I have posted this thread on the merits of having a national debt on Twitter this morning:
It is often said that if the government borrows we, as a generation, will leave debt for our grandchildren to repay. This, however, is wrong. The belief is based on a number of falsehoods, which are compounded to create a myth that both facts and history contradict. A thread….
The first falsehood is that governments and households are like each other when it comes to economics, or much else. They are not.
Households use government-created money to record their income, spending, borrowing and repayment. That's good news: the economy depends on us having a single currency.
But, the problem for any household is that to spend and repay any borrowing it has to create income in a currency it does not control. In other words, it has to work for it.
The household that passes on debt might, in other words, demand that a future generation work to repay the debt a past generation incurred, which is why the law protects people in most cases from having to do so.
Governments aren't like this. That's because they also use government created money to record their income, spending, borrowing and repayment. It's not hard to spot the difference. The government uses the money it creates. Households use money someone else creates.
There is another difference between households and governments. Households cannot tax, and governments can.
Then let me add another couple more differences. One is that the government has its own bank - the Bank of England (BoE). Like all banks, the BoE can create money by lending. But unlike other banks, it can just create money itself. No other bank can do that.
And the other difference? That is that, unlike the average household, people queue up to place money on deposit with the government.
By convention, we call these deposited funds government borrowing, but just for the record every time you pay money into a bank you make a loan to that bank meaning that all the money in every bank deposit account is a loan to a bank.
However, we don't call bank deposit accounts on the balance sheet of a bank ‘loans'. We call them deposit accounts, whilst recognising that the money is owed back to the people who've deposited the money.
We should do exactly the same thing for governments. We should call the money held on deposit with the government by savers (which is a precise and accurate description of what government ‘borrowing' is) government deposit accounts.
Now of course banks must be capable of repaying the bank deposit accounts held with them. To make sure that they can we put a mass of regulation in place. But they can still fail, as 2008 proved, and savers have long memories.
That's why savers like saving with the government. They know the government can never fail to repay the money it owes, because it alone can always create the money required to make a repayment. Everyone relying on the government deposit guarantee scheme implicitly knows this.
This brings me to another point about those supposed borrowings by the government which should really be called deposit accounts. Just ask yourself a simple question, which is how can the government borrow the money it has itself created?
This question is almost never asked, but it's important. I need to explain one thing before answering this question. That is that the government does not need to have money in its bank - the BoE - before it spends anything.
Imagine for a moment that you had your own bank and that literally everyone in the country wanted the money you alone can create. It would pretty quickly become obvious to you that you could just spend in that case, whether there was money in the bank, or not.
Now, of course wise politicians have realised that to do this without limit would be reckless: mad, even. Keep doing it a lot and confidence in a currency would collapse. That's precisely why it does not happen. But let's say what happens instead.
When the government wants to spend the Bank of England will always (because the law requires it to) pay whatever it is told to do. It does not check the balance on the government's bank account with it first. It simply creates an overdraft, if need be.
This is not a problem for two reasons. First, that's because tax comes in pretty regularly, especially in a country like the UK where most people pay their taxes. Those taxes then help clear the government overdraft at the BoE.
I stress, those taxes do not pay for government spending. What they do is clear the overdraft created by the spending, which is something that is economically and politically quite different. Tax controls the overall money supply and inflation. It doesn't fund spending.
But if tax coming in does not clear the government overdraft at the BoE then the Treasury can issue new savings accounts to make up the difference. These can be very short-term accounts, for a few days, long-term ones for 70 years, or new premium bonds. They all do the same job.
And where does the money come from to provide those new savings? It came from the money the government has already spent into the economy, using its overdraft at the BoE, which it has not then claimed back in tax.
In other words, the new money now saved with the government was actually created by it, and now the government is paying interest (generously) to those who have no current use for it. This is how deposits with the government, commonly described as its borrowing, are created.
Of course, it need not offer these savings accounts. It can, quite legally, run an overdraft at the BoE instead, and pay no interest on that, because it owns the BoE, after all. But it does not usually do that. It provides savings accounts - or supposedly borrows - instead. Why?
Four reasons. First, because people need safe places to save, and there is nowhere safer than the government because it alone can always repay bank deposits placed with it. The government is then the ultimate safe place to save, and the country needs that facility.
Second, the government wants to control inflation and just as tax does that so too does taking money out of circulation by locking it up in safe bank deposit accounts held with the government also achieve that goal. So, these accounts play an important macroeconomic role.
Third, the City of London really could not function without this debt being in existence. Government debt is now integral to the way the money markets work, and a lot of banking would fail without the security it provides to those markets.
Fourth, and vitally, the money the government injects into the economy to fund its spending which eventually comes back as government deposits (or borrowing, if you are still insisting on calling it that) is a key part of our money supply.
