To continue on from yesterday’s blog about where people think money comes from and how it is created, now people realise that the era when money rested on the value of gold has long past, so most, these days, seem to consider that money comes from tax. After all everyone ‘knows’ that there is no magic money tree.
Yet it would be remarkable if private commercial banks who the Bank of England has already told us create money out of thin air as a result of a banking licence granted by the government, were to be the sole new money creators in an economy. Why would a government permit these banks to create money but seek to prevent itself from creating its own money? It makes no sense. What advantage would be gained by making private commercial banks the unique creators of money? If your government were captured by private banking interests you could legislate for it to be so run, but if you have to legislate for this change, then that automatically implies that, really, the reverse is true.
The Bank of England also points out that private bank loans, apart from the interest, are destroyed when they are repaid. Why is this, for some unfathomable reason, felt to be any different when government collects tax?
People always claim that inflation is a great danger where government creates money (see below -click to enlarge- as an example, where true to form, even the Bank of England manages to get in the Weimar Republic and Zimbabwe. Chaotic though our current government is, it hasn’t yet reached that stage). When they say ‘in theory the Bank can create unlimited amounts of Sterling’ they are saying it is possible – that is how it works. They also imply that they can create more limited amounts of Sterling. Quite how the Economist article can infer that MMT is saying anything that is controversial or can quote economists denying that the system works this way – all the while never telling us how the logic is incorrect, is beyond me.
In fact the inflation dangers are greatly overstated and have been effectively debunked – even in the FT – as I outlined here.
They also take no account of the role of tax in clawing back money that is spent into the economy. Even on an annual basis the UK government taxes back most of what it spends – spending 38.5% of GDP and collecting 33% back in ‘revenue’. This takes no account of the so called velocity of money where £1 million pounds issued will require only 20 exchanges with 35% taxation to largely disappear. Nor either of the multiplier effect – as Charles Adams says ‘how are we going to pay for it? The answer is, it pays for itself.’ For when the government spends more, by definition it increases economic activity, and so more tax will be payable on this increased activity (which is why it is, for example, the economics of the madhouse to withdraw benefits from the poorest, who will always want to spend their benefits precisely because they are poor. Reducing benefits simply reduces economic activity.)
Money is also always an IOU. We have only to look on the front of every UK note: The Chief Cashier of the Bank of England ‘promise[s] to pay the bearer on demand’.
Money is issued as a debt with the intention of it coming back. And if it is an IOU, when you receive your IOU back, having discharged your debt, you don’t keep the IOU in your back pocket to recirculate another time, you put it in the bin. That is why when government creates money it gets destroyed and not recycled when it is collected as tax.
Perhaps the most persuasive point of all that demonstrates that we actually cannot tax and spend is the simple logic of how we are going to pay tax?
The government will not accept tax in the form of seashells or a currency that I might print out on my computer, or even Euros. It will accept taxes only in Pounds Sterling. So how am I going to pay these taxes unless the government first issues the money in which to pay them? If government wants to tax it has to create money for tax in the first place.
That’s why the monetary system described by MMT must be correct!
To summarise: how do we know that we spend first and tax later?
1.Fiat currencies are always a public monopoly – you cannot print your own.
2.Money is an IOU.
3.The Bank of England says so (see the reply above).
4.The Treasury also says so (see here).