the differences to date
@Paul Lockett
Shall I tell you something you seem not to have noticed?
People at the lower end of the wealth scale tend not to have savings
It’s why they’re at the lower end of the wealth scale
It’s why they aren’t much affected by inflation
It’s why the obsession with it is a wealth related issue – of the wealthiest imposing the pain of creating stable monetary value on the poorest by imposing unemployment on them
Try looking around you sometime Paul at the real world
It would help you get in touch with what’s really going on
“@Paul Lockett
Shall I tell you something you seem not to have noticed?
People at the lower end of the wealth scale tend not to have savings
It’s why they’re at the lower end of the wealth scale
It’s why they aren’t much affected by inflation”
No, I noticed it perfectly. I’ve addressed this issue in the past and made exactly that point. The very poorest don’t tend to have the opportunity to save. That much is self-evident.
However, the people who are slightly above that level and manage to scrape a bit together, will almost certainly have it in cash or Sterling denominated accounts and will be hit much harder by inflation than somebody who is much wealthier and has diversified into land, shares, commodities, etc.
“It’s why the obsession with it is a wealth related issue – of the wealthiest imposing the pain of creating stable monetary value on the poorest by imposing unemployment on them”
Don’t get me wrong. I’m not suggesting that inflation should never be used to dilute public sector debt. I just want people to understand and consider all the consequences of that course of action.
Surely you wouldn’t disagree with displaying that kind of responsibility?
@Paul Lockett
Yes of course I would
Deflation is much more dangerous
Some inflation is essential to a thriving economy
“Deflation is much more dangerous”
Now, you’re an economist and I’m not. I understand the theory here – deflation is bad because people don’t buy stuff as they expect it to be cheaper next week/year. And so we end up in a permanent slump.
But – surely people don’t put off essential purchases. They buy food and medicine and the clothes they need. They might put off buying televisions or cars or luxury products. But have you not argued before that the private sector basically is all “froth”, and everything essential is provided by the public sector.
And so does it not follow that if we want an environmentally sustainable future, an economic environment where people are encouraged to refrain from buying “froth” may actually be a positive thing? Perhaps what we need is a radically re-alignment from a “borrow and spend on froth” culture to an “earn and spend only on necessities and then save what is left” culture. Of course, I accept that we need sensible public spending to ensure that key necessities are available to all.
But surely the state of our society is evidence enough that drinking Cristal champagne in nightclubs, upgrading your phone every couple of months and buying 3 copies of celebrity magazines a week isn’t actually the key to happiness. And what troubles me more than anything else at the moment is not the likely economic difficulties of the next few years, but the fact that the opportuniy to rethink what we should be aiming for is slipping away and the assumption that economic growth is the measure of all value is being reinforced once more.
@mad foetus
But they also put off insulation
And thermal efficiency
And new boilers
And solar panels
And much more of the same
Adam Smith lamented states’ unwillingness to pay their debts and feared for the future. However after 250 odd years the UK has endured, and in many ways much improved (Despite wealth’s reluctance).
I doubt we are going to sink beneath the waves any time soon, but I genuinely fear the social engineering project.
All money is made up, it is a social construct to lubricate productive activity. Its quantity is irrelevant, its distribution highly relevant.
The inflation hobgoblin should scare no one if they have the means to acquire money in sufficient quantities.
(And don’t bother mentioning Mugabe or Weimar germany, hyperinflation is like hypertension, a pathological condition of a normal,necessary and naturally variable process)
However, as the thoughtful taxman Smith said:
“Labor was the first price, the original purchase-money that was paid for all things”.
So logically, you should seek to maximise employment and its rewards. The taxes derived would take take care of any remaining deficit.
However, if deficits were reduced, bond holders would lose their free lunch. The last thing they want is deficit reduction, that means the ‘markets’ would have to involve themselves in the tedious business of producing goods and services that people would want.
Far better to just have national governments post the rent for the money each year.
This is the beauty of Gideon’s plan, raise unemployment, which will raise the deficit and force the the ‘markets’ to tut tut at the mess, push up interest charges and reluctantly accept the increased return on their capital.
The ‘markets’ will also insist on being sold the exploitable social assets of the state to help ‘balance the books’.
The project’s aims would seem to transform as much of the state as possible into an interest collector for bond holders. To bend the process Galbraith describes wholly to the interests of capital.
So if a spoiled,vindictive minor aristocrat tries to scare you with tales of deficits, ignore him, he doesn’t really mean it.
@Richard Murphy
I take it that it is in response to my question:
“Don’t get me wrong. I’m not suggesting that inflation should never be used to dilute public sector debt. I just want people to understand and consider all the consequences of that course of action.
Surely you wouldn’t disagree with displaying that kind of responsibility?”
That you have said:
“Yes of course I would”
In which case, I am, quite frankly, astonished. I don’t see how anybody can view decision making based on an honest appraisal of the pros and cons of the various of alternatives as objectionable.
How else should decisions be made?
Richard,
Without getting too far off the point, does not peak oil do that job for us?
But my real point is that there should be a big debate going on about what sort of society we want to be in the future. Do we want to be based upon growth and consumerism or conservation and sustainability. And clearly, the items you mention are on the “green” side of that equation, whereas inflation is on the “red” side of the equation.
We should be discussing how we influence behaviour towards the green side of the spectrum. And it could be that deflation – couple with the right tax incentives and disincentives – breaks on the things you suggest, incrases on things like airline duty – could be part of that.
Instead the debate has become wholly focussed on cutting government spending but what is entirely lacking is any sort of vision of what the future should look like.
It’s hard to inspire people unless you have a vision. The only choice at the moment is between a rerun of the 1997-2009 public sector experiment and a rerun of the 1979-1987 yuppie boom only this time, mysteriously, without bankers.
“Deflation is much more dangerous”
Indeed it is. And it’s much more than just putting off purchases: cost reductions mean that wages reduce, and this increases the burden of debts as a share of income. The heavily-indebted get trapped in a deflationary spiral (this particularly applies to countries, as Japan has shown us).
“Some inflation is essential to a thriving economy”
And “some” is the key word here, for interest rates (or bond yields) must exceed inflation (otherwise the return on lending is sub-zero in real terms). So as soon as “some” starts to get big, interest rates start to rise. As we saw in the late ’70s and early ’80s, as inflation got embedded into the economy, interest rates rose, in some cases near to 20%. Think of what that would do to our economy now to all those with variable rate debt or those who need to roll over debt (remember that a government that is borrowing does not get to set its interest rates: the market decides them based on demand at debt auctions).
mf:
I would worry about peak unemployment far more than the rather dubious and distant doom of peak oil.