Prof Charles Adams of Durham University posted this on Progressive Pulse on Saturday. It is well worth sharing here. I have already tackled one of the falsehoods perpetuated about the UK economy this morning, which is that the UK has debt of £1.8 trillion when the real figure is less than £1.4 trillion. Charles slays another one of the gross misunderstandings that election economic debate suffers from:
The household fallacy
It's election time and the household fallacy is back in vogue.
On Radio 4s “Any Questions” this week a lady asked (more eloquently then my version, go to 14.45 minutes in), how are we supposed to teach our children about counting their pennies when politicians are promising to spend on this, that, and t'other? The answers given by the panellists were uniformly disappointing. Here's what I might have said.
We need to teach our children and everyone else, including politicians, that goverment spending and our spending do not work in the same way.
When the goverment spends, that spending is someones income and that someone pays some tax so the government immediately gets some of their money back. And then that someone spends most of their money which becomes other peoples income. And these other people also pay tax, so the government gets another fraction back. And these other people also spend which becomes the income of even more people who also give a fraction back to the goverment. And so on. If everyone spends then the government gets all its money back. Whereas when you or I spend we do not get anything back. That is a big difference. The only way the goverment can be in deficit is if the people decide to save. The goverment debt is simply the peoples savings. If at any point the people go out and spend their savings, then the goverment debt will be cleared.
Now if that all seems too difficult, and I am allowed a bit more time, lets try to think about things another way.
Imagine your household were like a country. In your household there are people that can provide everything you need. There is a lady who builds windmills that provide power, there is man that looks after the pigs, there is someone who grows vegetables and a wise person who teaches the children. In this utopian self-sufficient household there is no need for money. Everything you need is provided by the labour of the occupants. Everything works fine until someone decides to spend their days drinking beer rather than working. To prevent this, the elders introduce a system of credit based on post-it notes. The credit notes record how much work each person contributes and can be exchanged for beer, wooden toys or whatever they desire (you can try this at home, if someone does the dishes they get a post-it note which can be exchanged for chocolate or saved for a future purchase). When the elders need someone to mend the roof they reward them with post-it notes (of which they have an unlimited supply). But as the number of notes in circulation gradually increases, the makers of wooden toys realise that they can demand double and buy more beer, but then the brewers want more notes for each beer and people start to get upset. To stop this runaway inflation the elders need to prevent the quantity of credit notes growing faster than the amount of work getting done which they do by taking back a fraction of the notes each time they are exchanged. This we call tax.
The elders, via issuing credit, have enormous power to decide what gets done. Whether the roof gets mended or not, or whether we need another windmill. For this reason the other members of the household need some way of replacing them if they misuse their power. And lo, the household invents representative democracy!
Is this too hard for children (and politicians) to understand?
There is one good question a child might ask. “Why can't I create my own post-it notes like the elders do? Then I can buy everything I want without working.” The answer is. “Well you could, but others will not accept your notes. They have no value. The value of credit comes from the work that is done or promised to be done in exchange. That is why the elders have to be careful to only create credit on the promise of work and if they get that right everyone prospers.”
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I see it like this:
The Bank of England was nationalised I think in 1946.
The Bank of England is therefore owned or part of the State Government. The BoE has not been privatised – it issued billions of QE to the private banking sector from 2008 on the orders of the Chancellor and also printed money for the DUP to prop up Theresa May’s Government at her request. It does as it is told.
The Bank of England therefore issues our currency – the pound (£) under the direction of the Government. The Bank may have its opinion on this, but the Government is democratically accountable (well, until recently) and has the mandate to do this.
The pound (£) is therefore Government money – it is an expression of their fiscal policy and also funds the work and services its policies create and reflects its priorities (which is a double edged sword -see below).
Therefore the Government issues our money/currency either by telling the Bank to create it itself (as real cash or through its own very secure debt bond issuance) or through allowing private banks to create it usually as interest bearing credit/debt (but such debt actually destroys the value of real money in the wider economy and reduces the benefits of any returns to a narrow band of people which frankly is undemocratic).
The underlying worry about creating money is that of inflation. However, the tax system – if it is used proactively instead of being constantly reduced all of the time – acts as a cooling agent and helps to curb rampant inflation especially if it is targeted smartly at areas of the economy. Also, no one says that the Government has to print the same level of real money in perpetuity: the Government can vary the money creation and tax systems and adjust as needed when the maximum amount of benefit to the maximum amount of people in society is achieved. The tax system redistributes the return on printing money – or ‘investment’ more widely and fairly than returns on private debt. Period.
