Steve Laughton explains how government spending really works.

 “When we’re spending £100bn a year on servicing government debt, I don’t think anyone could seriously argue we don’t need to get a grip on government borrowing and government debt”. Rachel Reeves, on Bloomberg.

Think again.

“Piggynomics”

The principle that underpins Reeves’ concerns is that Musk is right: the state can run out of money and government debt burdens us all. This rests on the belief that when government spends, it gets its funds by either taxing us or borrowing from us. Governments, are like children: they have no money in their piggybanks until someone else has put it there. The government cannot create money, but taxpayers can.

Let’s think about this: supposedly, taxpayers provide pounds by either paying taxes or lending money to the government.  How do we taxpayers source the money?

We don’t create it ourselves. That would be counterfeiting.

In reality money, is not a thing or a commodity or a lump of precious metal. Since President Nixon abandoned the gold standard in 1971, currency is no longer exchangeable for gold or for anything else. Money is a measure of who owes what to whom, and only government or government-authorised institutions (banks) create it.

The government names its unit of account – pounds – and imposes taxes that must be paid in this currency. We get hold of pounds by selling goods or services to the government, which spends its currency into existence.

Those not directly paid by government get pounds by trading with those who are. Thus, government money circulates around the economy.

Imagine you were running a commune, issuing vouchers to members who provide services. They accept your vouchers because the commune imposes taxes payable only in vouchers. When they give you back the vouchers, they no longer owe anything. You cannot run out of vouchers. The vouchers are the commune’s tax credits. Sterling pounds are the UK government’s tax credits required for paying fines and taxes.

The constraint is that if you imposed a tax of ten vouchers and paid everybody twenty vouchers for anything they provided, they’d have no reason to do anything more for you. They would have loads of surplus vouchers with which to pay their next taxes.  Secondly, the more vouchers you pay for something, the higher its price in vouchers.  The constraint on government spending is the price it pays for purchases. The constraint is inflation.   

Deficit Spending

If a government taxes £1,000 but spends £1,200, it leaves £200 in the economy. It fulfils its promise to wipe out our tax debt, andleaves us with £200. It has ‘deficit- spent’: its deficit is our savings. The government does not have to ask us to give back what it has left with us. The government ‘debt’ is just the accumulation of our savings since records began. Higher savings are no risk.

No deficit, no savings. While individuals can save by spending less than they earn, the entire private sector as a whole cannot have net savings, unless the government runs a deficit. To understand why, you need only look at banking.

Bank IOUs

Banks, regulated by government, create their own IOUs in government currency. Contrary to the recent Bank of England book “Cant’ We Just Print More Money”, when a bank grants a loan, it does not lend out  existing money held as deposits in bank accounts.  Instead, it marks up your account with a deposit, matched by the loan. Loans create deposits, not the other way round. Deposits are liabilities for the bank but assets for customers. When loans are repaid that money no longer exists. The bank only grants the ‘loan’ because it charges you a fee or interest on the loan.

Private sector bank lending produces no net saving, because every deposit created is matched by a debt. While we can use this money when we get the loan, we owe it all back. We cannot save in the long run. By law, banks have to have some savings: positive equity. This puts the non-bank private sector in negative financial equity, unless the government deficit-spends. Running a balanced budget, or worse still a surplus, is highly irresponsible. Exceptions can occur when a country has a large balance of payments surplus, which brings extra money into the country. Suffice to say, the UK does not qualify!

Payment of Tax

The government promises that you can pay your taxes using bank IOUs, but the banks have to pay using their central bank reserves. Only the government creates these reserves.  The banks send them back and the government eventually destroys them. The myriad of accounts used to do this are definitively described in The Self-Financing State by Ryan-Collins, Voldsgaard, Berkeley, Tye and Wilson.

