#11 Where does UK Government money really come from?

(Image by fancycrave1 from Pixabay)

This is a guest post. In it, Professor Richard Murphy (read his excellent blog here) explains very clearly everything you need to know about how money is created by governments. And why it’s important for all of us to understand it. Longer than most of the posts in this blog, but all in plain, clear language. No jargon, diagrams, graphs, or anything you need a degree in economics to understand. My notes in italics, and I have highlighted some parts in Bold for reading convenience.

“Very few people seem to understand how money is created. Mainly that’s because when they’re told, it seems so simple that they can’t believe something that’s so important that we’re willing to pay a lot to get it, is created so easily. This thread explains how money is created.

What this thread also explains is that if we understand money we can completely reimagine how the economy really works, which is the pathway to rebuilding from the mess we are in. Which makes this a pretty big deal.  I make no apology for its length as a result.”

Let’s start at the very beginning. A person goes into a bank and asks for a £1,000 loan. The bank checks them out, and agrees. And that is all that it takes to create new money. Money is just a promise to pay. That simple exchange of promises is all it takes to create it.

Most people think there must be something that backs up the value of money. Gold, most likely. But there isn’t. Money is just a promise to pay, and has been for almost 50 years now. Mutual promises to pay creates all the money we have.

So in the example of that £1,000 loan, the customer promises to pay the bank. So the bank opens a loan account for them. That records their promise to repay. And the bank puts £1,000 in the customer’s current account. They promise to let the customer spend that how they want.

Two promises. Two accounts. And as a result we get new money. That is how all money is created. It is as simple as that.

There is no one else’s money involved in this process. The bank does not lend out the money saved with them. And there are no notes and coin moved from one pile to another pile to back this all up either. There are just two promises. And then there is new money.

Making money really is as simple as promising to repay it. So why is it so expensive for some people to get hold of it? That’s not because the money itself is expensive. Clearly, it isn’t. That’s because there’s a risk that they will break their promise.

Money itself is really cheap. The pure price of borrowing money has been falling for hundreds of years. It is now officially 0.1% per annum in the UK. That’s the rate set by the Bank of England. Or just £1 a year for every £1,000 borrowed. Which is staggeringly cheap.

That’s the rate the government pays. Around £800 billion of money deposited by UK banks and building societies with the Bank of a England gets interest paid on it at 0.1% a year. And if the Bank decided, the rate could be 0%, or even negative.

So the reality is that money is almost free. Allowing for inflation, which is higher than this interest rate, money is free to the government. In fact, in reality people are paying the government to hold their money. (In Japan, Bond Rates are actually negative.)

But the government borrows more cheaply than anyone else. It creates the currency – the pound – and declares it legal tender. And it has its own bank – the Bank of England. This means the government can lend to itself. So it can never run out of money. It is risk free.

The rest of us don’t have a bank, and can’t declare the money we make to be legal tender. So all other lending is riskier. Including the money that you lend to your bank, which is exactly what you are doing if you have a bank account that’s in credit.

If you think you have ‘money in the bank’, think again. You have not. You just have a promise from the bank to pay you money if you demand it. And if they can pay it, of course. You’re now the banker. They’re the borrower. And you have the risk they won’t repay.

And that risk is real. Remember Northern Rock? The government stepped in. This is why all bank deposits in the UK have to be guaranteed by the government to a limit of £85,000. If they weren’t it’s likely no one would trust the banks to repay.

But what this means is that for most people (not the wealthiest, and not big business) the government guarantees all the money that we have. And it even, by implication, guarantees that the banks exist so that they are there to lend if and when we require it.

How is it possible that although all money is made by promises – including yours, and mine – the government is so important? First, it alone creates the currency. Secondly, as I noted, it has its own bank. So it can always repay, because it will always lend it money.

So, it’s the government and its Bank of England, and their promise to pay that is actually behind the real value of our money. Not gold. Not notes. Not coins. Not how strong the rest of the UK banking system is. The promise that the government makes is what matters.

But why is its promise so good? Because it has the means to back it up. Having a bank is not enough. Having the means to tax changes everything. That, and the ability to pass law to make sure tax is paid. And then only in the currency the government chooses – the pound.

Tax is what gives the pound its value. If the government could just create money without limit it would soon be worthless. But it does not do that. Tax ensures that the government can control the amount of money in the economy.

A lot of that money is created by the government. Every time it spends it tells the Bank of England to pay whoever is required. And it does that, because it trusts the promise the government makes to repay it. Well it would, wouldn’t it? After all, the government owns it.

But what the Bank of England does not do is check whether it’s got money available to lend the government to spend. It does not need to do so, after all. All it need do is trust the government’s promise to repay. And then it creates the money that the government wants to spend.

This is really important though. What it means is that tax does not need to be collected before the government spends. Instead the government always spends the money its bank creates for it, when instructed to do so.

But that means something else. It means the government never spends taxpayers’ money.

It also means that tax does not fund spending. That can happen without tax.

So what does tax do? It does something really important. It recovers the money the government has spent into the economy. Enough has to be collected to control inflation and make good on the promise that the government gives when it guarantees all our money.

Does that mean the government has to balance its books? No way does it mean that. Controlling inflation is the goal, and what we’ve learned is we can run deficits, and control inflation.

But that has come at a price. That’s been unemployment, low wages and lots of crap jobs that add little value to society or the lives of those who do them. To be polite, that’s the economic policy of a callous government that does not care.

Forcing people into meaningless, low paid work is a price too high to control inflation, even if that also means lower taxes and that deficits do not threaten to create economic instability. There has to be a better way to manage the value of money than this.

And there is. We could have a government promise full employment. It could create the jobs we need. It could force up the minimum wage by guaranteeing local work for anyone who wanted it. And we could improve benefits too. All using government made money. Not tax.

But would there be inflation then? Not if we then taxed enough and cut spending a bit. But people at work in good jobs do pay more tax. And they claim fewer benefits. So that condition is easy to meet. And if we still needed more tax? Well, we could do that, if needed.

But that need would not be to fund the spend. Tax is never needed to fund spending. Always remember that. It’s needed to control inflation. And to redistribute income and wealth, and other social reasons. But not to fund spending. Ever. Money does that.

So, I hear you say, why do governments borrow then? After all, if they can create all the money that they need why do they have to borrow other people’s money? Doesn’t the fact that they borrow prove me wrong? No, it doesn’t. Because they don’t need to borrow.

The government did have to borrow when money was in short supply. That was when it was backed by gold. That system ended way back in the last century. Since then, remember, all money is just a promise to pay. But also remember, the government has by far the best promise.

So, people who are cautious, like big pension funds, large companies, the wealthy and banks themselves want somewhere as safe to save as ordinary people – those with less than £85,000 in their bank account – have right now. And that means they want to save with the government.

But they can’t not in ordinary bank accounts. Because the government has set a limit in them. So the government has adapted, fairly surreptitiously, a gold standard era savings mechanism to meet this need for a safe savings account in the modern world of money.

That mechanism is ‘the gilt’. Gilt, of course, is gold. Once, these gilts were gold backed savings products. Not any more they are not, of course. Remember, everything about money is just a promise to pay now. Gilts, or government bonds, are like everything else in this regard.

And money is not scarce for the government now, either. It could have all it needs on overdraft at the Bank of England if it wanted. And it need not pay interest on that. So why doesn’t it go for this cheapest of all funding options? Because people need safety, that’s why not.

So, just as the government guarantees most people’s money in the bank, it also offers gilts (or government bonds) for those with millions or billions to save because they too want guarantees on their money. And they will accept a low rate of interest to get it.