Only the government can create money at will in the UK. Look at a banknote as evidence of that. However, commercial banks can also create money, but only by lending money to people.
Literally, every bank loan creates new money. No existing money is ever lent by a bank. Banks do not lend depositors' money to other people. Each bank loan is a mutual promise to pay from bank to customer and vice versa that creates new money as a result.
These loans then create new bank deposits - because every loan has to be deposited in a bank account. Just as government spending creates new taxes paid and government deposits received, new commercial bank loans create new bank deposits. That's how money works.
But, there is a problem with relying on commercial banks to create all new money the economy needs. They stop lending in downturns. People also try to repay loans and so cancel the money that loan created when times are tough.
What that means is that just at the time when the economy might need new money commercial banks try to stop making it. We are going to be there very soon.
Just as inflation will demand more money in existence, simply because it's worth less, recession will mean bank lending will become rare, meaning this source of new money will dry up. So the government will need to create more new money instead.
I stress, this means it will need to create more new money that is neither taxed back or deposited back. That money should instead be left out there in the economy for use to keep people, businesses, schools, hospitals and other services afloat.
This is what quantitative easing does, in a pretty roundabout and obscure way. It just creates new money, which the government records as debt, because it is of course a promise to pay (as is printed on banknotes). But it is just money in reality.
Or, to be bolder, it's the money that will keep our society just about going and just about hanging in as we work out the way to deal with the mess that decades of economic mismanagement from Thatcher onwards has created.
But to come back to so-called government borrowing, which is where this began, we now have two types to consider. One is safe deposit accounts that are essential to the smooth functioning of the economy. Why do we want to be rid of them? Please tell me how that will help.
The other is new money, which is technically part of the national debt, but which is, once more, just like the £80 billion or so of notes and coin already in existence that are also part of that national debt, fundamental to making our economy work.
The national debt has existed since 1694 precisely because it does make our economy work. By under-taxing the economy grows faster. By deposit taking the government provides essential security. And the national debt creates our money supply.
So when people say they want to repay the national debt there are three questions for them to answer. One is, why do you want the economy to slow down, because this is what repaying the debt will do by taking spending power out of the economy?
Second, why do you want to make our savings and the whole of the City of London much less secure by denying us the chance to save with the government? Do you really want people to lose their money instead?
Third, if you don't want the government to create our money supply, which is what the national debt is, who do you think should do it instead, remembering that Bitcoin and other crypto have worked so well?
I stress, not everything about our current structure of national debt is perfect, but the reality is that we can't do without it because savers want it. What is more, the luckiest grandchildren will inherit some of it.
But even that is not a particular problem. As the national debt has almost never gone down, and is very unlikely to do so, the grandchildren who are fortunate enough to inherit the national debt will not have to be repaid by those who don't.
So, in that case what is this obsession with the national debt all about, when it is fundamental to keeping the good things about the economy we have (and there are some) going? And why do people want to get rid of something so useful? I am genuinely baffled.
That is most especially the case when to get through the coming winter with households, business and public services intact we are going to need £150 billion or more new QE-created money which will be described as debt.
You decide then. Do we want people, businesses and services to survive or do we want to stop the growth in debt? It's really not hard to answer that, is it? But I stress, that how the debt is used matters too, and we need spending and not tax cuts. Truss has to get that right. ENDS
_____
PS If in doubt about the merits of leaving the national debt to the grandchildren please read the novels of Jane Austen and Anthony Trollope: we have been doing this for a long time and the wealthy seem to think it a really good thing to do, and there must be a reason for that.
PPS This thread is dedicated to @marinapurkiss who has to deal with @thejeremyvine's obsession with this issue more often than I do: I hope Jeremy reads it.
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id love to read an official response to this blog from the Labour Party
incidentally i like your point that savers with the Govt are similar to savers with the commercial banks –but we conveniently call one form borrowings but the other deposits,
Indeed, a good illustration of how we’re controlled and misdirected by the inappropriate use of misleading language.
This cannot be repeated enough.
It really is about time we grew up and looked at this for what is – it is what is possible.
However, we also know that taxes would have to come into play – and at the higher end of financial activity too.
And guess who wouldn’t want that?
The rich naysayers who obfuscate the debate and dimwits like Thatcherite politicians who know nothing about money.
This problem of mis-allocating money and other resources to prop up the rich and vested interest really needs to be sorted out once and for all.
Money is a man made utility for ALL and it’s about time it was.
Its not debt that we would leave for our grandchildren in your world it would be an economy dependent on money printing and that unabated printing of money would debase the currency and ensure we continue importing inflation on an ongoing basis..much the same as Turkey
Tell me how much money QE created in 2008, and even 2020 come to that?
