State Funding and Modern Monetary Theory

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  • #49025 Reply
    Mr Shigemitsu

    “Even when a state does good things, like tax to provide healthcare, it ultimately depends on its ability to employ violence to enforce the collection of the tax”

    Dear Craig,

    Firstly, taxation in the UK does not “provide healthcare.”

    Apart from the fact that actual healthcare is provided by doctors, nurses, pharmacists, medication, equipment, hospital infrastructure and energy, i.e. the resources of the *real* economy, and not by “money” itself – taxation is simply an operation to drain money from circulation – it doesn’t “pay” for anything in the UK, and the follwing expalnation will expalin why…

    One of the primary functions of taxation in a modern economy – such as the UK – that is no longer on the Gold Standard, or in a currency union or peg with a foreign currency, is primarily to force (yes, by threat of confiscation of property, or imprisonment) the ubiquitous use and acceptance of its currency within the country. This is essential for a modern economy to function, and you can imagine the chaos that would ensue if the UK used a multitude of various currencies, something that is usually a feature of a chaotic failing economy, or one that has been devastated by war.

    As a diplomat with African experience, you will know that the Hut Tax that the British imposed in Kenya is the perfect example of ensuring the use of a new currency in a nation by the imposition of tax in that currency – which was otherwise of no value to the inhabitants. The imposition of taxation enables a Govt to provision itself with *real* resources (labour, materials, land, energy, etc) necessary for the public services of the nation (eg. doctors, nurses, teachers, police officers, civil servants, etc), by creating demand for the currency by forcing citizens to work for that currency in order to pay their tax.

    However, as monopoly issuer of the currency, the UK Govt doesn’t *need* to tax before it can spend. The causation is, in reality, that Govt spending *precedes* taxation. How else would the benighted Kenyans have been able to pay their hated Hut Tax, had the Government not first paid them – in Pounds – to carry out work that the Government required them to do? You can’t pay a single penny in tax until the currency is first spent into existence.

    What now happens in the UK, post Gold Standard (1931) and Bretton Woods (1971), is the Govt spends money into existence simply by instructing the BoE to credit reserves to the reserve accounts of the banks of the initial recipients of that public spending. There is no recourse to any previously taxed funds, or in fact any resource at all – these new reserves are created at a keystroke. And this process continues every single day, week in week out, as the government provisions itself with whatever goods and services it requires from the private sector, and payments are issued for benefits, pensions, and so on.

    Because money does not stop at first use, it will continue to circulate around the economy as the initial spending recipients spend their wages, benefits, payments etc on other goods and services.

    But imagine if this constant government spending continued day in, day out. Eventually there would be so much money injected in to the economy chasing more or less the same amount of real goods and services available in it, that demand would eventually exceed supply, and inflation, even hyper-inflation – would ensue.

    So in order to prevent this risk of inflation, taxes are imposed on each and every transaction – from the initial recipient of govt spending, and then on all the subsequent transactions that occur, as the ever-decreasing amount of currency circulates around the economy. Until, for any positive rate of tax, the initial amount will eventually return (“re-venue”) to the Exchequer until every pound of the original spend has been hoovered up and out of the economy. This achieved by a reserve-drain operation at the BoE, where the reserve account of the taxpayer’s bank is depleted by the amount paid in tax – effectively destroying the money as it removes it from circulation.

    But because it would be impossible to carry out a reserve-drain (taxation) operation at the BoE *before* a reserve-add (spending), it can be shown that in fact spending *has* to precede taxation, and not the other way around. In this way, by using taxation as a hoover to drain away excess spending at the point of every transaction, the govt can ensure continuous public spending *without* causing the inevitable inflation that would occur if taxation was never imposed.

    The usefulness of this knowledge is that politicians can no longer hide behind the Thatcherite lie that the UK Govt has no money of its own, and is therefore financially constrained by what it can raise in taxation. In fact the govt can create an infinite amount of pounds. But in reality, it’s constrained by the capacity of the real economy (labour, materials, land, energy) to absorb all the spending without causing inflation. If the govt spends more that the economy can absorb then inflation will result. If it spends too little, the result will be unemployment and recession.
    It’s therefore encumbent on the Govt to maximise the capacity of the real economy to absorb the highest amount of spending possible for the benefit of its people – so that it’s a virtuous circle. This can, and must, include environmentally beneficial spending and growth.

    If we are armed with this understanding of how the modern monetary system actually works, politicians will never be able to tell us that “we can’t afford it”, when demands are made to improve public services – all they will be able to say is that “we don’t have enough teachers/doctors/nurse/hospitals, etc.” But the challenge will be for them to explain why not, at a time such as now, after years of Tory neglect, when there is *plenty* of spare capacity in the economy.