Government bonds are not, then, real borrowing by the government. They are instead a savings mechanism. Sure, they look like a loan. But then so too is a building society bond a loan to a building society. But it’s also a savings account in reality.

And that’s what government bonds are: they are just savings accounts. That’s all. And, as I noted when I explained how money is created, savers’ money is not involved in money creation by lending, at all.

In the same way, government borrowing is not in involved in the funding of its spending. Sure, the government borrows. But then all savings institutions do, all the time. But they don’t lend savers’ money out. And the government doesn’t fund spending with borrowing either.

And before questions are asked about quantitative easing (QE) and where this fits in, let me address that one. QE is a process that involves the government buying back gilts. So, it is a mechanism to control the amount of savings it makes available. That’s it. No more.

QE also controls the amount of money in the banking system. QE forces money out of government gilts because the government buys them back, making them more scarce. The flip side is that government pays for these bonds using free money that the Bank of England creates for it.

This money creation puts more money into commercial banks, backing up the government guarantee that they will be solvent. That money injection is pretty important in that case.

But just to add to the list of what QE does, it also shatters the myth that governments are under the thumb of bond markets, for good. Now if bond markets get uppity about anything the government simply has the power to buy its debt back and bond dealers are left high and dry.

And another QE fact; by controlling the money supply into commercial banks the government gains almost complete control of short term interest rates, and through QE it has a massive influence on long term rates too. QE delivers protection from economic shocks as a result.

I’m not saying QE is a universal good, by the way. It’s forced money into the stock market, and overinflated it. That has increased inequality. Neither is good news. But it does add a powerful weapon to the government armoury for controlling the economy.

So, the government can now create money at will, control how much of that is in commercial banks and in government backed savings accounts at any time, control inflation through the tax system and deliver full employment if it wants, all if we understand money. Pretty cool, then.

But to make sure this is clear, where does this new knowledge that comes from the very simple understanding of how money is created (not printed, or made – created is the right word) leave us?

First, it says the government underpins the value of all our money, because whilst all money is a promise to pay, the government’s promise is the best, and our banks could not function without the support of that promise. We need to remind arrogant bankers of that, often.

Second, whilst cash saving is important to people it’s also pretty important to realise that it is much like dead money. It is not used to fund bank lending or to pay for government spending. That does really mean the state should not be subsidising it with things like ISAs.

Third, spend comes before tax, always.

Fourth, the government always spends its money, and not taxpayers’.

Fifth, tax does not fund government spending. Tax is instead used to control inflation, redistribute income and reorganise the economy, but never to fund spending, and that’s true in any country with its own central bank and currency and that never use another country’s currency.

Sixth, the government does not need to borrow because it can always create the money it needs on overdraft at the Bank of England.

Seventh, the borrowing it does do is a favour to those who want to save with the government. It does never need the money people save with it.

Eighth, that means we need never have a debt crisis. If we don’t need people’s money, because the government can always create its own, where’s the debt crisis? Especially when a government can always repay on demand, simply by asking the Bank of England to make the payment?

Ninth, the amount of savings a government wants to accept, and the interest rate it now has to pay on it, can always now be controlled through the QE system. All this does is regulate the government backed, cash based, savings system. Nothing more, and nothing less.

Tenth, I stress, that means all interest rates are now heavily influenced by the government and many are under its direct control. So where is the interest rate panic?

Eleventh, inflation is not now controlled by interest rates – because we don’t want them to rise. It’s going to be controlled by tax. I admit, right now no one has an ideal tax to achieve this goal. I am working on it. It is possible. And it’s progressive, and so fair.

Twelfth, we can have full employment at fair wages, and it pays for itself.

Thirteenth, there is no need for austerity, at all in that case.

Fourteenth, please go and talk about this. By really understanding something as simple as how money is created – and by being aware that it is never in short supply as a result – we can rebuild from the mess that we are in. We can have the sustainable world we want.

Sorted. The End.

#10: ITN Squalid Housing Scandal Reports- what’s behind it?

“Housing scandal: ITV News uncovers widespread problems with leaks, damp and mould in tower blocks across UK”  ITN report, 01.04.2021.

Pic: sodden carpet in Franzoy’s flat (ITN)

“To prevent electrocution, the fridge has been unplugged for more than three months.She has no light in the bathroom, her sofa has been destroyed along with many of her children’s shoes and toys. The only room in the entire flat undamaged is the small bedroom the family of three cook, eat, play and sleep in.” (ITN). Reporter Daniel Hewitt saidAfter reporting on the squalid conditions in a tower block in Croydon, described by several housing experts as the worst they had ever seen, we were inundated with examples of damage and disrepair in properties from around the country”

ITN have been shocking the country, to a creditable extent, recently, with reporting of appalling, squalid, damp-ridden rented homes. At first, some owned by councils, and now by housing associations and private landlords. No reliable numbers, yet, but a very substantial and shameful total seems likely to emerge. In the year, 2021. In a developed Western country, with a relatively large economy. What has caused this?

First, I’m going to look at the causes of damp and mould in houses and flats(A). (if you already know this, skip to the second part (B) below, “That’s the technical stuff….”). Secondly, a look at the broader picture of the state of social and rented housing in the UK, to understand why the problem is so widespread, and the factors underlying this.

A. What causes damp in people’s homes? Basically, it’s one, (or sometimes a combination of) or two things.

One is: some form of penetrating damp. This is moisture which has got through the protective armour against damp of a building. This could be from a leaking roof, porous walls, poor seals around windows, a cracked wall, or bridging of a cavity wall, etc.  Or, less common in modern houses, rising damp, which is when moisture seeps up from the ground underneath, into walls or floors, because of an absent or faulty damp-barrier. ( for example, a DPC or damp-proof-course in walls, or damp-proof membrane in floors). Houses built before around 1920, might have no DPC at all, or a crude one which has failed over the years. And, to make it worse, modern building materials, no open fires, and less draughty windows, tend to keep that damp trapped inside the house.

All these are repairable. Some cost more than others to deal with, and most are fairly expensive to do properly.

The second is: condensation, usually resulting in black mould.

What causes this? When damp, moist,  air in a building, (which could be the result of penetrating damp), comes into contact with a colder surface-walls, windows, ceilings etc- it condenses. What else makes the air heavy with moisture? It could be from washing and showering, boiling water, cooking, laundering- all the things humans do in everyday life.  Worse, when a dwelling is over-crowded. When this moist air hits a colder surface, it becomes water again, so the surface becomes damp- and that damp surface is an ideal breeding ground for mould spores, which are both unsightly, and unhealthy. The pictures you will have seen on the News will be evidence of just how horrible it can be.

Mould on walls (pic: ITN)

How can condensation be kept to a harmless level? There’s two ways, often in collaboration wih each other. If the surfaces in the house/flat are warm rather than cold, because it it’s a warm home, the moisture won’t condense out onto the surface as much. And the other is ventilation, which can be as simple as opening windows, or extractor fans, or in bad cases use of a dehumidifier. Old houses, with heating from coal or wood fires were good at venting damp up the chimney or flue.

Now, it gets more complicated, unfortunately. Trying not to get too lengthy, factors which can make the condensation worse, include poorly insulated walls (normally outside-facing) , and ceilings. These are, obviously, colder surfaces, so condensation forms more readily. And, tenants living in a cold home, who may be struggling to afford heat in winter, will of course, be more reluctant to open windows, which might otherwise allow damp air out.  Modern windows, and homes generally, tend to be more draughtproof than homes were years ago, adding to the problem.  It doesn’t help, that tenants may not understand that lack of ventilation encourages damp and mould, although if they are feeling cold it’s entirely natural that ventilation is not the top priority. All these things may combine to produce a conducive atmosphere for mould, which readily increases in the right conditions. It grows, producing more spores.