The biggest threat to an economy is the rise in credit – debt money produced under license by the private banks. It creates rampant inflation (bubbles) in say house prices that spill over into other areas of the economy such as rent rates and then into commodity and service pricing.
The biggest risk therefore is if the Government withdraws REAL money from the economy by cutting its wage bills for the public sector, it’s grants for social policy and its support for healthcare via the NHS and relying therefore on the issuance of credit as money.
Since the Bank of England that issues money is owned and directed by the Government, the Government can never run out of money – ever.
What is not understandable about any of this?
The follow on questions for any turned on citizen should be (maybe you can come up with more:
1. Why would a Government not print real money and leave it mostly to the private banks to do it through the issuing of credit? Clue – what job did your MP have before he/she got all public service spirited. Cui bono?
2. What are the interests of the private banks and their rich clients and how might they attempt to ensure that money was created mostly by issuing debt? Clue – look at who funds your political party. Again, Cui bono?
3. Why does an English bank note say on it ‘I Promise to Pay the Bearer on Demand the Sum of x Pounds’ and who actually pays that sum – the Bank of England, the Government or Both since they are actually one and the same?
I tell you I am getting heartily fucking sick and tired of arseholes and naysayers prattling on about the potential for Government to help people in this country.
I had to sit there and listen to the BBC tell me and others this weekend that Moody’s – the ratings agency that couldn’t even rate MBS products properly as of the 2008 crash – rating them as AAA even though the underlying loans in them had long ago began to fail as the teaser rates began to end – was ‘downrating’ our Governments credit rating!!!!!
Moodys – I wouldn’t wipe my bottom on any of your so-called ratings – OK?
Am I right in thinking that house price inflation has only become an issue after the financial deregulation of the 80s? Before then the vast majority of house purchase lending was conducted by Building Societies, usually mutual,l where their only source of income was the money they attracted from savers as they could not create money under licence from the government and the only they could lend was for house purchase? This would have put a natural brake on house prices as there would have been more of a direct relationship between house price movements and the general public’s capacity to save rather than the speculation we have today.
Paul Mayor says:
“Am I right in thinking that house price inflation has only become an issue after the financial deregulation of the 80s? ”
I think tat’s probably about right There was house price inflation to some degree before that, but more or less in line with general rampant inflation of that extraordinary period.
Following deregulation house prices were determined by estate agents having a good idea how much money the banks were good for. And it turned out to be quite a lot. Mortgage lenders (even what was left of the Building Societies) were guided by ‘market prices’. Objective property valuation had gone. If it ever existed.
@Meg Gilling
It is impossible for Governments or any one else for that matter to spend local currency outside in another currency. Pounds can only be spent in the UK. If I travel abroad I have to buy in the local currency. When a country imports it is on the basis that someone from outside wants to swap some of its goods and services for some of our goods, services or assets such as land or factories or businesses but these again cannot be removed from the country. Even if I “buy” foreign notes and coins the pounds I use to “buy” them have to be swapped or “sold” to someone who needs to spend the currency I have used in the UK. The pounds in the system do not leave the UK because they have no value anywhere else. I know I have simplified but it is basically how it works.
That is not true
I can agree to but goods and services from outside the UK in sterling
The seller just has to agree
Then they have to, in effect, buy from the UK, or find someone who does to get value for the currency they hold
But that happens every day
PSR, the ratings that rating agencies give fiat currency operating governments are worthless. Such a rating indicates the likelihood that the entity being rated is likely to go bankrupt. The likelihood that the UK government will go bankrupt is zero and will remain zero as long as it keeps its present currency system.
larry says:
“… the ratings that rating agencies give fiat currency operating governments are worthless. […]. The likelihood that the UK government will go bankrupt is zero and will remain zero as long as it keeps its present currency system.”
But that doesn’t prevent political gaming. Because politicians don’t understand that Sterling is theirs to work with.
They are cowed by exchange rates which they believe to be beyond their control. The tail wags the dog.
I heard exactly the same comments on Question Time and have been attempting to write about it myself as part of my work with UBI. The National Economy = Household Economy is a popular and very annoying fallacy.
