John McDonnell correctly said this weekend that running a surplus on the government's budget makes no sense.
He is right. In a clear indication that he understands sectoral balances he said:
There is an economic illiteracy about this. If you have a surplus in that sense you are actually taking capacity out of the economy.
Let me elaborate a little. What a government surplus means is that the government is not borrowing anymore: it is repaying debt.
There are two consequences of this. The first is that because government debt is a private asset its repayment necessarily reduces private wealth. You cannot interpret this any other way: it is a fact.
And if the process goes on for too long cash is cancelled: in fact, we would have no money left and there would be no functioning economy.
The reality is that government debt is the basis for private welath.
And that government money has been the foundation on which the the rise of capitalism has been built.
So, if you want to ensure the economy has cash it needs to function and you want growing stocks of private wealth the last thing you do is run a government surplus.
And John McDonnell did make that clear. And he was right to do so.
PS There is, of course, more on this in The Joy of Tax.
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There is also the aspect that, when public spending goes down, private spending has to go up, which eats into private savings. And if private spending doesn’t go up, there is likely to ne a recession, because it means the private sector is not selling enough product.
True
In the macroeconomy one person’s spending us another person’s income
Givernment cuts do, therefore, reduce income
I’m still failing to see the logic. If he knows this why has he explicitly signed up to a fiscal charter that targets a revenue budget surplus in 2021 ? Neil has pointed out what the depreciation transfers and interest payments on capital borrowing will do to that deficit over a few years so it makes no sense especially if you take it on trust that they are initiating a ‘new kind of politics’
Cuts and austerity are not the only means of reducing deficit – if anything, they increase the deficit by increasing unemployment, reducing income and thereby reducing tax receipts. That consideration may inform part of his thinking. I was also under the impression that McDonnell’s commitment was conditional. That he would not be seeking a surplus in the presence of a continued or renewed downturn. Which will almost certainly be the case under this regime in 2020.
“I’m still failing to see the logic. If he knows this why has he explicitly signed up to a fiscal charter that targets a revenue budget surplus in 2021 ? Neil has pointed out what the depreciation transfers and interest payments on capital borrowing will do to that deficit over a few years so it makes no sense especially if you take it on trust that they are initiating a ‘new kind of politics’”
I was going to ask exactly the same question. Why commit yourself to the same straitjacket? I can only surmise it is a sop to the media. I firmly believe it could well cost them too. He should abandon it and make a passionate appeal for big investment in the economy and seriously stress that this is badly needed.
I am badly dismayed by this deficit obsession, I have to say.
Richard,
“ What a government surplus means is that the government is not borrowing anymore: it is repaying debt ” ??
To whom is the government repaying this debt?
If a loan had been obtained from the US govt denominated in US$ the answer would be obvious. But if the “debt” is just an accountancy device to create assets for the non-government sector, as debts in its own currency actually are, then no repayment is possible. All governments can do is tax away those assets. ie destroy them.
You go on to say that (sort of), but, to make the process clear to the average person we ought to avoid phrases like “repayment”. It’s normal to think in terms of the repayment of debts being a good thing. We need to emphasise that govt debts are not normal!
Warren Mosler says much the same thing in his ‘7 Deadly Economic Frauds ‘ booklet (amongst others). If you don’t believe Richard, then triangulate – go and find out who else is saying the same thing. Then look for the arguments against.
The effect of surpluses on private wealth (and the effects deficits have on private wealth) is what macro economics actually looks like; not micro economics dressed up as macro that we have been fed by too many willing idiots over the years.
“The first is that because government debt is a private asset its repayment necessarily reduces private wealth. You cannot interpret this any other way: it is a fact.”
How does that reduce private wealth, assuming it is repaid and not cancelled? Repaying debt with cash preserves private wealth.
go and read some MMT
Each dollar or pound or euro of public debt increases net financial wealth of the non-government sector because each dollar or pound or euro of public debt is a balance in a securities account. Reducing the public debt reduces balances in those securities accounts.
