The debate on this blog over the last few days on money creation by banks - as a result of which it has been shown that all central bankers now know, even if they do not freely acknowledge - that all money is created out of thin air by the banking process, has powerful policy consequences.
I was going to write about one of these, which is that this means that most savings have no relationship to investment in the economy, but then read a paper by Michael Kumhof and Zoltán Jakab for the IMF in 2016, and note what they have to say on this instead:
Many policy prescriptions aim to encourage physical investment by promoting saving, which is believed to finance investment. The problem with this idea is that saving does not finance investment, financing and money creation do. Bank financing of investment projects does not require prior saving, but the creation of new purchasing power so that investors can buy new plants and equipment. Once purchases have been made and sellers (or those farther down the chain of transactions) deposit the money, they become savers in the national accounts statistics, but this saving is an accounting consequence—not an economic cause—of lending and investment. To argue otherwise is to confuse the respective macroeconomic roles of real resources (saving) and debt-based money (financing). Again, this point is not new; it goes back at least to Keynes (Keynes, 2012). But it seems to have been forgotten by many economists, and as a result is overlooked in many policy debates.
The implication of these insights is that policy should place priority on an efficient financial system that identifies and finances worthwhile projects, rather than on measures that attempt to encourage saving, in the hope that it will finance desired investment. The “financing through money creation” approach makes it very clear that with financing of physical investment projects, saving will be the natural result.
The obvious question that follows is why is the UK still spending more than £70 billion a year subsidising savings that deliver almost no economic value in that case?
I would argue that value could be recreated if those savings were genuinely saved as new capital. But in their current form that does not happen.
This is an area where massive rethinking is required, as has been signalled on this blog in recent years. That work will continue.
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“The “financing through money creation” approach makes it very clear that with financing of physical investment projects, saving will be the natural result.”
Fact: most/many renewable projects have a debt/equity ratio of 80/20. The debt coming from ……..well the article explains that. Thus does the real world of renewable financing reflect what the IMF said. (& for the nit pickers – yes the 80/20 ratio is not fixed & does vary).
It’s the renewable projects that don’t happen where we want to know the financing not the ones that are up and running.
Take the supposedly big issue of nil bids for offshore wind in 2023 or something mundane as Salford council backing out of installing a heat pump. (https://www.energylivenews.com/2024/01/02/salford-abandons-heat-pump-plan-over-costs/)
Let’s not pretend that the failures were down to getting their debt/equity ratio wrong and the learning what went wrong should start from there.
Your explanation is?
Mr Political Economist,
“Let’s not pretend that the failures were down to getting their debt/equity ratio wrong and the learning what went wrong should start from there.”
I did not pretend they got the debt/equity ratio wrong. In the case of AR5 (allocation round 5) the reason for no off-shore was straight forward – despite the gov’ having been told by various orgs & companies that the maximum bid price of £44/MWh was far far too low (£65 – 70 was more like it) the gov stuck to its guns and the result was: nul points (ref: Euro-Its-A-Knockout). The reason that 65 – 70 was needed was (in order of impact): raises in raw material costs (caused by raises in energy prices) coupled to raises in interest rates. The latter has an amplifying impact on WACCs (weighted average cost of capital) given most projects, as I noted tend to use lots of debt (cos its cheaper than equity). For the avoidance of doubt and to avoid ping-pong on this – I’m not offering a PoV – these are realities.
Expressed another way: the auction strike price is, +/- the levelised cost of electricity. Whilst the gov could do little regarding rises in raw material/equipment costs, it made matters worse by hiking interest rates – thus feeding the growth in WACCS – which in turn force levelised costs higher. The end result is that UK subjects – like you – pay more for their electricity. That was clever wasn’t it? & given utterances from the “loyal opposition” the situation will continue. Something to look forward to eh!
Completely agree, savers don’t necessarily invest and I think the very obvious reason that this policy is in place is because it suits the wealthy. Giving away currency to those who already have enough currency is a recipe for increased societal inequality and perhaps eventually political chaos. Who wants or benefits from that?
“The implication of these insights is that policy should place priority on an efficient financial system that identifies and finances worthwhile projects”.
