Tuesday, 5 August 2014

I think that this deserves a wider audience...What do you think?

I have been wasting too much of my time making and responding to comments on here.

The following was posted in response to a post of mine. (Mine tend to be as brief as I can make them)

"Don't fall for the idea that future tax revenue are required to pay-off government debt. In fact, it is a myth that taxes "pay" for any government spending.

When an economy is at 'full capacity', (i.e. very low unemployment and all resources in the economy being used productively), a government may wish to spend say £20 billion on something everyone agrees is needed - it could be repaying govt debt, defending the country, building hospitals, whatever.

When it spends this money it inevitably causes inflation - this is because you have more spending chasing the same amount of goods and services. The amount of goods and services does not change because the economy is already at full capacity.

To enable the government to spend without causing an inflationary spiral, the government taxes by an equal amount to prevent the private sector spending by the same amount - so overall the spending (public and private) remains roughly constant, so no inflationary spiral.

So the extra tax is to prevent an inflationary spiral when the economy is at full capacity - it is not required to "finance" govt spending. This is why government economics is nothing like household economics.

However, when an economy is the position ours is in with excess capacity, spending by government is permissible without taxation as it doesn't cause inflation.

Given that our economy has not been at full capacity for over 30 years (hence the high unemployment), the government does not need to increase taxes or cut spending elsewhere to "pay" the interest on govt debt or to "pay" for anything.

The big question is why does the government issue bonds at all and pay interest to private investors? Why doesn't the government just create the money at the mint or Bank of England - this won't be inflationary as there is spare capacity.

An answer often given is that when governments issue bonds someone has to surrender money to the government. If it wasn't for the bond that money would probably have gone into the banking system instead. This is called a 'reserve drain' and was clearly necessary when we had the Gold Standard/Bretton Woods or some other type of Fixed Exchange Mechanism.

The theory is outdated and based on the idea that there is a liquidity trap in the banking system. This was true 1945 to 1972 when the Bank of England forced all banks to buy up 50% of government bonds in order to deplete bank reserves and so prevent the money supply rapidly expanding due to banks being able to lend out massive amounts into the real economy.

Since 1972 until 2009 the corset has been removed and the uk money supply ballooned as banks weren't required to buy up government debt (pension funds did it in this period). This caused the massive build up of debts that caused the collapse in 2008 - http://www.positivemoney.org.

Since 2009 over 90% of government debt is being bought up by UK banks (because gilt yields are so low pension funds can't make enough money from the gilt interest to cover their future liabilities).

The result of this is that the biggest risk of inflation we face is the eradication of the governments budget deficit. The £150 billion a year public sector deficit acts as a reserve drain on banks. The gilts the banks buy up from the government to allow the deficit means their reserves are depleted by £150 billion a year. Given leverage levels in banks this potentially means that £1 trillion or so is taken out of potential circulation.

Of course this doesn't truly matter as since 2009 the Bank of England has been making good the difference by buying up an equivalent £150 billion or so a year of outstanding government debt from banks.

The overall effect of course is that the effect of deficit and QE are cancelled out. The only thing that happens is that the government cancels out about £150 billion a year of outstanding government debt. The money supply neither widens or contracts.

So the the theory of deficits and funding them via banks buying them is utterly destructive and irrelevant when we don't have the need of fixed exchange rates. By issuing bonds the government can take money away from the banking system and make sure that it is being spent. The issue is that it doesn't need to be done this way and shouldn't be. All that happens is that taxpayers pay another subsidy to the banks and we get crashes every few decades. This is also what causes inflation and recessions.

However, it's pretty obvious that for countries with their own floating currency, deleveraging banks and with economies working at way, way below spare capacity that you can use QE to clear government debt at will without any inflationary effects.

This is obviously in the UK since there is £375 billion sitting in the Asset Purchase Facility. This money "unaffordable" government credit card bills. At the same time over a third of the debt they are moaning about is stuck in the government owned Bank of England with no hope of it ever being anything other than cancelled and retired.

To add to the hilarity the Treasury, through a wholly government owned agency called the Debt Management Office pays interest on the £325 billion in the APF to the wholly government owned APF. This money is just building up and will eventually (as all profits for the Bank are) be returned to the taxpayer. You couldn't make this up.

So clearly in economic circumstances such as now you can print money directly, buy outstanding government debt and retire it with no inflationary consequences.

Nevertheless Governments are continuing to use an explanation built up at a time of Bretton Woods with full employment, fixed exchange rates and no deleveraging to explain why they don't use the QE to clear down debts.

QE is a pure asset swap. No money is entering the economy. All that is happening is that outstanding public sector debt is being retired. Look at the M4ex money supply figures. They are contracting despite £375 billion of QE and £150 billion a year deficit spending.