If the U.S. government runs a $100,000 deficit it credits both a reserve account and a deposit account. When the government issues $100,000 in debt it debits a reserve account and the buyer’s deposit account; so far we have no net change.
The security, however, is a $100,000 balance in a securities account which increases non-government net financial wealth by that amount.
If we reverse this process by “paying off” the security the non-government sector loses that $100,000 in financial assets. U.S. Treasuries are as much currency as reserves and so are U.K. Treasuries.
So the more money the government borrows from someone and the less they pay back to that person, the richer that person becomes? This seems counter intuitive. I will have to try that next time I borrow money off of someone – I’m going to make you richer by not paying you back and borrowing even more.
This is a government relationship
All money is valued by government debt at the end of the day
Haven’t you noticed?
“All money is valued by government debt.” Sorry, don’t get that. What has the issuance of debt got to do with the currency? What mechanism is that? Some countries have very low or even no debt. Some run surpluses. No problem for their currencies.
Read my book – out tomorrow
I am not rewriting it here
The key here in understandng that the debt issue is in realising that it is a hangover from fixed the exchange rate /gold standard mentality where the authorities had to prioritise maintaining the exchange rate so ‘borrowing’ was necessary to drain spending power to keep imports down. That all changed in 1971 when Nixon ended Bretton Woods.
Incidentally you could replicate the money system in a classroom where the teacher has the ‘authority’ say to stop the kids gong to the school disco unless they pay their taxes and the taxes need to be paid in the teacher’s old business cards. When they ask how they get the business cards, the teacher says he will pay them for various jobs that need doing around the school. You could actually start a monetary economy (or a business card economy) where kids that didn’t want to work could obtain the cards from other kids by trading.
You could even allow them to start their own banks using their own tokens but then you would have to insist that the teacher’s cards get returned to the teacher by the bank when any taxes are paid. So in that scenario with excess cards in issue would the teacher borrowing them back offering an interest rate on the ‘loan’ be considered ‘debt ‘ ? Hours of fun.
When you say that those not “willing” to work could trade cards to those that are working you are missing an essential point. What if there is no work to be had? What if human beings are surplus to the working populations needs? We still need consumers to be strong because invariably there is a product that costs supporting jobs available but what if politicians refuse to see “the changing of the trade” and do nothing! about the fact that technology and bots are replacing human human labour at a fantastic rate leaving many around the world “out of the loop”
Shouldn’t we consider spending a basic income to those people to ensure that our business community’s retain a strong consumer. We would not have to tax until an inflationary reaction were seen in prices that truly represented “inflation”
I am sure a robotic system could be designed and programmed to do exactly that a lot more efficiently than the governments current system of educated, or rather NOT very educated or reasoned guesswork
Sall,
One problem is there are going to be more people who want to work than receive a welfare check. If we’ve learned anything we’ve learned our tribal psychology required a sense of one’s own contribution to society for well-being
Also, a basic income will only reinforce the trend of growing income inequality. Changing this means altering the capital/labor income ratio and that means pushing effective demand to full employment.
Government deficit of $100: credit to reserve account of $100 (to recipient)
Government sale of $100 security: debit to reserve account (of buyer) of $100 + credit to securities account (of buyer) of $100.
$100 reserve credit + $100 reserve debit + $100 securities credit = net change +$100
Now reverse:
Government taxes $100: debit to reserve account of $100 (of taxpayer)
Government purchase of outstanding $100 security: credit to reserve account (of seller) $100 + debit to securities account (of seller) of $100.
$100 reserve debit + $100 reserve credit + $100 securities debit = net change of -$100
“because government debt is a private asset its repayment necessarily reduces private wealth.”
How does that work then? Private investors hold £100 of government debt. That debt is paid off. The investors hold £100 of cash. How does that reduce private wealth, professor?
