When I was writing the White Paper on Scottish Taxation for Common Weal that was released yesterday, Robin McAlpine, that organisation's director, asked me a range of questions on the idea of money creation and destruction by government through the spend and taxation cycle. In response I wrote a note that ended up as an appendix to that report, but as it touches on issues rarely addressed (at least here, and not elsewhere that I can think of) I thought it worth sharing in its own right. It's important to note that the concept is not exclusive to Scotland (and nor is the vast majority of the White Paper): this idea could be used anywhere.
As this report argues, government spending creates new money for circulation in the economy, at literally no cost. What it also argues is that an independent Scotland with its own currency should use this ability to generate economic activity, and so jobs, until such time as there is full employment in Scotland. At that point tax has to be used to cancel all the new money created by government spending. Until that point is reached then that is not necessary: creating more employment is the higher priority because the more employment there is the more Scotland uses its most valuable non-renewable resource for creating value, which is its people's time. And by doing that Scotland will boost its income to the highest possible degree, which is good for well-being, the supply of public services, demand, and the creation of vibrant businesses that not only meet Scottish need but also create products for export markets. Indeed, there is no better way to ensure Scotland has a strong currency than by stimulating the domestic economy in ways that in turn maximise export potential.
But this will, as some will point out, mean that Scotland will need to create more money for a while by spending than it may claim back in tax. And there will those who will say that this means that Scotland will be in debt and this process will then burden future generations with a liability reflecting current overspending. I completely disagree with that logic, as an accountant and as an economist.
In both roles the spending the Scottish government will incur will either create new Scottish assets (like infrastructure) or will, when used to pay for invaluable public services, look like what is conventionally called a deficit. Importantly, that shows the spend can, in accounting terms, be treated in two ways. But what anyone who knows anything about accountancy will also then say is that cannot be the end of the story because however the spend is accounted for there has to be another side to this story, which is how the national economy accounts for what is called the credit side of the transaction.
Only one option is usually recognised for this credit side: that credit is usually called national debt. In fact, since much of that credit balance is at present sold off as debt to insurance companies, pension funds and savers looking for a safe place for their funds that isn't wholly inappropriate as a way of describing the credit balance that is managed in this way. But what is important to note is that when this happens the country's debt then becomes private wealth in the new owners' hands. There is no mistake in saying that: government debt always represents private wealth: double entry accounting demands that this is true.
But, it should be noted, there are many forms of private wealth, and another type often favoured by those same institutions that buy what I described as government debt is ‘equity capital'. In companies this is called share capital, and the same companies that issue this equity, or share, capital often also issue debt. The two can comfortably co-exist alongside each other and both are credits on the balance sheet of a company and, come to that, of country if only a country were to recognise that it too might have equity capital.
I am now suggesting that Scotland should, when it is independent have equity capital.
Unlike debt, equity capital is usually issued without a repayment date, indicates ownership of a stake in the concern, and maybe a vote, and is considered to be the foundation on which the company is built. Indeed, it's usually said that a company is run for its shareholders, who are the people who own its equity capital.
In my opinion the idea that equity capital only exists in companies but that debt can exist in both companies and countries is absurd. After all, countries do have people they are run for. And those who run countries do have people they are accountable to, who have a vote. And those people do, as a matter of fact, have a stake invested in the success of their country. Now suppose that the money a country can create costlessly if it wants to do so, as happened, for example, when the UK created £435 billion of money to fund its quantitative easing programme, or which it can create to fund its money supply by spending that necessary money into the economy (as Scotland will need to do to create enough of its own currency to keep the economy going if it becomes an independent country) was not treated as debt reduction (as happened in that case) but was instead treated as being the equity capital of country held in trust for all time for the benefit of the people of that country.
A special body, or court, elected by the people of Scotland, or alternatively drawn from a second parliamentary chamber, could become trustees for this capital. The capital in question would not need to be repaid. Why should it? After all, it was created out of nothing. And nor would it carry interest. Again, why should it? It cost nothing to create. But it would, nonetheless, be the core funding that would keep the Scottish money supply under control, increasing over time if economic expansion demanded it, and maybe being reduced if the risk of inflation demanded that as well.
But what it would not be is debt. It would be Scottish equity capital: the money created by the nation for the people of Scotland to be held on their behalf by trustees but with the politicians of Scotland responsible to the electorate for its careful management in the interests of all. Debt be damned in that case: the balance sheet credit created by the spending Scotland would need to create the prosperity that investment and full employment would deliver would not pass into the hands of a few as private debt but would instead be held in trust for everybody in the country. This is entirely technically possible, at least if created when outside the EU (as Scotland would be bound to be for a period). And what this represents is money, economy, tax, politics and nationhood being combined into a new concept of capital that transforms opportunity for all.
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“The capital in question would not need to be repaid. Why should it? After all, it was created out of nothing. And nor would it carry interest. Again, why should it? It cost nothing to create.” On this basis, we certainly shouldn’t be paying anything like the interest we do on mortgages or bank loans in general, especially as many of their costs are essentially self-determined and could be far lower.