Phil, as creating money is a state monopoly, then if the state did not create money by spending there simply would not be pounds sterling. Growing the economy (i.e. an increase in GDP) means a combination of more money in circulation, or that money circulating faster since GDP is simply the sum of all transactions. Due to the persistent accumulation of more money in the savings of the very wealthy, which takes it out of circulation, then the speed (velocity) at which money circulates in the UK has actually persistently fallen and is now less than half what it was forty years ago. That is a prime reason why UK money supply rose from £1 trillion in 2000 to about £3.5 trillion in early 2020. If the state had not accommodated that by deficit spending and QE then there would simply have been a substantial fall in GDP, otherwise known as a Depression. ALL economies depend on constant money creation by the state (no printing involved) and your comment simply displays profound ignorance about the subject. The skill is to create the right amount to avoid unemployment and not trigger inflation. Austerity in the UK simply meant the state spent far too little and thus wasted our resources and productive capacity.
Thanks
You sure you’ve got that understanding of GDP right Dr Tim.
You say that it’s simply the sum of all transactions.
So if you sell me a book for £20, and I provide personalised packaging and sell it on to the intended reader for their birthday for £25, then GDP contribution from those two transactions is £45.
Or if you sell it to me for £20, and I make a business error in my line of work, take a loss and sell it on as unwanted stock with no value added for £15, the GDP contribution is £35 from those two transactions.
Srsly?
GDP is calculated in three ways
One consequence is it is meant to identify end consumption
Micro issues of the sort you raise are inconsequential
Leoni, to be more precise. It is the sum of the money value of all transactions in final goods and services in the economy, or it is the sum of factor earnings (wages, rent, profit, interest, etc) that are the costs of production of those final goods and services. Either method gives the same answer. You can see Chapter 10 National Income and Product in Samuelson’s ‘Economics’ – my edition is 1976. There hasn’t been much progress in this area – he has a discussion about the failings of these measures (GDP, GNP, etc) which Economics has failed to do anything much about 40 years later.
Very useful and thought provoking explainer. Thanks.
Government debt is the lubricant of the economy. As they discovered 500 years ago in Venice, you cannot rely on commercial banks.
Commercial bank loans also create risk. If we all want to realise our deposits in cash, where does the bank have to turn? Only the government can cover their back.
In this sense there is a fundamental difference between commercial bank created money and government created money.
The wealthy make up fictions about passing debt onto the next generation because they want to divert us from the fact that they are hoarding all the money and they are really worried about progressive taxation.
Thanks Charles
“I stress, those taxes do not pay for government spending. What they do is clear the overdraft created by the spending, which is something that is economically and politically quite different. Tax controls the overall money supply and inflation. It doesn’t fund spending.”
Thanks for that, Richard. I do struggle to explain taxation to people I’m trying to convince that taxation doesn’t fund spending. This explanation is very helpful and may make more sense to them.
It’s also short!
The debt to grandchildren argument is obviously fallacious in its usual meaning. Every generation will have a standard of living which is defined by the goods and service which it produces, and will have a government which will decide how these will be shared out. What we may or may not borrow from each other now won’t change that.
It might make some sense if we include environmental factors such as climate change. If we allow that to happen there will be a real price to pay.
Good point. The real debt burden we deliver to the next generation is not investing in sustainable energy, clean water, etc.
So lets minimise the National Debt and make all students take out a massive student loan instead. So what has that achieved? – we have removed the non-existent ‘burden’ of the National Debt and replaced it with a crippling real burden on the next generation instead. One that will see many of them have to live with parents for years, put off starting a family, etc. That is a society that really isn’t interested in the future and has some sort of selfish death wish.
Agreed
It might catch peoples attention if it was pointed out that as savings are a part of the national debt and reducing it means the government reducing your savings. This can only be achieved by taxing savings. The traditional method is a recession but this does not work as most savings are held by rich people and the government has to provide support for the extra unemployed.
I am not sure I quite follow that
The same people appear to have no problem leaving a carbon debt to their grandchildren….
I only got half way through Capital by Piketty but was fascinated by his description of Jane Austens England, in effect the rich lived of the interest on their Government Stock and the interchangeability between income and Capital.
For example if she said that Professor Murphy was worth £2000pa it was the same as saying that Volunteer Relief Stoker Boxall was worth £30000
Correct
If it wasnt for the UK’s National Debt we could not have defeated Napoleon, Hitler or The Kaiser
The Kaiser defeated himself when he fell out with Bismarck. By the time he went into exile he was just handing out honorifics to worthies.
Hitler lost above the skies of southern England, certainly, but the financial burden was ultimately shouldered by America. Bretton Woods ushered in the hegemony of the dollar after the war made it possible.
Bismarck was sacked in 1890. It is probably true he would never have got involved in WWI, but he was dead long before then. I think WWI was quite a close run thing, but ultimately Austria / Germany were surrounded and cut off from too many raw materials.