Many attacks on Unconditional Basic Income are aimed at its assumed unaffordable, based on confusion over the Gross vs. Net effect (see Scott Santens excellent explanation http://www.scottsantens.com/the-cost-of-universal-basic-income-is-the-net-transfer-amount-not-the-gross-price-tag). It’s also not widely grasped by the public that monetary inflation and price inflation are not directly linked, especially in an abundance economy (within the bounds of a nation – specifically currency union). If every householder can have whatever they need or want and there’s still more left over, in theory there should be no inflationary pressure as there’s no scarcity. But if goods are needed from outside the nation then there may be an issue, as exchange rates will come into play. Of course there is also the ancient evolved human ‘Savannah Hunter hoarding for bad times instinct’ to be overcome, and it’s hard for logic to trump instinct a lot of the time.
I’m staring to wonder what the impact of a cashless world will be on inflation as well. One of the images of hyper inflation is that of pre-war Germans carrying around piles of Marks that are worth half as much in the afternoon than they were in the morning. If carrying physical cash wasn’t necessary then it would be less of a physical issue and could be constantly devalued electronically if necessary. Again it may only be an issue as far as exchange rates are concerned.
So my thinking is that with a highly automated, abundant, cashless economy the rules will be significantly different to those of classical scarcity based economic thinking.
There’s always scarcity. There’s the scarcity of land in the most desirable parts of town, the scarcity of expert surgeons, the scarcity of Harry Kane’s, and most importantly there’s a scarcity of minutes in the day to do all the things you would like to do. Hyperinflation happens because money is more plentiful than the supply of resources and services.
Our problem is less the overall scarcity of money but rather how that money is distributed and into what activities it is directed. UBI can help with the distribution problem but we also need a top down strategy the grows resources in a sustainable way, e.g. the Green New Deal plus training more surgeons improving run down parts of town etc.
Agreed Charles
That’s because it, quite literally, makes the money the rest of us use. Richard Murphey
Not really; the economy runs largely* off private bank deposits and the banks create those too when they “lend.”
To be sure, even 100% private banks with 100% voluntary depositors might safely create some deposits but vastly less than they may currently create via government privileges such as deposit guarantees.
*Except for mere physical fiat, coins and paper bills.
Banks issue government money under licence
See what would happen if they issued their own
And don’t quote Scotland, that is 100% note backed with BoE
Sorry, but the fact that some of the task is sub contracted does not change the reality of what is happening
Banks issue government money under licence
Actually no; banks create new liabilities for fiat when they “lend”. The problem is that those liabilities are largely a sham toward the non-bank private sector since the nbps may not, for example, even USE fiat except for mere coins and paper bills.
Sorry, but the fact that some of the task is sub contracted does not change the reality of what is happening
The reality is that sovereign spending is at least purportedly for the general welfare while the deposits banks create when they “lend” are assuredly for their own welfare and the welfare of those deemed “credit worthy” of what is currently, due to government privilege for depository institutions, the public’s credit but for private gain.
Why then should government continue to subsidize/privilege a rival for real resources whose purpose is not the general welfare?
The system we currently have is of privateers – government privileged pirates looting their own fellow citizens – not government sub contractors. Nor is the current system an ugly necessity either.
That is so bizarre, as well as wrong in parts, I can’t be bothered to comment
I live in the real world
You can live in a fantasy if you wish
Andrew Anderson says:
Why not nationalise the banking system. It’s a good enough question ?
Why allow private banks to issue money that is not theirs and charge whatever they like for it ?
I fail to see why, Richard you consider that question to be “… so bizarre, as well as wrong in parts, I can’t be bothered to comment”
I re-read it and do
And since there are 300 or so banks in the UK, which ones are on the list and not for nationalisation? And why, when regulation is what is required, in either case? Ownership by the state does not change anything unless the regulation and governance does, and there is no garantee it will. Look at the behaviour of the Bank of England on occasion as proof of that.
Exactly Richard. It is still the Government either by design or stupidity (commission or omission) who makes that private investment happen.
But why would any Government allow an economy to be dominated by depositor created funding except that they were into enabling rentier capitalism?
Even rentier capitalism cannot really fund everything (some of these functions would not give them the yields the rentiers wanted). So why keep fucking things up by underfunding them?
We need a true mixed economy of funding for economic activity. The finance sector has had its wicked way for far too long. And even then I’d like the Government to be doing MORE – not less.
If any free marketeer with any doubts about the state’s involvement in these matters needs to remember 2008.
All very worthy (lengthy) answers. I suspect it may be more relevant to the young, and certainly simpler and a great deal easier, to propose that the two main reasons that households are not like governments is that households cannot tax everyone else, and do not command the power of the currency government uses. Ask them to imagine their household decided tomorrow to issue their own currency; whether the local shop would accept their currency, or pay them a tax which their household had decided to set? If the answer is “no”, then households are not really much like governments.