The Uk money supply is contracting very rapidly:

Look at the graph half way down. It is showing M4ex is contracting (by 5% at last measure). M4ex needs to grow at a rate of at least 5-10% per year in order to hold off contraction of the money supply. There is no prospect of core inflation.

Policy interest rates are at 0.5%, there are 5 million people looking for work, bank capital adequacy ratios need to double according to Andrew Haldane, Basel 3 and the Vickers reforms kick in in a few years meaning capital creation will slow down further. It is perfectly and utterly safe to retire the £375 billion in the Asset Purchase Facility.

The arguments Lord Turner, the IMF and many others are making that is perfectly safe for the UK to retire the £375 billion of debt in the Asset Purchase Facility are of course absolutely moot.

The QE cannot possible be reversed until the government has eradicated its deficit. If the APF sold the debt whilst the government was running the deficit the effects would be two fold-

1. Gilt yields would go ballistic making the deficit difficult to fund.

2. The reserves in private sector banks would be very rapidly drained so the uk money supply would crash. Bank lending would plummet. We would enter a deflationary depression.

The deficit is not really being paid down at all. Even the OBRs wildly optimistic estimates have the deficit persisting until 2018.

This is without factoring in their idiotic under estimate of the fiscal multiplier (they were expecting 6% growth over the last two years remember). Now we know for certain that austerity is utterly self defeating and as long as it persists the economy will stay flat with only QE keeping it from entering a fully fledged depression. The deficit doesn't decrease and all we get for our troubles is unemployment, declinging in living standards and reduced quality of public services.

By 2018 most of the gilts in the APF will have reached maturity and retired themselves. This is of course why the Tories would never do it. It would reveal the Tory economic strategy for what it is - a policy purely designed to keep the UK economy on its back permanently whist raising unemployment, lowering living standards all in order to suppress wage demands in order the Tory donors gain more profit.

I rate that as a tour de force of Keynesian analysis.



Mark Wadsworth said...

"To enable the government to spend without causing an inflationary spiral, the government taxes by an equal amount to prevent the private sector spending by the same amount - so overall the spending (public and private) remains roughly constant, so no inflationary spiral.


That's also known as 'Modern Monetary Theory', which is a good way of explaining things.

Lola said...

MW. That seems to me to be the first piece of nonsense in the whole thing. It's mad. The end result is that government taxes to spend. That is it creates an overdraft for itself, and then pays that off by taxing the productive economy.

Then there's the error as to what inflation actually is. Inflation is not the rise in prices. It's the arbitrary expansion of money - the overdraft from nowhere - which the government then spends on goods and services. Creating money from nothing must increase prices (but not value).

And it is self defeating. People cannot spend money that the government takes away from them. So the increase in activity promoted by government spending can only be achieved by a an equal and opposite decrease in private spending (and investment).

Or am I missing something?

Mark In Mayenne said...

Will someone please explain to me what is meant by "no inflationary spiral" as opposed to "no inflation"?

Mark Wadsworth said...

L, no it makes perfect sense.

Some people use this explanation to justify deficit spending during depressions, i.e. now, well I'm not convinced that is the correct conclusion.

But look at what they are doing, spending like madmen, running up huge deficits, but price inflation is low and govt bond interest rates are low.

Which sort of proves their point, I'm afraid.

He gets a bit muddled further on, but these Positive Money people always trip themselves up in the end because they don't quite understand things properly. Nearly but not quite.

Dinero said...

The government does not tax people to prevent inflation. The money supply is not fixed and taxes are in themselves often inflationary when they become part of what establishes a price.

Also there is no reserve drain from the banking sector from selling bonds. The government spends the proceeds and so the reserves circulate back into the banking sector.
The corsett was a credit control scheme from 73 to 75 it was not about reserves.

Lola said...

MW I am not at all sure that 'inflation is low'. Certainly the RPI / CPI are 'low' - if you think 2.5% http://www.bbc.co.uk/news/10612209 is low, and I don't. But look at house prices, the stock market and energy costs. Also there is a time delay in these things. Prices rise in one area and then leaks out as the rest of the prices catch up. Usually the last set of increases are the wages of the workers. Economies are not homogenous.

Lola said...

MW. Aren't government bond interest rates related to Bank of England base rates? Part, a big part, of the reason for very low base rates is so that government bonds can be sold at low rates.

I have research elsewhere that proves holding bonds with a greater than two year duration is not worth it. You get no additional reward for the additional risk. And the same research shows that the short end of the bond market prices in short run 'inflation' very well.

Furthermore, in a flight to safety from really dodgy sovereign bonds elsewhere - Greece, Argentina etc. etc. - the price of UK Gilts rises due to demand for them, which pushes down yields.