(B) That’s the technical stuff on the causes of damp and mould, but what’s the bigger picture? Why is damp, unhealthy, housing so widespread today? Why has the problem not been addressed, for years?

In  ‘#5,‘The Rigged Housing Market’   , in this blog, written in Dec 2019, we looked at how the UK housing market has been rigged for years, so that there are nowhere near enough homes to meet demand today. This forces prices, to buy or rent, steadily upward. So, rent is often so high a proportion of outgoings, as to leave little income left for heating or other necessities,  which adds to the problem.  

Worse, the building of social housing, i.e. houses and flats available to rent at a genuinely affordable rent, has plummeted, as funding to build them was deliberately, and  steadily reduced.

As Inside Housing journal noted, referring to delivery of affordable home in the year to 31st march 2020, “Of these, 6,566 were for social rent – the most affordable tenure – up 4% on the 6,338 completed in the previous year but still the third lowest on record.”  Against a need for new homes, estimated by the Government’s own website Gov.uk, at 300,000 per year. And, as ITN says, “The number of homes for rent from councils or housing associations in the UK has been decreasing from a peak of around seven million in the early 1980s, to just under five million in 2014.”

So, when there are far more people in need of acceptable-standard housing than homes available, people in substandard private-rented homes have little option to move to somewhere better- and councils/housing associations have little option to move tenants to sound homes, while substantial repairs are carried out.

Clarion (a housing association in one case reported by ITN)“told ITV News overcrowding is the major reason for the mould in Sherri’s house and blames a housing crisis, caused by a lack of affordable homes to rent, for being unable to rehome the family “.(ITN)

Tenants are trapped in squalid homes, as the only other choices are unaffordable private-sector homes- or the street. It’s the perfect storm, for people on low incomes.

In #6 Austerity, a choice, not a necessity we looked at how a false pretence, that the UK’s budget was overspent, so cuts in spending had to be made, was imposed on the UK society and economy, from 2010 onwards. False, because the UK has its own sovereign currency and central bank, so can never have “financial constraints”, in pounds sterling. £ sterling, its own currency, which it has the legal and moral duty to issue as required for the benefit of the country. Instead, we were assured that spending was way in excess of receipts from taxation, and “borrowing” (smoke and mirrors) had to be kept in check. So, belts had to be tightened.

So what was the effect on local authority budgets? Councils do not, (unlike a UK government) have the power to issue money at the point of spending. Their only income is, mainly,in two parts, revenue from Council Tax, and the government support grant (for most councils, Council Tax is nowhere near enough to cover providing the services they are legally obliged to provide adequately. So they are allocated a sum from government funds).

From 2010 onwards, austerity policy meant a large and sustained cut in local authority support grants . Councils were, in plain language, strapped for cash. Hardly surprising, therefore, that they restricted the money available for repairs, let alone improvements, such as better insulation for older homes. And many suspect that Conservative governments have a natural disregard, even contempt, for social housing tenants, whom they tend to characterise  as “scroungers”-( or worse, “immigrant scroungers”). People on low incomes,  gig-economy contracts, under-employed people, public service workers whose wages have been kept way below inflation by government decree for years, disabled people, etc, are implied to be too feckless, or not aspirational enough, to make the effort to buy their own homes.  Despite the cost of their own home having ballooned to insane, unrealistic levels.

So, there it is. The causes of damp & mould in people’s rented homes, and why the chances of anything much being done about it are very slim.  Government, the only body capable of making a real change (because of their financial & policy powers, if they chose to) are solidly in denial, as this ITN quote makes clear. “We put our findings to the Housing Secretary Robert Jenrick, who denied the rising number of substandard council homes was down to cuts to council budgets and a fall in social housing under successive Conservative governments.”

#9 Why is the (Budget) Deficit a Myth? And why does it matter? Stephanie Kelton makes it clear.

If you think economics is terribly complex, full of jargon and charts, dull and boring, only for professional economists-this book will change your mind. It will open your mind and make you understand how governments and their finances really work. As opposed to what we’ve all been persuaded to believe since around the 1980’s, which has been very useful to those who have governed the UK and other countries on behalf of the interests of the wealthy.

As the late distinguished, international Professor of Economics John F Weeks said in the preface to his 2014 book:

“Mainstream economists have been extraordinarily successful in indoctrinating people to believe that the workings of the economy are far too complex for any but experts (i.e. the economists themselves) to understand.”

The mainstream of the economics profession achieves this indoctrination by misrepresenting markets, or to be blunt, systematically marketing falsehoods…….Among these reactionary absurdities  is that gender and race income discrimination is an illusion, unemployment is voluntary, and sweatshops are good”.

Well, Professor Kelton’s book, a New York Times bestseller in 2020, changes all that.

A very quick summary of the book -why the obsession with “Budget Deficits”, “National Debt”, and “Pay for it”, is based on a false understanding of the reality. And allows policy choices which are very harmful to people and economies. Chapters cover Inflation (risk of), “National Debt”, International Trade, and Building a Better Economy, etc. It’s all there for us.

As she says on p31: “Once you’re able to see that the government’s ability to spend doesn”t revolve around the taxpayer dollar, the whole fiscal paradigm shifts. Or, as that journalist put it, “Once you get it, you will never see things the same way again”.

Hang on, I hear you say, this is an American book, it’s not how government money works here in the UK? Well yes, it’s written in America. But, it all works the same way in the USA, the UK, or any other country which has its own sovereign currency and central bank, such as Australia, Canada, China, Norway, or above all, Japan. (see note 1). Not the eurozone countries, because they have a shared currency, the Euro, and shared European Central Bank. OK, some details of how the U.S. does things in practice are different. But, the basis of it all is the same, as she explains. You will, I’m afraid, have to do a bit of transposing for the UK, such as read £ for $, Bank of England for Federal Reserve Bank, etc, but it gets easier as you go on. For “Uncle Sam”, read: the British Government. And, the book does directly talk about the UK in places, such as Chapter 1, (“Don’t think of a household”) p20, where Margaret Thatcher’s famous, but wrong, explanation of taxes and spending is discussed.

Here’s what someone, who has direct expert knowledge, said about the book:

Frank Newman, former Deputy Secretary of the US Treasury: “A robust, well-reasoned, and highly readable walk through many common misunderstandings.” (note, “highly readable”. The book is full of examples of things we all know and can relate to) “A must-read for anyone who wants to understand how government financing really works” (and here’s the killer) “how it interplays with economic policy”. (yes, it’s going to give you the understanding to see how government policy decisions, such as level of pay for NHS staff, could be very different from what we have come to see. For example, why pretending that there are “financial constraints” which influence NHS pay levels are, to put it kindly, misleading.)

What have British reviewers of the book said? “Kelton’s game changing book on the myths around government deficits…..reminds us that money is not limited, only our imagination of what to do with it. After you read it, you will never think of the public purse as a household economy again”. (Mariana Mazzucato, University College, London, author of Mission Economy). “The best book on rethinking economics anyone will find right now” (Professor of Political Economy Richard Murphy). Murphy, like Kelton, aims to write about economic matters in clear plain language, avoiding academic jargon as much as possible. For a UK explanation of how government finance works, here’s a good starter: https://threadreaderapp.com/user/RichardJMurphy. There are also videos on his Youtube channel, such as this one.) For other writers, see my Links page.