True
Hello Richard -. I have taken as fact for quite sometime, thanks to you and others, that the finances of gvts do not run like household finances.
Although I am reasonably well educated, but, in economic matters, have more in common with the child you are addressing here.
I understand all this post EXCEPT ‘ the sentence ‘when the gvt spends, that spending is someone’s income’. How can that be? I just can’t get my head round that. It suggests to me that gvt spends tax after it is collected, which is not true. Everything that follows makes complete sense but not that.
I feel sorry for economists who try so hard to get the general public to get to grips with these things. I think it’s very hard for you to conceive of how difficult the concepts, that you take for granted, are for us to understand.
Suppose the government chooses to spend, make it in anything
A pension
A teacher’s pay
Buying vehicles
Paying interest
Whatever it is, what the government spends becomes someone else’s income
And if no saving in the spending chain get all money back as tax.
Thank you, Richard!
If patience is a virtue then you along with the legion heterodox economists must be among the most virtuous on the planet. There’s really nothing I can add that hasn’t already been said in academia and public over the past 20+ years. 100 years ago Einstein had a less of a problem with his Theory of Relativity which is arguably a touch more complex! https://www.smithsonianmag.com/science-nature/one-hundred-years-ago-einsteins-theory-relativity-baffled-press-public-180973427.
So one keeps asking the same old question time and time again : why do governments & orthodox (classical) economists fail to embrace facts that, albeit somewhat counter-intuitive, are actually not that difficult to understand, especially given the decades of available empirical evidence that prove the illegitimacy of Hayekian/Friedman economic theory. I think the answer may be probably brutally simple. The further right one is philosophically on the socio-economic spectrum the more likely one is to embrace (and promote) the concept of ‘scarcity’ in order to protect and maintain one’s acquired status in terms of material assets and assumed consequential influence (ego). Hence by telling the general public that there’s only so much wealth available governments have a critical lever of control over society at large that both plays into the Rees-Mogg school of superior intelligence while strengthening their bonds with the ‘Capital’ class.
It was a fortuitous stroke of (accidental?) genius by Margaret Thatcher to frame what we now know as neo-liberal monetarism via the Household Budget analogy. It makes logical sense to an electorate across the political spectrum. In a way it was a perfect storm whereby a number of events in different countries came together which seemed at the time to give credence to the Chicago economic ideology. Unpicking the argument such that it can be understood by ‘ordinary people’ and replacing it convincingly with a better analogy, I fear is a challenge too far. Even the inspired attempts of Charles Adams above, Warren Mosler before him with his (less convincing) business card analogy, Stephanie Kelton’s ‘Angry Birds’ plus many others I’m sure – have thus far failed to capture the public’s imagination. And no thanks to the MSM which gave up on independent critical analysis probably from the very day they set up in business.
Of course it’s a chicken and egg situation, isn’t it? As long as the principal academic bastions continue to peddle economic illiteracy on such a scale, supported by regressive, top-down, undemocratic governments in cahoots with their Ayn Rand-inspired sponsors then – as with the theory they promote and prefer – there isn’t going to be any meaningful trickle-down of the economic truth.
Gotta’ stop before I get carried away with what may be construed as a ‘conspiracy theory’. Which, of course, it is. A conspiracy to defraud nations of their rightful and legitimate wealth and well-being. In the meantime …. one has to maintain the impetus to educate anyone prepared to learn. As a positive post-script, it seems Bill Mitchell is encouraged by what’s happening over in Japan. With the help of W. Edwards Deming, the Japanese taught the world how to build reliable and affordable cars. So maybe they can do the same with macro-economics – given support from new western friends.
Tha5 would be good…..
“When the goverment spends, that spending is someones income and that someone pays some tax so the government immediately gets some of their money back. ”
Stupid question: what if government chooses (or Brexiteers may say forced) to spend outside UK in another currency? How does the tax flow back to the government?
It doesn’t usually spend in other currencies
But I agree the tax does not flow back, usually
But there again, they choose to spend here
And the vast majority of government spending is domestic
@Meg Gilling
When a government spends in another currency, it needs to convert fiat £ to the foreign currency first. It must go to an forex trader to buy foreign currency . The fiat £ hasn’t been destroyed… the trader still has it. That trader later on might sell the £ to someone else, and that person would then spend the £ on uk goods/services, at which point it is subject to tax and returned to the government.