That aside, we’ve been collectively bamboozled for centuries about the idea of debt. The mislabelling of equity capital as you describe above is just one example. Our thinking is wrong on this, and other issues. I see a parallel between people having a hard time accepting money is created from nowhere and that the EM drive could work, that being the electromagnetic propulsion drive powered by microwaves which is essentially fuelless. It’s the one they’re saying could get us to Mars in months, not decades. It appears to run on a ‘something for nothing’ basis, then, and all our conditioning would suggest that is a state of affairs which simply cannot be. Yet, testing indicates it appears to work. I wonder what else we’ve missed through being hoodwinked about what can and cannot be in the world?
Is there perhaps a danger that from this point of view, the government could be seen to be offering “ownership” of the state to bondholders? Is that not in some senses worse than the idea that the government is in debt to them? There’s already a commonplace idea that “taxpayers” as opposed to “citizens” are somehow the owners of what governments have and do, a sort of “pay the piper, call the tune” attitude. I know that’s not the intention, but how is it avoided in this model?
Also, what would be the role of interest rates in this case? Are they analogous to dividends, or is non-infrastructure spending more like the dividend?
Hence my ‘trustees’
Something very strange is going on in Japan by all accounts (some accounts) – The collapse of the economy in Japan which was ardently capitalist has gradually, and apparently increasingly, led to the Japanese government/central bank becoming the major shareholder/bondholder in most of the country’s industries.
This is strangely perverse in that although being notionally a market economy it is drifting into an economy where in effect the state owns the means of production as if it were a nationalised economy.
In terms of economic cycles and boom bust theories Japan is actually ahead of the curve and showing us the way other major economies are headed.
My head hurts.
Energy from nothing will probably come at the same time as the discovery of the Philosphers Stone.
Thankfully sensible finance is a goal far more likely to happen in the foreseeable future.
Brian faux. I don’t see much prospect of sensible finance any time soon. Too many people in positions of power have a vested interest in it not being sensible.
Free energy however is a given. It comes from the Sun. Admittedly we need to expend some effort in harnessing it, but if you plant a potato it produces more potatoes. It’s very nearly free. If planting £1 coins offered the same yield there wouldn’t be much untilled ground. (but the rich and powerful would make spades very expensive)
Yes, viewing the state as a [peoples] company – great analogy.
My mind has fancifully ruminated on your article.
1) If your Scottish solution could apply to Wales and NI?
2) What does an independent state require to survive?
3) What would the minimum size of such a state be? Are Cornwall or East Anglia too small, who decides? A world full of peoples’ companies/co-operatives.
4) What’s the mechanism to initiate such a transition to “independence”?
5) What would a currency look like? Most money is electronic, cards etc, acceptable anywhere in the world (even surviving a trip between Gretna Green and Carlisle). Commerce has survived the open Irish border, separating different currencies. Establishing fair exchange rates, perhaps problematical in a world of mini states and national and global Establishments fighting back.
6) What would the coins and notes be? Any currency could be used? So long as tills and people recognise, display and accept those notes/coins e.g. Dollars, Pounds, Euros or Arian (Welsh for money). Why not. Like current Scottish banknotes. Waft your phone at an article or the shopping wand and get the price in your chosen denomination.
7) A better way for a devolved Europe — more sovereignty?
More questions than I ever anticipated
And good ones
I will muse
I haven’t explored this very deeply, but the Transition Movement may already have done work on answering some of Tony_B’s questions.
See: https://transitionnetwork.org/
Careful, this is almost the Positive Money constitutional change needed for money creation argument!
“Trustees for the [country’s equity] capital” is an absolutely fantastic idea. To have an extra chamber looking after the capital of the country would provide a true balance (and so much better than the MPC on steroids additional constitutional arm that is PMoney’s idea). It could be elected with the sole purpose of caring for the country’s assets/capital and would be able to prevent the sale of the family silver such as the current government engages in. A separate chamber looking after the country’s capital be they people or things is just what is needed. It would tend to enshrine the common purpose that is the reason for a country existing at all and be some sort of safeguard against its dismantling. A really excellent idea!
Thanks
“politicians of [ ] responsible to the electorate for its careful management in the interests of all”
LOL
only for somewhere like Norway with its high levels of consensus, social cohesion and sovereign wealth could such a phrase be meaningful
maybe there’s something special about Scotland…
Teflon Don, Scotland certainly is more socially cohesive than England. It may not be socially cohesive enough and Westminster policies seem deliberately framed to keep driving the wedge ably supported by an insidious media.
….Hmmmm.
If there was a chance this could happen, many people in high up places would not be happy. Scotland’s economics would be scrutinised, and slated as a ‘socialist experiment’. Supply channels to Scotland could be restricted, bribery and corruption could take place to ensure the economy could never take off and do incredibly badly. And in years to come, economy of Scotland would become a poster child on how not to run things. Venezuela 2.0 .
Because if it became a economic success, then what would happen next in the economies of the EU , UK, USA ? What happens to those who have profited from the status quo? Countries populations revolting in protest to the now obvious lies Mainstream media / politicians have told them for decades..
What i’m saying is there is many with huge vested interests, who will never let this happen.