Stephanie Kelton born October 10, 1969) is an American economist and academic. She is a professor at Stony Brook University[1] and a Senior Fellow at the Schwartz Center for Economic Policy Analysis at the New School for Social Research.[2] She was formerly a professor at the University of Missouri–Kansas City.[3] She also served as an advisor to Bernie Sanders’s 2016 presidential campaign. (Wikipedia)

Note 1: As you learn more about the modern understanding of how government finances work, what has happened in Japan’s economy over the last 20-30 years provides a very illuminating light on the themes of this book.

It would be nice if anyone, who reads this book as a result of this, would like to write to me (see contact page) and let me know how they feel about it. It may well be available free from libraries, and it’s sold by the usual sellers online or in shops (when open) and I believe for about £1 as a digital download. Not many secondhand copies available yet, perhaps because no-one wants to part with it!

#8 The “National Debt” …in two minutes.

Out of intense complexities, intense simplicities emerge”.  W. S. Churchill.

Imagine that you personally own, outright, Britain’s largest bank, and you are legally entitled to put any credit figure you choose in your own account. Would you really go out and actually borrow any money from anyone? Of course not.  But, you are aware that if word gets out that you have unlimited money available, various fools and chancers, (and a few deserving cases) will come knocking, asking for some.

So you hit on the idea of making an elaborate facade of your “borrowing” this money, rather than just typing it into your account. To make it convincing, you allow institutions with substantial funds to invest, (such as pension funds) to “lend” it to you, in return for some interest. You stipulate that all transactions must be in pounds sterling. This “lending” gets called “Bonds”, and you know that when the Bond matures, you can give them their money back. No need to actually use it, as you have plenty of your own funds, and no need to worry about the interest, as you have an unlimited supply of £ Sterling to pay it to them from. You can then tell the fools and chancers that, sorry, you can’t afford to borrow any more to give them. To convince them, you occasionally add up all these Bonds, and call this scary-sounding total “the National Debt”. You can also, if you choose, tell deserving cases (such as public health care, or similar, that you don’t really care about), that you can only “afford” to give them so much. You can also pretend that the Bank is independent of you, and makes its own decisions.

Get the idea? You’re thinking, this can’t be it, can it? But it’s a simplified version of what actually happens. The UK government, of any party, owns the Bank of England outright, and we all know that he who pays the piper calls the tune. And because of this, it can no more run out of £ sterling, than a football stadium can run out of goals, or a marathon runner short of kilometres.

Still not sure? Have a look at these. C, from a politician, is a fib.

And, if you’re still not sure…..here’s Robert Peston, on ITV News at Ten, 14th May:  “…..when you’ve got an independent central bank, as we do, in the shape of the Bank of England, the Government can, er, for a period at least, more or less borrow as much as it likes. The Bank of England buys the debt. That’s what’s going on at the moment. It’s creating new money now.”

(note: The Bank of England is “independent” in name only. It is wholly owned by HM Government and is controlled by HM Treasury. It has a few minor autonomous powers subject to Treasury approval. )

#7 Paying for the Covid Economic Crisis?

At the present moment, when it’s clear that the imminent economic crisis resulting from the Covid-19 pandemic, will need a massive financial intervention by the UK government to avert a catastrophe, a lot of people are worried about how the cost of this will be met. And, what long-term effects that will have.

So, it may be very helpful to think about how these issues were coped with when we last had a financial seismic shock- in 1940, at the start of World War 2. This letter by Tom Griffiths, quoted by Australian Professor of Economics Steven Hail, does that superbly.

“A recent phone-in comment by LBC Radio’s economics correspondent set me thinking, as it led to the usual nonsense over equating Govt. spending with ‘debt’. There were phrases like “UK Govt is paying the salaries of 60% of Brits- even another month will bankrupt us” etc. I thought of a useful parallel which went on immensely longer, and yet the promised bankruptcy never arose.

Shortly after the declaration of war in 1939, Britain ramped itself up into practically the most single-focused economy ever seen in the modern world. Within 2 years, 6 million Brits were paid directly by HMG in the armed forces alone. That is, at least 25% of the adult population. On top of which, a huge percentage of the UK economy was switched to exclusively war materials output. Domestic car, bus and truck manufacturing stopped completely. As did train manufacture. Dockyards concentrated on war vessels or freighters which often had a very short life.

This continued until early 1946: in other words the UK Govt closed huge swathes of private industry, and more or less directly employed over half the UK population for 5 years uninterrupted. Practically nothing of the ‘traditional’ industries worked for anything other than Government money, apart from farms, food industry, shops and a token amount of clothing and domestic items manufacture. For 5 whole years.

According to enthusiasts of the simplistic “household budget” metaphor, this would have left us with a decimated economy, a crushing mountain of ‘debt’ equal to 5 years or more of GDP, and plunged us into a deep and savage depression.

Instead, the only visible debts were a combination of the real ones: the $6.5bn dollars owed to Canada and the USA for provision of food, oil and war materials, and the sum total of war bond redemption costs in £Sterling. The Dollar debts began repayment in 1950, and the total apparent visible debt was only about a third of what the ‘household’ model would have predicted, i.e. about 2-2.5x GDP

The whole 5-year complete takeover by Govt didn’t lead to much inflation, due to rationing and price controls.

As troops were demobilised in a planned way, because the infrastructure of the economy was still in place, although rather battered, output simply started again. Not quite as simple as turning on a tap, but not far off. The promised depression never occurred, probably helped by the stimulus of having to rebuild lots of things, and re-supply our old markets which had been turned off by the almost 100% cessation of international trade. So the answer to the pessimists is: we weathered a similar international hiatus which involved the Govt paying almost everyone, for a full 5 years once, and bounced back. That is (with this current lockdown scheduled to probably last 4 months) an almost exact parallel economic hit, but 15 times greater in magnitude.”

Professor Hail adds: “

We of course think about Keynes’ pamphlet ‘How to Pay for the War’ when thinking about the economics of resource mobilisation. Real resources had to be transferred from production for private markets to production for the Government and for war.

These days, things are very different . As then, the Government isn’t going to run out of pounds, but now, in the absence of significant foreign currency debt and/or a fixed exchange rate, it doesn’t face a purely financial constraint at all. It has a lot more fiscal space.

In the late 1940s, there were US dollar debts and there was a fixed exchange rate system, but as Tom’s message reminds us, the Government was far from bankrupted – indeed, the Welfare State was introduced – and post-war growth naturally reduced the debt/GDP ratio over time too.”

#6 Austerity: A choice,not a necessity.

Photo: Pixabay.com

Imagine a doctor, who is treating a patient for anaemia, deciding to reduce the person’s food intake. Pretending this will be good for him, and will allow him to recover. Accusing his previous doctor of reckless mis-treatment, wasting the hospital’s resources. Think that would never happen?  

The year is 2010. Following the Financial Crash of 2008, the banks are still reluctant to lend, businesses are nervous about investing, and consumers are scared to spend. Doctor George Osborne is appointed to take over a patient’s care by new Prime Minister David Cameron. He decides that the patient, United-Kingdom-Economy, who is suffering from a condition close to malnutrition, having been badly weakened by the Financial Crisis, needs to go on a diet, and eat less. He says the hospital is short of food, and has to live within its means, balance the budget, and so on. The relatives and friends all know what it’s like to have to live within a budget, so they agree to this. What they don’t know, is that this hospital has access to unlimited food and medicines, if it chooses to use them. And, that Dr Osborne knows this, and has his own plans for the hospital’s food and medicine.