Sobers said...

MMT actually makes sense in an academic and theoretical way. Its just how one could apply that in the real world of politicians, voters and pork barrel politics that remains an unsolvable conundrum.

If politicians thought they could spend money 'for free' without having to tax anyone, and voters too got used to the idea that there was a free money tree out there, you would create a monster that would soon be out of control. And if you created some 'Wise men' committee to oversee and control it, well, Bang goes democracy, if a group of unelected people (who would have to be outside of political control otherwise they wouldn't be independent) can decide what public spending and taxation levels should be.

In practical democratic terms I reckon we are stuck with mental financial framework we have (whether or not it is a fiction) because we either don't have the ability to control ourselves under a more laissez faire one, or would not accept the constraints on our freedom of action such a system would entail.

Lola said...

And if you created some 'Wise men' committee to oversee and control it, well, Bang goes democracy, if a group of unelected people (who would have to be outside of political control otherwise they wouldn't be independent) can decide what public spending and taxation levels should be. Not 'independent'. I prefer 'unaccountable'.

Ben Jamin' said...

@ Lola

Ultimately, MMT is just a way of looking at things. It changes nothing operationally as far as I can see. Not sure why everyone gets so excited about it.


Lola said...

@BJ. Thanks for the link. I'd read it now - but I MUST do some work....

Ian B said...

Keynesianism is nonsense on stilts, based on some arithmetical skulduggery so blatant that it looked credible in a strange "so bad it's good" kind of way.

Anyhoo, the inflation has been (deliberately) directed into property (since, particularly, the early 1970s). I would have thought that writers on this blog would spot that one straight off the bat.

Ian B said...

The other way of avoiding high street price inflation is that much of the money circulates within the financial sector and never leaks out to the plebs, as also discussed here previously IIRC.

Part of the complexity of it is that under current banking regulations, the amount of money banks have out on loan is not proportionate to their reserves (as many people believe in the "Simple explanation of fractional reserve)" but is instead proportionate to the banks' capitalisation, which is different. So there is sufficient complexitude that simple expectations of what money supply expansions and contractions ought to do don't work in the real world very well.

Dinero said...

gilts in the APF in 2018 that reach maturity will not retire themselves. They will stand to be repaid from the receipts of government revenues such as taxes or possibly govenment bond sales.

Mark Wadsworth said...

Din; "The government does not tax people to prevent inflation. "

Well yes it does, it's easiest to understand why in the conditions of full employment, full capacity as explained in the article.

L, yes, CPI is low but "money supply" in the abstract sense is out of control, this is the flip side of land and share price bubbles, the two go hand in hand.

L, govt bond rates are ultimately set "by the market" not by the BoE.

S, agreed, but MMT is not policy prescription, it merely offers a way of understanding things. It does not actually recommend deficit spending, even though many MMT fundamentalists think it does.

IB, everything the UK government has been doing for the last 30 years is about pumping up land prices, everything.

IB, "the amount of money banks have out on loan is not proportionate to their reserves (as many people believe in the "Simple explanation of fractional reserve)" but is instead proportionate to the banks' capitalisation"

Not really,. Banks just lend as much as they can, the upper limit is set by how much people are prepared to borrow and how much people are prepared to deposit with them.

The concept of "reserves" is more or less redundant.

Din, yes they will retire themselves. You cannot owe yourself money or pay yourself interest.

The article says this, but then says the opposite, as per usually for the Positive Money fundamentalists.

Anonymous said...

Ben, while I agree that most MMT'ers overstate the earth-shattering-ness of the accounting identities, your link seems to simply assume that even an MMT-theory-led government would continue to issue bonds, and then spend half the post pointing out how such a government is thus still vulnerable to the bond markets. The whole point of MMT is to point out that the practice of bond issuing is kind of pointless, when you have a sovereign currency.

The problem for MMT comes when you try and nail down just how much money you can print without it being inflationary and then the question of the best way for the money to actually enter the economy. On the former all I've seen is "when there's full employment" which seems a little imprecise to me, and on the latter all I've seen is "normal government spending" which says to me that they basically have given this question no thought at all!

Steven_L said...


I think a lot of it is about what folk believe. If folk believe 1,000,000% inflation is around the corner, so dump currency to load up on whatever durable goods are left in the shops it becomes a self-fulfilling prophecy.

If enough folk believe that land and other asset prices going up is not 'inflation', but that what the statistics people put in the CPI basket is 'inflation', then they'll act according to that thesis.

If everyone truly believed the world was going to end at midnight on Saturday, civilisation as we know it would end, until such time that belief was shown to be erroneous and things returned to 'normal'.