Hitler lost the war by Operation Barbarossa and then declaring war on the USA after Pearl Harbour in December 1941. It had very little to do with the UK other than our inflated egos about the importance of ‘Blighty’.
Dr Tim Rideout,
Sure, the Soviet Union took the brunt of the Allied causalities in WW2 but this doesn’t mean that Hitler’s loss of the war had “very little to do with the UK”.
If the UK had been occupied, it would have been down to the Americans alone to have defeated Hitler. We can only speculate on how that would have gone. They wouldn’t, at the time, have been able to conduct effective bombing raids on Germany. My guess FWIW is that there would have been some sort of negotiated settlement for Europe, as there probably would have been if the D Day landings had failed. The Americans would have settled for that rather than allow the entire continent to be occupied by the Soviets.
Not that we can assume the Soviets would have still won. The Suez canal would have fallen under Italian and German control. They would have had access to much needed food, oil and other raw material imports. The Soviets would have had much reduced allied support and supplies. It’s quite likely they would have lost outright. It was a close run thing as it was.
Tim I agree with the idea that people have overemphasised Britain’s role in defeating Hitler and that the Soviets bore the brunt of it, but had Britain fallen to the Nazis then the picture might have been quite different. The Americans would not have had a foothold in Europe for one.
I accept the point that it was important the UK was not occupied. To that end Churchill directing the RAF to send a bombing raid to Berlin in August 1940 enraged Hitler and caused him to divert the air force away from bombing RAF airfields and towards London instead. That saved the RAF from elimination. However there was zero chance of the UK defeating Germany without the USA and the Soviet Union. Of those the Soviet Union was by far the most important (I think the biggest US effort went into the Pacific and not Europe). German losses on the Eastern Front were huge in both men and equipment. The bombing of Germany was peculiarly ineffective, largely because of the daft influence of Bomber Harris. The best month for German armaments production was actually November 1944. Because the Germans were supposed to be reaping the spoils of victory Hitler kept the priority on the production of civilian goods until 1941. In 1940, for example, there was no blackout in Berlin. It was only when Albert Speer was put in charge of war production that German industry got properly sorted out in terms of armaments production. I can’t remember the exact numbers but the November 1944 figures were huge – something like 2000 tanks in the month springs to mind. Interestingly the largest and most modern Krupp steelworks in Essen was never bombed while thanks to Harris the workers’ housing estates were flattened. In January 1945 Goebbels actually took 10,000 troops off the front in order to be extras in his latest film project which was a depiction of the war between Napoleon and Prussia. That was a two hour full colour (thanks to Agfa) costume drama with cannon, cavalry and the whole works. You can still see it today – I have seen a few clips on German TV.
The government isn’t particularly generous with interest rates on bonds. If you tried to save money with the government to buy a house it wouldn’t go too well. The BOE and the government are only generous with the rich and centralised control is a calamity.
A misplaced impression, I think
[…] Cross-posted from Tax Research UK […]
Regarding QE, a question that’s bothered me for some time is: Instead of giving it directly to the banks, why not use it to pay off all or a percentage of FCA registered debt? This will reduce the debt burden of families and give money back to the banks. Giving people more money to spend and banks more money to lend at the same time.
I’ve read your post above about the banks not lending in trying times, maybe this would help everyone in the short term and get things back to normal quicker.
A good number of the poorest, whose debt is not often FCA registered [loan sharks for instance], would miss out, but maybe the Citizen’s Advice Bureau could help there.
I don’t know if this is even feasible.
The money is used for public services
Do you have a problem with public services?
Good god no.
Without public services there is no society. Without a society you can’t have a decent civilisation. While there is a limit to what public services can do, they are absolutely necessary. In the past the role was taken on by feudal lords and kings [to an extent], then by philanthropy. In a modern society it’s best handled by a government and should ensure that everyone has a decent life. Sometimes that means government owned services and industries, other times bailing out companies to ensure a short term survival. I think even Adam Smith suggested that in Wealth of Nations.
I may have misunderstood QE and where it goes, but from the descriptions you’ve given before and above, as well as descriptions in the media, it sounds as if it all goes directly to the banks at the moment. Hence my question.
Banks get cash, that is true
But only because the government spends money on othjer things
See https://www.taxresearch.org.uk/Blog/2022/06/21/the-double-entry-behind-the-money-creation-in-the-central-bank-reserve-accounts/
Bloody hell that’s complex.
Appreciate the answer and the time you put into these blogs. Still don’t understand this aspect of economics, but sometimes that’s the way of things. Thank you for taking the time.
Martin
p.s. I’ve used some of your explanations to help my family and friends understand economic realities as well as point them at your blog. You’re a great help.
Thanks
Appreciated
I try….
Richard, if a country is part of the Euro, I am assuming they cannot embark on a programme of QE at all/unless it happens collectively?
Only collectively via the ECB
One of many reasons why I have never been convinced by the euro