Go and read some MMT
I have no reason to rewrite it for you
Please see my earlier comment.
You can begin with the premise that ‘your income is someone else’s spending’ and vice-versa (easily understood).
You could stop trying to confuse the specific experience of the individual bond-holder (and the repayment of current bondholders) with the overall expansion or contraction of the govt. sector(not helpful).
If your still uncertain, see Ben’s earlier comment.
Repeat after me: sectoral balances must sum to zero
“The net saving of corporates and foreigners during the pre-crisis years was balanced both by a public sector deficit and by a growing deficit in the household sector (blue line). We now know that the household deficit was associated with unsustainable credit growth. When the crash came, households switched abruptly from deficit to surplus. Foreigners, corporates and households were all net saving at the same time. As I said, the sectoral balances have to sum to zero: so the increase in the government deficit balanced the desire of all three private sectors to save at the same time. When no-one wants to spend, someone must, and that someone is inevitably government. Government is the “spender of last resort” ”
http://www.coppolacomment.com/2015/03/repeat-after-me-sectoral-balances-must.html
“Economist Martin Wolf explained in July 2012 that government fiscal balance is one of three major financial sectoral balances in the national economy, the others being the foreign financial sector and the private financial sector. The sum of the surpluses or deficits across these three sectors must be zero by definition. Hence, a foreign financial surplus (or capital surplus) exists because capital is imported (net) to fund the trade deficit. Further, there is a private sector financial surplus due to household savings exceeding business investment. By definition, there must therefore exist a government budget deficit so all three net to zero”
https://en.wikipedia.org/wiki/Sectoral_balances
Richard what was that simple equation you quoted some months ago about Government Spending Private Spending and the balance of payments with the rest of the world equalling zero
http://www.taxresearch.org.uk/Blog/2015/06/10/why-osborne-cant-deliver-perpetual-government-surpluses/
That one?
Ben Johanssen, the key to this is not the paying-off of government debt itself but the means by which it does so. Running a sustained fiscal surplus withdraws money from the private sector that would otherwise have gone into private sector saving and consumption. That money is then returned to the private sector in the form of (we assume) early redemption of government bonds. The majority of government bonds actually in circulation (ie not bought by the Bank of England) are held by banks and pension funds, which would be obliged to reinvest in alternative safe assets rather than spending the money or investing in risky assets. So paying off debt works exactly like QE – tightening the government bond market to force out those investors that can switch into riskier assets or spend the money. The difference is that the money is extracted from the private sector first, including those parts of society that have much higher propensities to consume than the holders of assets generally do. Paying off debt via a sustained fiscal surplus is therefore neutral from a money supply point of view but contractionary because of its distributional consequences. It is also regressive.
Oh, and to clarify: the money supply position is neutral, but because government debt (which is the savings of the private sector) has been destroyed, the net financial asset position of the private sector is smaller. I don’t think it’s quite correct to equate this with wealth destruction, though, because all else being equal, the smaller supply of debt should reflect itself in a higher price. Wealth may therefore be unchanged in value. As I see it, the problem is one of distribution. Paying down debt extracts money from workers and gives it to the owners of capital. Admittedly this extinguishes part of the notional claim that the owners of capital have on the incomes of workers through their ownership of debt assets, but personally I’d rather see private sector debt assets written off than government debt assets either paid off or written off. I think this is far more important.
Treasuries can be used for settlement of debts just as reserves can be. It’s money, and with a market of $180 trillion a highly liquid one.
And the last points are fundamental and key
The question was how paying off the debt reduces financial wealth. I’m just presenting a simplified accounting relationship to answer the question.
“The reality is that government debt is the basis for private ”
welath.”
So how come there are so many rich people in Hong Kong, where the government has been running a surplus for years? By your reasoning, they should all be dirt poor.
Hong Kong is a satellite state
The money merry-go-round:
http://www.zerohedge.com/news/2015-09-28/cotton-candy-market