If you have read my earlier pieces in this blog, you will realise that the United Kingdom has its own currency, so can spend into existence whatever amount of pounds sterling it chooses to. Doesn’t have to “borrow” any, doesn’t have to “pay any back”, in real terms. (Bonds, and their interest are repaid when they mature, but as this is done in £sterling, and we have complete control over how many pounds sterling we have access to, it’s not like debts as you or I understand them. See #4, deficits and debt.) But we have been repeatedly told that “there’s no magic money tree”, that Government “borrowing” is dangerously high. That “fiscal responsibility” is important. That the UK could “go bankrupt”. So, budget cuts had to be made, public spending had to be reined in, the wages of public sector workers such as nurses, police officers, fire-fighters, binmen, etc, had to be capped. As Alexei Sayle’s bitter joke went, we were told that “the Financial Crash was caused by too many libraries in Wolverhampton”. The previous government was alleged to have caused the banking crisis by its reckless spending. (Forgetting that the crash was caused by the greed and irresponsibility of the banks and financial services industry, who had been saved from catastrophe with an injection of funds called “quantitative easing” by Gordon Brown’s government, which then merely maintained normal public expenditure).

So what happened between 2010 and today?  Huge and savage public spending cuts.  Not challenged by the papers and TV news, who accepted the official story, and faithfully relayed that to a public who understood very little about economics. (What little they did know was based on an utterly false picture painted by the Monetarist School since the 1970s, which most people still believe). here’s what happened to wages:

Public sector workers are no better off in real terms, than they were in 2009. Police officer numbers were cut by 20,000. Council government support was cut by £billions, so councils had to make reductions in the services they were obliged to provide to the public. The funding of schools was cut so much that today, teachers buy stationery for the pupils to use out of their own pockets, class sizes have risen, and staff are demoralised. Fire stations were closed, and staff numbers cut. Legal aid was severely restricted, so poorer people didn’t have help to get fair access to justice.

As zero-hours working increased (now approximately 1,000,000 people), and many were forced to rely on precarious self-employment, this combined with wages being kept down, to cause widespread in-work poverty, on a scale not known since the 1920s.

This, together with a 1920s-style harsh benefits regime, including the notorious Universal Credit, (dressed up as “Welfare Reform”), means  we now have more foodbanks providing a lifeline to those in real poverty, than the total of McDonalds and Burger King restaurants combined. Even welfare benefits to support those with severe disabilities, have been withdrawn, often by corrupt means.

I could mention many other serious effects on society, but it’s time to consider what effect that all this reduction in public spending has had on the overall economy. Put simply, when a government takes £billions out of an economy, it tanks. People struggle to pay bills, with, for many, little or nothing left over to spend on clothing, household stuff, eating out, gifts, toys, etc, etc. Once prosperous High-Street giants (Toys-R-Us, House of Fraser, Maplin, Debenhams, restaurant chains, and others) have either gone bust or had to reduce staff and close shops. Not just because of the move towards internet shopping. Many towns in less prosperous areas, have many boarded up shops, and little else besides charity shops, cash-converters-type businesses, and pound shops- and even the pound shops are struggling. Unless you live in the wealthier parts of the South-East or South-West, you will know what I am talking about.

So, what happens to tax revenue, when many people have reduced wages, so they pay less income tax? When less goods are sold, so less VAT is paid? When businesses fold, putting people out of work, and paying less business taxes? When large businesses that do survive, make less profit, so pay less Corporation Tax?  As I explained in #4 here, the “budget deficit” is (put simply) the difference between what a government spends and how much it claws back in taxation. So today, we have a (relatively) huge budget deficit, with nothing to show for it.  Except either reduced living standards, or actual hardship.

All this economic vandalism, is what happens, when governments, aided and abetted by “journalists” who should know better, persuade the people that a government’s financial management is like that of a normal household, so they have “budget constraints”. That we “can’t afford” proper public services. That we “can’t afford” to pay student nurses while they are training. That support for the sick, disabled, and old has to be paid for out of taxes, so we “can’t afford” it.  That we “can’t afford” to pay fair wages to essential workers, such as emergency services staff.

A government with its own currency and Central Bank, such as ourselves, or the USA, or Australia, Norway, Canada, etc   can no more “run out of money” than the FA can run out of goals. Yes, it is possible in certain circumstances, for public spending to exceed the real resources (people, raw materials, energy) to provide what a country needs, which could cause inflation. But the UK is nowhere near that situation. And, unless governments spend money into the economy as they should, everybody, (except the very rich) suffers.

The sad thing is, it’s not as if we shouldn’t already realise how public money really works. That governments need to provide funds, for a healthy economy. In the 1930s, following the Wall Street Crash, economist J.M. Keynes knew it, and helped to rescue the UK economy. In the 1930s and 1940s, economist Joan Robinson wrote about it. The British wartime government of 1940, and the Attlee government of 1945-1951 understood it. U.S. President Kennedy understood it in the early 1960s:

 

To sum up: If you have read as far as here, you will now understand why austerity policy is a political choice, not an economic necessity. (photo: Jeff Morgan08/Alamy)

I am grateful to Malcolm Reavell for his input on some points in this chapter.

#5 The rigged housing market

It has been reported that if the rise in the cost of housing over the last 30 or so years was the same for everything, a loaf of bread would be £10, a litre of petrol £13, an oven ready chicken £50. Imagine the outcry, rioting… but many seen to just accept with resignation the scandalous cost of buying or renting a home, an equal or greater need. Partly because, I suspect, many already own a home, and most of those bask in the satisfaction of seeing its vastly increased value.

John Harris in the Guardian: “It is, in other words, time we talked about our national predicament – and indeed, what might be at stake in the election, whenever it arrives – by acknowledging that housing is a central issue, and always has been. The nitty-gritty of politics is often reduced to the cliche of “schools and hospitals”. But think of the aftermath of each world war, and the great steps forward marked by the concerted building of council houses……. And let’s not forget: it was housing that tipped the world into the crash of 2008, when the banks finally confronted the lunacy of sub-prime mortgages, essentially a replacement for the public housing the US – and the UK – had forgotten how to build.”

“According to research commissioned by the National Housing Federation (which represents housing associations), 3.6 million people in England are living in an overcrowded home, 2.5 million are unable to afford their rent or mortgage, and another 2.5 million are in “hidden households” they can’t move out of – including house-shares, adults living with their parents, or people living with an ex. Rates of home ownership among the under-35s are at less than half the levels of 20 years ago. Homelessness, both visible and hidden, has become a grimly mundane part of life. A million families are stuck on council waiting lists; in 2017-18, a pitiful 6,463 units of social housing were built in England, down from 30,000 a decade before.”

Let’s look at arguably the strongest factor influencing this insane rise. Cast your mind back to the Thatcher era.  If, then or now, you are a seller of goods that everyone needs, but there is a plentiful supply of those goods, and other successful sellers,  then you are only going to make a modest profit. Now, imagine you are a large house-building company. You are making a profit, but a lean one, and you would like to bump that profit up.

