Why ConDem economics is wrong – in about a side of A4

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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 ‚Äî 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.