This approach relies on an approach to the economy and money, that essentially takes us back to Minsky. Money is central to economics; it is not neutral. The traditional paradigm of money as a “veil” obscuring the real economy, may be countered, according to Minsky’s account in “On the Non-neutrality of Money”, in this way:
“Every capitalist economy can be described in terms of two sets of balance sheets ………… In this structure the real and the financial dimensions of the economy are not separated: there is no so-called real economy whose behavior can be studied by abstracting from financial considerations…….. Furthermore, the presumption that this system has an equilibrium cannot be sustained ………. In this model, money is never neutral”.
Agreed
Many thanks for this post. 🙂
The obvious answer is that savings are not just about investment. From the perspective of the saver, they are also for deferred consumption (e.g. pensions). That is a good thing and is encouraged by tax, as it means people provide for themselves and they are not an additional burden on others in the future (e.g. for providing income in retirement). In the case of pensions tax relief (the largest component of your £70 billion), tax is mostly only deferred, as pension payments in retirement are mostly taxable, with the tax free lump sum being the exception.
The other important point about investment in companies is that it does NOT all come from banks creating new money / new debt. No bank will lend a project all the money it requires – They all require someone else to take on most of the risk of losses (e.g. by equity holders in companies or a company founder’s own assets (e.g. their house) in the case of guaranteed lending). It requires genuine investors to provide equity capital that is at real risk of being lost (e.g. private equity, venture capital or the wealthy investing in start-ups). This is existing money being invested, not newly created money from bank borrowing.
In the case of start-ups, none would get off the ground without being initially financed by founders, friends and family. The rich are disproportionately important in this aspect, as they tend to be the ones willing to risk their own money on new ventures where there is a very high risk of total loss, which those who are less well off are generally not able to accept that level of risk.
If you want an entrepreneurial culture with new start ups being able to access capital to get started, you will need to encourage the rich to invest in such companies, which the current tax system does through schemes like EIS.
Yet more drivel
The £70 billion is made up of:
1) Income tax, much at 40%
2) NIC
3) Corporation tax
4) No tax on fund accumulation
At best part of returns are taxed to income tax – the rest are all permanant losses
And it is only part of the return that is taxed (75% at nost), and then usually at basic rate
So your claim is a work of fantasy, not fact
And yes, I undertsand equity – but right now it is negative for large companies (share repurchases exceed flotation proceeds) and the EIS etc market is tiny whilst private equity is asset stripping
Call again when you have a real world comment
Rupert,
You are in danger of over-reaching. I write as someone who spent a life in business; so no soft-soap please. The amount of seed risk capital in start-ups is typically low, proportionately; and notoriously difficult to raise in the UK. Often it comes with severe penalties for the entrepreneur (perhaps an engineer or scientist). The vulture capital industry (well, that was what it was known as, by insiders in the 1990s), would often design a deal with severe penalties that delivered the controlling equity cheap, in the event of failure – and they cleverly defined what ‘failure’ meant, after all they had the money for lawyers; the likelihood of failure under these conditions may be far higher than the originators foresee, wrapped up in commitment and enthusiasm. Equity capital hates taking real risks, and is always looking to off-load risk. Do tell me it isn’t really like this – any more? It is all a breeze.
Even where non-vulture Angel or seed investors will bite, it arises where there are special features that offer some unique market advantage; but even more likely, the investors do not go first, but wait for someone else to make the first supporting move for the start-up; often a public sector source. The most famous case of all is the US development of the original Google algorithm, that was funded first, by a Federal Grant. Then the equity money moved in. Google was intended as a high aspiration open access business vision. Eventually, when the real money came in, it was corporate, and the ‘aspirations’ drastically changed, after the dot.com crash (Zuboff). Mazzucato has also written well about the reliance of seed-capital investors, allowing the initial risks to be first taken for small start-ups by public funding sources (which, of course are also very scarce). The ground-breaking, risk-takin proclivities of Capital, is not all it is cracked up to be; and although it never gives any credit, it often lives parastically off the risk-taking of the public sector; but it would never do to admit it: the omertà of risk capital.
Much to agree with
Reflecting on this makes me realise more than ever before that it is the rich who seem to accumulate money for money’s sake or use it to terraform for themselves, thus robbing everyone else of the fabulous utility of money.
Would it be right then that savings are required not for investment but for liquidity purposes?
I think the answer is regualtory purposes – b ut let’s be clear – lending always creates them. It is their allocation that is the issue.