Your biggest competition is the fact that millions of people can rent a good-standard home at a reasonable rent from their local council, so they don’t really need to buy one of your houses or flats. Suppose you hit on the idea of persuading the Government of the day to reduce the supply of these council homes. You make some big donations to ruling-party funds, and suggest council tenants be given the right to buy their homes at a discount. The bonus for the ruling party is that the lucky former tenants will be thrilled to be able at last to buy their own piece of real-estate, and will be grateful to that government at the ballot box. So Thatchers’s government does just this, making a soon-to-be-forgotten promise to build new social homes to replace those sold. (Actually, I’m not sure whether the developers suggested the scheme to the Thatcher Government.  Or, some Conservative strategist came up with the idea as a vote-winner, and the developers said  ”Wow, fantastic, happy days, here’s a helping hand for your campaign funds”. See note below. But, the result was the same. Note, what follows would not have happened if Thatcher, and subsequent governments, had kept the promise to build replacement council homes for each home sold under Right To Buy(RTB). They didn’t.

Over the next 30 years the number of council houses built steadily declines, with a very rapid decline from 2010 as the Conservative government refuses to allow even Labour or other councils, or housing associations, to raise finance to build or acquire houses in any significant number.(Blair’s government,1997-2008, to its shame, did nothing like enough to counter this. It was too keen to continue with the nonsense of “budget constraints”).

 Naturally, the price of houses and flats rises steadily, helped by a rise in the population and number of households in that population. Because now, there aren’t enough homes to go round. (This process was also made made even easier by Thatcher-era de-regulation of the banks, and global finance trends, which resulted in greater and cheaper mortgages being easily available.) It becomes highly profitable for companies, or individuals, to buy homes to rent out, because if the cost of buying homes goes up in a time of shortage, so does rent.

So, we now have a situation where the cost of renting or buying a home gobbles up a huge proportion of people’s income. Not to mention the misery of homelessness, or living in sub-standard accommodation. In Bristol, for example, today, there is strong competition to take even the vastly-overpriced flats offered for rent, which detracts from the ability of businesses to recruit staff there. They often either commute huge distances from cheaper areas, increasing traffic congestion and pollution, or live in the “grey” housing market. This is living in old caravans, vehicles, boats etc. Bristol is just one example of the problem in many cities in the UK, indeed in most of the South of England.

And, it’s worse than that, by a long way. If a large number of people are spending most of their income on their home, plus council tax, utilities etc, they have very little left to devote to even modest expenditure on clothing, eating out, cinema visits, other purchases, etc,  etc.  Hardly surprising that formerly successful and profitable large businesses, such as Sports Direct, House of Fraser, Pizza Express, Thomas Cook, and many others are either struggling to survive, seeing profits shrink, going under, or shedding staff. Those redundant staff, or those on zero-hours contracts, now have even less money to spend, so more businesses suffer. This has combined with ruthless suppression of public-sector wages over the last 9 years of Conservative Government, claiming “budget constraints”. If you have read my earlier pieces in this blog, you will realise that this is economic nonsense, a fairy-tale which the media have encouraged for many years.

By contrast, look at what happened under the Attlee Labour government of 1945-1951. A decision was made to bring about the building of hundreds of thousands of council houses, and a programme commenced that would continue well into the 1950s and beyond. This was partly because of the urgent need to house returning service-men and women, many of whose homes had been destroyed by bombing, or who had been living in squalid pre-war slums. The “baby-boom” was happening, (I was one of those babies!), and young families needed decent homes. But I believe that Attlee’s government also realised that a council-house building boom would mean thousands of good-quality jobs– the building trades, the designers, the administrators, the materials suppliers/transporters/merchants, etc, etc. And all those jobs would boost the economy generally, helping to create a prosperity which would benefit the mass of people, not just the already-rich. Those lucky enough to become council-tenants at reasonable rents, and with decent jobs, had some money left over each week or month to spend boosting businesses generally, which created more jobs. (Not, stash it away in the Cayman Islands.)

This is a prime example of how a government that chooses to create investment-spending can transform both the economy and peoples’ lives. Contrary to what the “experts” and media are always telling us, “deficits” need not be anything to worry about!

Note: re sale of council housing policy: the sale of council homes to tenants was not a new idea, it had been suggested by Labour in 1959, and by the Conservatives in 1970. (Here’s Dr John Docherty in a letter to the Guardian, “Andy Beckett describes right to buy as a “Thatcherite” policy. It was Hugh Gaitskell’s 1959 Labour manifesto that pledged that “Every tenant will have a chance to buy from the Council the house he lives in”. Then Ted Heath’s 1970 Tory manifesto promised to encourage local authorities to sell council houses to their tenants so that “tenants of today will become the owners of their own homes tomorrow”. But, as Dr Peter Estcourt replied to that, “Under Labour the money raised was to be used to improve existing stock and add new builds. Under Mrs Thatcher a large taxpayer-funded subsidy was granted and most of the money raised was diverted to the Treasury. Local government was forbidden to use what little money it was allocated in the council housing sector.”

Of course, all housing is politics, because all politics is competition for resources.” From an article in Thejournal.IE about the rigged housing market in Ireland. You can read it here.

For more information about the “National Debt”, see my piece #3 in this blog. 

4. “Who’s afraid of the Big Bad National Debt?” The reality of deficit and debt.

We hear TV news, the papers, and politicians bleating on about “the National Debt” and “The Budget Deficit” a lot, don’t we? And, as we all know what it’s like to have debts to pay, we worry about it. We think, “how is the country going to pay for…..?” “Our children will be burdened with debt for ever…” Well, it’s time we looked at the reality.

In my second and third pieces in this blog, we realised that taxes don’t fund government spending, it’s actually the reverse. Governments (if they have their own currency, like the UK) decide how much money the country needs, and then provide it by spending it into existence. ( They also license the commercial banks to make loans, a form of money creation.) They then take some back in the form of taxation, for various reasons. (See my 3rd piece, Let’s talk about taxes). Virtually all other economic activity flows from this government money creation. And this process is often referred to as the “Budget Deficit”.

Even more confusingly, it is often called Government “borrowing”, which is nonsense. It is nothing like “borrowing“, as you or I understand it in our daily lives. If you, or I, were allowed to, and entitled to, put whatever credit figure we liked in our bank accounts, would we really go out and borrow money from anyone?

So, what actually is the “Budget Deficit”? Well, first of all, let’s realise that “deficit” and “debt” of governments, are frequently used confusingly as meaning the same thing.  Let’s start with “Deficit”.

The “Deficit” is actually the total amount of money injected into the economy each year by the government of the day, less the total tax collected, plus the “Debt”.  It’s not a real thing, like my or your car loan, or mortgage. It’s an accounting device. At the end of the government’s financial year, it disappears, and is replaced by the next year’s budget, not “carried over”. If a government chooses to run a “budget surplus”, this means taking more money out of the economy than it puts in, which will almost always cause a recession or slump.  Yet, many politicians talk about it as if it’s a beneficial thing, like us paying off a loan. It’s actually very destructive. (I will talk about this more in the next article, on “austerity policy”.) In the words of economist Ellis Winningham, “budget surplus is the act of the UK government reducing the number of British pounds available for people to save and to spend.”

What about the “Debt”?  Governments can, and do, “borrow” money, in the form of Government Bonds, also known as “Gilts”. Organisations, and in some cases people, “lend” money to the government, in return for a guaranteed repayment, and modest interest. For historical reasons, mainly to control interest rates, governments have sold Bonds equal to the amount of new spending which is over and above its receipts. But this is nowadays really a case of the government providing a safe place for spare cash to be placed, because, in the words of an Australian blog, “Monetary sovereign governments do not need to borrow, and when you understand the monetary system fully, you understand that they do not borrow in a meaningful way at all (as long as they never borrow foreign currency).You can’t meaningfully borrow the tokens you yourself create. You certainly don’t need to do so.”