I believe in the power of people
But those people cannot be allowed to run free doing whatever economic nonsense they think works and appears, only appears, to be making society wealthy. The power of people is surely best harnessed and pointed in the same direction for the benefit of the national good. That is proper socialism.
I am not sure I follow your logic
Yes Richard I agree ” the power of the people”. But what you propose although compatible with private business organisations is incompatible with the property relationships of Capitalism. Unless we can solve this problem what Tony says will come to pass. The second chamber should not be subject to elections; that will just pass its control to the MSM. People should appoint themselves. Ok it will need to be largely internet based, but as a body it would be very difficult to suborn and corrupt.
Power of people, Richard.?
Interesting theory.
The EU, UK and USA are likely to have their hands full as it is in the future. International economic chaos looms as the West’s financial system gets ever creakier. In the midst of the confusion would be an excellent time for a new economic operation to get itself quietly established while those who might wish to obstruct its emergence are occupied elsewhere. No better time than the near future for Scotland to take a punt at going it alone. May the road rise with them if that’s the route they choose.
“Power of the people” or “power TO the people”. Down with elections and professional politicians. Sortition and deliberative democracy would be an ideal basis for the proposed overseeing chamber.
Tony,
I too worry that the rich and powerful would sabotage any attempt at radical economic overhaul. However, I don’t think such sabotage is inevitable or inevitably destined to be successful.
Firstly I think the bigger and stronger the country is that attempts it the less success wealthy individuals, corporations and foreign powers will have in their sabotage. For that reason I believe Scotland must stay a part of the UK and the whole UK has to go down the radical reform route. Furthermore the UK should stay a part of the EU and work with progressive movements across the continent to try to get Europe to go down the same route together.
Secondly the rich and powerful are not all the same. Yes some are sadistic narcissistic sociopaths, probably more than you find among the rest of the population. However, many are good people who are as much caught up in the system as the rest of us. We have to appeal to the good people among the rich and powerful and convince them that a better way is possible for all of us, them included.
Only by uniting the good people from all levels of society will a new way ever be possible.
Richard , you have probably blogged on this subject and I have missed it but could you give your opinion on whether an independent Scotland would actually need a Central Bank if it were to adopt the Euro ?
Yes, but only as a regional debt management office
So the European Central bank would be the bank of last resort so to speak?
It would have to be
But I would not recommend it
FWIW I fully endorse this proposed way of looking at Government money.
Changing the lenses that we use to look at things is a very important part of developing a new narrative for a better society.
I think an equity contract for a whole country might look pretty much like a debt contract as there is no chance of getting a return of say 40% pa and also little chance of losing 50%. Essentially the risk profile for a country looks pretty much like the returns on bonds or any low risk investment.
But I am not suggesting that one be paid
I am proposing reinvestment for the national interest
If the creation of money by a bank is simply a double entry – debit loan account, credit borrowers account – then the destruction of money comes with either repayment by the borrower or through the debt becoming bad and being written off.
A bad debt would surely require the reversal of the originating double entry – debit borrowers account, credit loan account. And so, unlike with commercial entities generally, the outstanding loan amount would not be debited to the P & L account. Commercial banks make money through the manipulation of social constructs which, by defintion, are underwritten by society.
The greater part of Government expenditure is immediately cancelled out by receipts leaving a “deficit”, if the Government had a cash book this would be the excess of the debits over the credits. The Government has no store of cash, it simply has a balance on a control account, I can’t see how it can have a liquidity problem. But it chooses to act as a company and issues gilts to the value of the deficit. We know this is not necessary because the BoE (the Government) has repurchased the gilts proving that the control account of the government and that of the BoE are linked and can be consolidated.
I think that the concept of a social equity control account is a splendid one.
Your logic is sound
But incomprehensible to most
Full employment is a pipe dream with the era of machines/robots replacing workers around the corner. Scotland will not be able to mitigate the impact of less workers in the economy.
I simply do not believe this
We will need to change what we understand by employment
And we will
Glenn,
Unless you think robots are likely to be able to teach our kids, take care of our sick and elderly, create art, perform in sporting events, invent new ideas and technologies, expand our scientific knowledge and entertain us then there’ll always be plenty of worthwhile stuff for us humans to be doing. In fact the more robots there are doing all the mundane and repetitive tasks of production and maintenance the richer we’ll be because there’ll be so many more humans freed up to do all the human stuff that matters most.
Reading some of these comments I think a lot of people should take a look at the work that Akhil Patel is doing on the influence of the 18 year property cycle and the way that land prices underlie the entire flow of the economic cycle via ‘the economic rent’.
Much of his thinking is not new but harks back to much earlier insights which more recent economists seem to have forgotten or choose to ignore.
Akhil is not so much proposing a financial revolution as pointing out that understanding the cycle is of considerable benefit to investors and they ignore these longer term trends at their cost.
Understanding the inherent relationship between land prices and wealth creation would however radically alter the way we implement financial, fiscal and economic policy.
Assuming that what his studies reveal is actually correct. I don’t have enough grasp of the ‘dismal science’ to be entirely confident, but it sounds rational.