That is so bizarre, as well as wrong in parts, I can’t be bothered to comment Richard Murphy
Even Steve Keen, a noted economist, admitted his ignorance of basic accounting – and remedied it.
And so did I. Basic accounting does wonders for one’s understanding of what is going on.
I know basic accounting
Unlike Steve, I am a chartered accountant
Good to hear. Then surely you know that “Bank loans create bank deposits” but not for the general welfare but for the private welfare of the banks themselves and for the so-called “credit worthy.”
Then what is so bizarre about wishing to de-privilege depository institutions?
Because the payment system must work through private banks?
But that’s easily remedied by allowing everyone to have a debit/checking account at the Central Bank itself AND by abolishing all other privileges for depository institutions so as to remove any artificial incentive to use bank deposits over a nation’s fiat in account form.
Then we shall have two payment systems:
1) the current inherently-risky payment system that must work through private depository institutions
AND
2) an inherently risk-free payment system consisting of accounts for all who desire them at the Central Bank itself.
Note that this is not nationalizing the banks but merely de-privileging them and ensuring that all their depositors are entirely voluntary
I have long advocated nationalising the banking platform to ensure that a bank failure does not threaten the payment system
That is not in any way nationalising banks
And now tell me why the state should be in the business of advancing loans to all comers?
Given that all money I credit created rather oddly your scheme requires that unless those who use the central bank only save their – depositing the left over fragments of credit created by private banks – that will be the requirement
Really?
You want to give that role to the state?
The inappropriate comparison between household/national income (and micro/macroeconomics) is not ignorance, it is possibly the most deliberate deception neoliberals play on the population.
It is quite simply the real project fear – you’ll get your household into a mess if you do this, and you know it; if you are stupid enough to elect a similarly profligate government, they will get us all into a mess.
I could scream.
And now tell me why the state should be in the business of advancing loans to all comers? Richard Murphy
It absolutely shouldn’t – TO ANY ONE, including depository institutions. That, quite arguably, violates equal protection under the law via fiat creation for private interests and not for the general welfare.
Given that all money I credit created rather oddly your scheme requires that unless those who use the central bank only save their — depositing the left over fragments of credit created by private banks — that will be the requirement ibid
If I understand what you’re saying, an equal Citizen’s Dividend* would provide the new fiat required for the transfer of bank deposits to accounts at the central bank itself as deposit guarantees, for instance, are progressively (to avoid unduly shocking the system) abolished.
The banks would then have to borrow that fiat from citizens to obtain the new reserves they would need – since the Central Bank would be forbidden to create fiat except for the general welfare, which would include an equal Citizen’s Dividend.
*financed, to a large but not complete** extent, with negative interest levied on non-individual-citizen and large accounts at the Central Bank since, arguably, ONLY individual citizens have an inherent right to save and use their Nation’s fiat FOR FREE and then only up to reasonable account and transaction limits.
**Since some fiat creation is an ethical and practical requirement.
I’m sorry – bit you’re going into areas money reform I am really not interested in
As a result I am choosing not to engage
Richard Murphy says:
November 12 2019 at 7:56 am
“That is not true
I can agree to but goods and services from outside the UK in sterling
The seller just has to agree
Then they have to, in effect, buy from the UK, or find someone who does to get value for the currency they hold
But that happens every day”
Yes. But the final transaction has to be in the UK. As you say “they have to, in effect buy from the UK, or find someone who does to get value for the currency they hold” so it doesn’t matter how many intermediary transactions take place the only way that the sterling currency can be spent is in the UK by someone.
I can buy a German car but that German manufacturer has to find a buyer for my currency using an intermediary and the eventual holder of that currency will want it because they need to transact in the UK. Exchange rates come into play as to what the value of the transaction is but with the possible exception of the US dollar most currencies can only be used to pay for things in the issuing country.
Hi Richard,
It is depressing that this homespun wisdom about economics has been successfully foisted on us. In other fields we mostly allow that things might be a bit more complicated.
To bring home the difference between the individual and the state I like to think that I would be like a currency-issuing state if, when I wanted to borrow money the lender would assume as part of their lending decision that:
1. I would live basically forever
2. By the action of me borrowing and spending money in any way I would necessarily increase my income.
3. There was never any possibility of my defaulting on the debt unless I willfully chose to do so.
4. If they decided not to loan me money I could just make my own which would work in exactly the same way.
Sadly I don’t think they believe any of the above!