If David Cameron was the only person who believe he was PM he wouldn't be allowed in 10 Downing St, despite what the paperwork said.

etc etc.

Ian B said...


The amount of loans a bank can have out is set by the Basel Regs, which are defined as a multiple of the bank's capitalisation. How much people deposit is irrelevant to that; deposits are ready cash used to pay demands, which sets a different practical limit which hardly ever comes into play, except during a Northern Rock type run.

Dinero said...

There is no oweing to oneself involved.

The money is not owed to the Bank of England it is owed to depositors in commercial banks who in turn have reserve accounts at the BoE.

It doesnt make a difference if the gilt is held either by a commercial bank directly or the Bank of England it still has a deposit in someones bank account assosiated with it.

When gilts at the BoE mature the treasury does pay them back and it does need to raise revenues to do so. I don't know why you dispute this simple fact that actually happens its that simple, so there is no reason to dispute it.

Lola said...

@ fraggle

This 'amount of money' bit they bang on about. No-one - as in no central authority - can ever 'know' how much money is required. In the same way that no-one knows how many individual baked beans are needed. Liberty, responsibility, property rights, enforceable contracts, markets AND sound money work their magic to make sure that there are, mostly, 'enough'. I accept that the demand for beans will fluctuate a bit, but overall cans of them are always available at a price that's acceptable - no 'inflation'.

As with baked beans, so with that other universal commodity - money.

Plus, it seems to me that MMT people have not really thought about what 'money' actually is nor where it came/comes from.

Lola said...


L, yes, CPI is low but "money supply" in the abstract sense is out of control, this is the flip side of land and share price bubbles, the two go hand in hand. Well, yes. That's what I was saying.

L, govt bond rates are ultimately set "by the market" not by the BoE. True. But in the meantime the Bank of E is doing what it can to rig market forces. Sooner or later that will come home to bite them in the arse.

Mark Wadsworth said...

F, agreed.

SL, agreed.

IB, Basel Regs are made-up after the event.

Maybe banks are supposed to only be 95% deposits/bonds and 5% share capital/retained profits.

Point is that loans out are 100% and deposits/loans in are 95%.

That 5% "buffer" is fairly meaningless in the grander scheme of things.

For example, imagine that a bank has £5 share capital and £5 in the safe, but nobody wants to borrow anything or deposit with them. The other £95 does not come into existence on either side until people borrow from them and other people deposit with them.

Din, we've done QE over and over. All that happened was that the BoE swapped long term debts for short term debts.

Before QE:
BoE owes banks, pensions companies etc £375 bn long term bonds.

After QE:
BoE owes banks, pensions companies etc £375 bn short term.

(As an accounting fiction, one part of the BoE owes another part £375 bn long term bonds, ignore this bit).

L, yes, the BoE appear to be rigging things and getting away with it, but sooner or later the markets will come back and bite them - i.e. us taxpayers - in the arse.

Lola said...

MW. Ah yes. But when? If we can work that out we can make a killing.

Dinero said...

banks can satisfy regulatory capital by charging a loan arrangement fee.

For example a 5% requirement

capital = assets - liabilaties.

therefore if someone borrows £100 and pays a £5 arrangement fee

assets = £100

liabilaties =£95

and capital = £5 = 5% which satisfies regulatory capital.

Mark Wadsworth said...

L, that is the multi-billion dollar question :-)

Din, that is an excellent example.

A lot of banks now charge interest up front aka "arrangement fees" presumably partly for this reason and partly because they can book it as profits on Day One (in exchange for slightly lower profits over the next 25 years).

Lola said...

MW. But with 'your brain the size of a planet' I am sure you can work it out....

Lola said...

Din and MW.

Mortgage lenders have been doing up front profit fees for years. Mostly up front fees on fixed rate loans mortgages cover the 'loss' of interest in the fixed rate period, plus a not inconsiderable bit.

Mark Wadsworth said...

L, I wish I could but I've used up my nine lives and have retired from the speculating game.

As to up front fees, have they? I took out a ten-year fixed rate in 19998 from The Halifax and there was no up front charge.

There was penalty interest if I repaid early, fair enough.

Lola said...

MW. Yep, 1998 would have been OK. But as you have already said previously, and as I agreed and observed at the time, by 2001 / 2003 it was all getting very silly.

The best deals from then on were low spread whole of term trackers, often at base plus 0.5% and I did quite a few of those (on the basis that you couldn't really lose at a spread of 0.5%).

Got a lot of happy clients now...!

Pablo said...

MW: these Positive Money people always trip themselves up in the end because they don't quite understand things properly. Nearly but not quite
What about Zarlenga over at AMI - do ya reckon he's got a grip?