Thatcher and Piggynomics

Thatcher claimed there was no government money, only taxpayers’ money. She had it back to front: there is no taxpayers’ money, only government money. What we misleadingly call its ‘debt’, is merely money not returned in taxes. The clue is in the word revenue derived from the French revenir, meaning to come back. Tax Returns return the tax credits, extinguishing our debt to the government.  Once returned, the tax credit ceases to exist, just as, when you pay back a loan, that debt no longer exists. Money is just this IOU promise: the government owes you the right to redeem your debt. When it meets that promise, its IOU no longer exists. The government can’t spend taxes.

A government never taxes and spends: it always spends and taxes.

The government doesn’t need our money: It needs our labour, and it is our labour that gives money value.

Government Debt is a Misnomer

Money issued by the government is recorded as its liability and our asset. When the government offers to swap our bank deposits for bonds paying higher interest, these bonds are frighteningly called Government Debt. But this debt is unlike debt as we understand the word. 

Unlike private debt, the tax credits it leaves in the economy, whether in deposits or bonds, are merely promises to accept them back in payment of tax. It doesn’t’ borrow the promises from us, it can’t give them back or run out of them, any more than the commune can run out of its vouchers.

 As Alan Greenspan testified under oath, regarding social security payments, it doesn’t pay them “with taxes” and it can’t run out of payments.

The first and last sign of madness: Government Surpluses

Only government, or institutions authorised by government can spend tax credits, that is central bank reserves, into existence.

After spending on essentials, most people who have money left, like to save for a rainy day or for some expensive purchase. Without government deficit-spending,private sector financial saving cannot exist. If the deficits are too small, our attempts to save cause a shortage of money, resulting in unemployment and private debt.  This causes economic stagnation. Loans can’t be repaid. Banks stop lending. Extreme result: 1929 crash or 2008 financial crisis. Note that the 1929 crash occurred after the period in which Coolidge, like Clinton in later years, was boasting a government surplus.

Insufficient government spending crowds out private investment and encourages unsustainable increases in bank lending. Increased government deficits stimulate private investment.

A positive step by Labour has been the relaxation of borrowing restrictions for infrastructure investment. 

Wealth Tax and the Piggybank Trap

Progressives who call for wealth taxes to fund spending, fall into the Piggybank Trap, reinforcing the idea that government depends on the wealthy’s money, that the rich hold the purse strings and we don’t want them leaving us; they control the markets which must be appeased. Why peddle a false narrative that supports the 1% and enfeebles governments?

An example of this was when during the Great Financial Crash many thought US dollar lending to Europe indicated helpless dependency on global capital. It actually aimed to lower LIBOR rates, which control US interest rates. The US wanted lower rates. We were not helpless.

Taxing the wealthy destroys money: it doesn’t’ provide the exchequer with more money. Taxing the rich should aim at reducing their power, or bearing down on inflation, if it appears they are spending so much that they are driving up prices (of Bentleys and superyachts?). We don’t need their money to spend on public services.  

Responsible fiscal rules require a correct understanding of money. For two decades or more, centre-left parties globally have been losing ground to the populist right. In the UK, if Reform or the Conservatives expanded deficits (by raising tax thresholds) this would spur growth. The supposed economic crisis under Lizz Truss vanished as soon as the Bank of England behaved rationally. If she had understood money, she would have told the BoE to act appropriately before her tax cuts. But no, the myth of the all-powerful markets prevailed and the left encouraged it. This story of the bond vigilante ruse  will be explored in a further article.

Fiscal rules based on a mis-conceptualisation of money are the pathway to even greater inequality, economic stagnation and electoral oblivion. 

Steve Laughton Dip Econ/ MA Econ has been in the Labour Party since 1981. He was the Political Education Officer of Bournemouth East and Bournemouth West Labour for several years. He is a member of Momentum. Recently he has devoted his time to economics, and remains an independent philosophical economist, who believes current economic wisdom is deeply flawed and that centrist politicians who follow it are paving the way for their own demise.

Image: https://dailymontanan.com/tag/budget/page/4/ Licence: Attribution-ShareAlike 3.0 Unported CC BY-SA 3.0 Deed