In the current circumstances, (April 2020), the world’s financial markets are in freefall, so it would be impossible to sell Bonds to anyhting like the huge amounts that need to be spent. If necessary, the Bank of England just creates money to, effectively, buy these Bonds from itself. In Japan, most Government Bond rates are negative, which means organisations pay the Government to store their money.

The “National Debt” figure also includes the amounts people have saved in National Savings and Investments, which includes such things as Premium Bonds. To call these savings “debt” for a UK government, is, as Professor Richard Murphy of taxresearch.org says, grossly misleading. The savers wouldn’t want them “repaid” or paid off, unless they have actually asked to cash them in!

So, how much do we need to worry about the National Debt?  Not much, actually. In the words of Richard Murphy of taxresearch.org.  “a government that only borrows in its own currency cannot, as a result of this understanding, ever default on its own debt because it can always issue the instruction to its central bank that the payment of that debt be settled.”

President John F. Kennedy understood this, back in the early 1960s: “Is there any economic limit to the size of the debt in relation to national income? There isn’t, is there?….That’s right, isn’t it? The deficit can be any size, the debt can be any size, provided they don’t cause inflation. Everything else is just talk.” JFK to James Tobin. ( James Tobin (March 5, 1918 – March 11, 2002) was an American economist who served on the Council of Economic Advisers and the Board of Governors of the Federal Reserve System, and taught at Harvard and Yale Universities-Wikipedia.)

Those who believe that governments need to raise money by issuing bonds, might be surprised to learn that in Japan, bond yields are negative. That means that the Japanese Government pays no interest on its bonds, in fact the reverse. Organisations acually pay the Japanese Government to store their unused money.

I realise this all sounds a bit shocking, because we have all been conditioned to think government finance is like our own finances. But, think about it: if you were allowed to put as much money into your bank account  as you liked, would you worry about paying off debts? The UK government is not only entitled to create money, but has to. And does not allow anyone else to.

Why might a government want to let people/voters think that the UK budget is like our own household budget?  Because it may well suit their  political agenda. We will look at this in more detail next time, when examining “austerity” policies.

Here’s Mike Hall, of the Facebook group MMT for the British People, 13.02.2020 :

“In reality, when they’re in power, and just like US Republican Party, the Tories don’t care about Gov deficits. Despite all the propaganda media guff that they do, their policies never change because of deficits.
When convenient as an excuse, deficit hysteria is invoked, and when it isn’t deficits are ignored, and mass media oblige likewise.”

I will wrap up this bit by giving us two contrasting statements  to consider. Firstly, from former Chancellor George Osborne:

“If we don’t get a grip on government spending, there will be no growth”. George Osborne Read more at: https://www.brainyquote.com/quotes/george_osborne_464526

Then this:

Note: I have, of course, rather simplified a very complex subject, but not so as to mislead. In actual fact, the term “National Debt” is a rather vague term, and nobody- not even professional Economists- can really define it accurately. To explain why, this video, by Chartered Acountant & professor of Political Economy Richard Murphy, tells you how impossible it is to find out exactly what “National Debt” is, even from official sources. https://www.youtube.com/watch?v=oXwmRDM6InI

I am grateful to Catherine York for proof-reading, and her support.

3. Let’s talk about taxes

#3     Let’s look at Tax-why is the economy like a washbasin?

In #2, we looked at how we have all been led to believe that Governments spend “taxpayer’s money”, and can only afford to spend what they receive in tax receipts, because it’s convenient to justify political agendas. “There’s no magic money tree, dear”, Theresa May told a nurse who asked why they were only getting a very small pay rise, in 2018. What’s the real story about tax? What is taxation really for?

We worked out, in #1, that tax receipts are not something any Government, with its own currency, needs in order to spend on all the things Governments provide for their people. So why do governments have taxes? Well, first of all, if you are a government with your own currency, such as pounds, dollars, roubles etc, you can create whatever money your country needs, but to do that, you need to make your currency the one that everybody uses. If half the people in Britain are trading in dollars, or krone, or something else, you have no control. So, to make everyone trade in pounds, you demand and collect taxes in pounds. The people then need the pounds you have created, to be able to pay their taxes.  And, if they don’t pay their tax, you can cause them big problems by using the law.

Let’s recap on how money is created. A Government decides (“fiscal policy”) how much money its country needs to provide all the public services they need, and everything that goes with that. Plus defence, social security, pensions, etc etc. The government then orders the Treasury to put suitable numbers on a spreadsheet, so the Bank of England can issue it.

It can also authorise other banks to create a certain amount of money to lend to businesses and people, in the same way. It can also control things like interest rates, and under what terms banks can lend (“monetary policy”).

Okay, if we agree on that, what else are taxes for? Governments can create as much money as they choose, and stimulate the economy. But, what happens if the country gets to a point where everybody who is capable of working is fully employed?  And  there is no ability to create any more goods and services for people to buy? If raw materials to build hospitals etc, have run out? Then, you get a situation where too much money is chasing not enough stuff to buy, which is when prices are forced up, which we call inflation. (We already have this in housing prices, because the housing market has for years been rigged to ensure more demand than houses/flats available to buy or rent.

A government does not want runaway inflation to happen (because the people get extremely outraged), so it uses taxes to reduce (claw back) some of the amount of money in the general economy. If the people have, in effect, too much money to spend, taxes reduce that a bit to balance things up (“dampen down demand”).

Sounds odd? Think of it as a washbasin with water (the economy) in it. The water (government-created money) comes from the tap, and the government controls the tap. The waste plug is used to drain excess water off (tax), to prevent the basin over-flowing.  The water (money) drained off goes down the drain. So, in the UK, and similar countries, the money that governments take in tax is simply cancelled on the Treasury master spreadsheet (the same one that money is created on). It is not actually paid out to anyone. “Taxpayers money” is nothing more than a very simplified idea of what happens. (Some call it a “fairy-tale”). This is very useful, if you are a government that wants to pretend that the country cannot afford to pay fair wage increases to nurses, or other things.

Now, apart from making people trade in pounds sterling, and countering runaway inflation, what else can a government use taxes for?

Taxes can be used to encourage more fairness in the economy, or tax concessions can be used to encourage particular industries to develop, or regions to attract new industries. So for example, people on high incomes are taxed at a higher percentage rate than folk on low incomes. (Although we know, in reality, that very rich people can manipulate the tax regulations to minimise how much they pay).

Taxes can also be used to persuade people to do certain things, or not do things. For example, tobacco can have its tax duty increased, to discourage smoking. In Denmark, the government wanted to make people use bicycles or public transport more, so the fees for registering a vehicle were raised substantially.

In the words of Australian economist Ellis Winningham:

The question, then, for tax policy is, “What kind of society do the people want?” and then once the voters speak, the UK government aims its spending and tax policies towards creating and maintaining that kind of society.”

This may not happen, though, if a government wants to pursue its own agenda, (such as weakening the NHS to pave the way for privatisation) and can convince the voters that it is acting in their best interests.

I am indebted to the writing of Ellis Finningham, and the economist John Harvey, for much of the material in this article.  

2. What is “taxpayers’ money?”

From the early 80s, the idea that Governments can only spend what they receive in tax, was heavily promoted, especially by Mrs Thatcher. The concept of “no magic money tree” was created, and it sounded quite convincing. Because we all understand “budgeting”. But let’s think about it.

Almost all of us have an average income of, say, £x per month, and  outgoings/expenditure of say, £y per month. If £y is less than £x, then happy days, we’ve got more to spend next month. If £y is more than £x, we have to spend less next month, or borrow some. We’re all familiar with this, so it has been easy to convince us that government money works the same way. I used to believe it, too. It has been called, “handbag economics”.

So, if that isn’t true, where does money actually come from? It’s created by governments, by spending it into existence. If they didn’t, there would be no money in the economy for services to be provided, public buildings, roads, the NHS, businesses to grow, banks to lend, or people to spend or pay taxes. Still think it comes from everybody earning money in various ways, spending some of it, and paying tax with the rest? That went out with the barter system, hundreds of years ago. We can’t dig money up from the ground, or grow it in fields, and if we hire an industrial unit and manufacture our own, the police take a dim view. So, it is created by the State.

How? The money governments create is spent into existence on things like the NHS, schools, Police, Courts, the Civil Service, Armed Forces, etc etc. Much of that goes on wages, which are spent to sustain lots of other businesses. Or, on materials needed for these, which creates more companies, jobs, etc. Part is given to councils to help pay for all the services they provide, because council tax isn’t anywhere near enough. Some goes on social security, so that people with no access to income, have some money to spend (remember, benefits tend to be spent on buying goods & services, not stashed away in the Cayman Islands!). All this business creates tax income back to the state. The Government can also control how much money the banks can lend  to allow businesses to build, or consumers to buy stuff. So the whole economy is based on Government money.

A government with its own currency, such as the UK, can create as much money as it chooses to. About £400bn was created in 2008, to rescue the banks from the consequences of their greed and irresponsibility, without causing any inflationary problems. And no, it doesn’t “have to be paid back by future generations”, because we effectively “borrowed” it from ourselves, and don’t have to ask for repayment. This year (2020), it is more or less openly admitted that most of the Govt bonds issued to cover Covid-related expenditure has actually been purchased by the Bank of England-an arm of Government.The media talk about “printing money”, but that is nonsense- when you go to the bank for a car loan, they don’t go to the vault and bring back a big sack full of banknotes. They press a few keyboard keys. The Government of the UK, effectively, does the same, via the Treasury and the Bank of England. Sainsbury’s don’t “print” Nectar points, they issue them electronically.

So howw does taxation work? It’s actually a sort of regulating valve, which prevents the economy from over-heating. Amongst other things, It regulates the amount of money sloshing around, and under-pins the economy. It can be used to damp down demand, if for a while, if there aren’t enough people/materials resources to be utilised. My third piece, “Let’s talk about taxes”, explains this more, and talks about what else tax does. Our tax system is fairly efficient (except when we allow large multi-national companies, or very rich people, to pull a fast one.) . But, taxation is not a government’s source of money to spend.

The money collected in tax is just cancelled on the master balance-sheet, the same one that is used to spend.

If you are uncomfortable with the realisation that the UK Government can spend as much as it chooses to, you may be glad to hear that there is a situation where Governments need to rein in spending, or take back money through taxation.

When is that? It is when:

*Everyone who is capable of working is fully employed for an appropriate number of hours at fair pay

*All reasonable demand for health and social care is met promptly and to a high standard

*Education is freely available to a high standard

* There is enough decent, affordable housing to go round.

*There is still enough bricks or other stuff needed to build houses, hospitals, etc

*Energy consumption and pollution have been reduced to a minimum, by conservation and “green” generating

This list doesn’t cover everything, but once all these are in place, excess government spending into the economy will cause demand which cannot be met, resulting in high inflation. Ain’t gonna happen anytime soon, though!

A country, with its own currency, (and not tied to the dollar, yen etc) can just order its central bank to create funds, to finance investment or proper funding of services. And if it does, then, for example, the healthier level of public sector wages gives all those workers more to spend, so they spend it, creating more business activity, creating a healthy economy, creating more tax income, etc, etc. This is what actually happened in Britain in the 1950s. Remember, nurses, fire-fighters, prison officers etc don’t usually have expensive accountants advising them how to pay less tax!

I am grateful to David Harvey and David Vigar  for suggesting edits to this article.

1. “But how will you pay for it?”

Long ago, most people believed that the sun revolved around planet Earth, instead of the other way around.

Today, most people still believe that a government gathers up all the money paid in taxes, and then uses that to pay for all the things that governments provide.

It’s actually the other way around-people pay tax out of the money that governments put into the economy, when it provides what the country needs.

( Unless it chooses not to, in which case you get  all the hardship and decline that comes from “austerity” policies.)

Think that’s wrong?  We’ve all been told about “taxpayers’ money” for years, so it must be true?

Well, have a little think about what happened in 1940. The government had to find a mind-boggling amount of money to provide ships, planes, armaments, servicemen, etc, etc, in order to fight the Second World War against Nazi Germany. I don’t know the actual figure, but I would guess about £500 billion in today’s money. Yes? Okay then-

Did they go to the bond markets to borrow the money? No, there could not possibly have been enough money to be had like that, even if the bond markets were functioning in the normal way.

Did they raise taxes, and then wait for the money to roll in? Of course not, it would have taken many years, by which time tax would have been paid in German Marks, after the War was long lost.

Did they outsource the war effort to someone like Richard Branson, believing that the “private sector is more efficient”?   Hardly, they needed to run a successful war, not be ripped off royally.

So they just authorised the expenditure. Told the Bank of England to produce the money.  Of course, it wasn’t digital in those days, but I don’t expect they actually printed pallet-loads  of banknotes. But, the process of government money creation is often called “printing money”.

What’s that? Governments wilfully “printing money” leads to rampant inflation, destroying the economy? So, was there an economic catastrophe after the War? Nonsense. In the 1950s, the UK was actually more prosperous than ever before in history.

Not in the sense that the rich got richer, though. In the sense that millions of ordinary working people, for the first time, had decent affordable housing, because millions of council houses were built.  They could go to the doctor, or a hospital, without fear of a huge bill that they couldn’t pay.  Anyone who wanted work, could get a secure job, not hired by the day, or on poverty wages. They could get a pension to live on when they were too old to work, and an allowance, called “National Insurance”, if they were sick or disabled. The railways were nationalised, and became more reliable and affordable. All these things came about because the Labour Government (1945-1951) had the vision to provide them, and created the necessary funding. (despite a “National Debt” of approx 250% of GDP) Just like the War government did between 1940 and 1945) to provide what they needed. This investment drove the whole economy.

(note: an important part of this was the launch of a drive to build a million council homes. This alone provided an enormous amount of good jobs-the builders and finishers, their suppliers, designers, planners, administrators, etc. People who now had decent wages and affordable housing were able at last to afford to spend a little on furnishings for their new homes, leisure, clothing, transport, etc. The whole economy started to boom in a way it had never done before.)

My own parents were able to buy a house in 1955. (My father had a good job as an engineer, but was not filthy rich, and my mother stayed at home to look after my sister and me.) In 1957, Conservative Prime Minister Harold Macmillan made his famous “You’ve never had it so good” speech, in which he said:

 “Indeed let us be frank about it – most of our people have never had it so good.

“Go around the country, go to the industrial towns, go to the farms and you will see a state of prosperity such as we have never had in my lifetime – nor indeed in the history of this country.”

And it was the same story in the USA, but bigger. So, still think governments can only spend “taxpayers’ money”? You’ll be telling me the Sun revolves around the Earth next.

Note- I know, there was an actual debt, in dollars, to the USA & Canada for the armaments, ships etc we bought from them, that did have to be repaid, because the goods were priced in dollars, not pounds. But this debt was managed so that it never became a burden, and did not prevent the UK becoming prosperous.