    It will also free us of the erroneous belief that we depend on the rich for our public services – because nothing could be further from the truth. If the rich hoard their money, it doesn’t prevent the govt from spending at all – all it does is slow down the rate at which the Exchequer taxes away and destroys the excess currency. The worst that happens is that there is a budget deficit, which exactly matches the money saved, and continues until the money is eventually spent; at which point it will be taxed, and destroyed. All the National “Debt” actually is, is the accumulated savings of the private sector, so it doesn’t need to be paid off ever – unless you really want to tax away people’s savings just for the sake of neat accounting.

    So taxes don’t grow on rich people. It’s certainly a great idea to tax them till the pips squeak, but only to reduce the power and political influence that their wealth brings them – and *not* because either we or the Govt *need* their money. We never have to be grateful to millionaires.

    Taxation is absolutely *essential* – but not for the govt to collect in order to spend, just for ensuring we all use and accept Sterling, and to avoid the massive inflation that would soon occur if public spending continued year after year, without being taxed.

    The enforcement of taxation by the State is to the benefit of all of us – though absolutely not for the reasons that are commonly believed.

    #49027 Reply

    Neatly explained, Mr Shigemitsu. Thank you.

    #49029 Reply

    That’s a neat explanation of taxation, but somehow, I’m not entirely convinced it does apply to our modern system for two reasons:

    1/ Money is created by the central bank, which in most modern economies is an independent body. (At least, that’s how the story goes. It’s debatable whether for instance the FED or the BoE are really independent from their respective governments. The ECB is though, much to the ire of the Germans.)
    2/ Most of the money nowadays is created by private banks, not the central bank. So, to make your story complete, you have to say something about the creation/destruction process of that money.

    Also, as an additional point, what do you think of Modern Monetary Theory?

    #49031 Reply
    Mr Shigemitsu

    Raskolnikov, it absolutely applies to our times!

    1) The BoE was nationalised in 1946, and is owned by the Treasury Solicitor. It has some operational “independence, though this is largely illusory – being mostly restricted to setting interest rates to stay within the inflation target – and was only implemented by the coward Gordon Brown in 1997, in order to pacify the markets when he became Chancellor, following pure neoliberal dictat.
    The Chancellor is the one who actually sets the target inflation rate, and has been responsible for dictating the amount of QE, for example.

    Considering the Consolidated, or Whole of Govt, Accounts, there is no essential division between the BoE and the Treasury, just that some accounting conventions, include some as a result of EU legislation, attempt to create a separation between them – but this is also pure neo-liberalism, and intended to hamstring governments from directly meeting their citizens’ needs, by kowtowing to market forces. Its suits banks and Tory politicians to let us believe that we, and they, are the sole sources of money, not the government.

    2) Private banks just create *credit* (horizontal, or low-powered money), which, needing to be repaid (at interest), nets to zero – so there are no new financial assets created. Only Govt spending (vertical, or high-powered money) is the sole creator of new financial assets for the private sector.

    Yes, I am a huge fan of MMT – as should anyone else be who cares to see through the economic guff we are constantly brainwashed with in order to preserve the neo-liberal status quo.

    #49054 Reply
    Brian Vickery

    “as monopoly issuer of the currency, the UK Govt” Still depends on state violence or the threat of violence.

    #49047 Reply
    Mighty Drunken

    I agree with you Raskolnikov.
    Also governments tend to run deficits, they spend more than they raise in taxes. This money is then burrowed from the bond market, not printed. Mr Shigemitsu gives a good story which could describe how money works, but we don’t run that exact system.

    Here is a critique of MMT I have seen which I tend to agree with.

    #49033 Reply
    Mark Russell

    Thank you for these helpful and cogent posts regarding money supply and taxation. The global financial system has become no more than a monumental ponzi scheme thanks to the abandonment of the Gold Standard and Breton Woods – and deregulation of the City. MMT is certainly the future – if humanity survives the coming few years.

    #49058 Reply

    MMT explains very neatly that any Government with a sovereign currency creates money basically out of thin air and brings it into circulation.
    A fine example is Germany after WW2 when the Deutschmark was created and every adult person received some 60 DM “Kopfgeld” and the Reichsmark savings where traded 10/1, where the Reichsmark basically was worthless and did not represent any value.


    #49049 Reply

    “Borrowed” from The Bond Market!

    Pray educate us where that Bond Market ‘lenders’ got their £’s to ‘lend’ to the Government?

    Take it step by step, as many of us are thick as shit and think the governments finances are the same as an individuals. And that there is no such thing as a ‘society’.

    #49052 Reply
    Mr Shigemitsu

    The budget deficit is the difference between what the Govt has spent into existence, and what it has then recovered in taxes in one financial year. The shortfall *exactly* equals the amount of the currency that the private sector (i.e. us) has chosen to save.

    Because all of this unspent money would be sloshing around as BoE reserves (where else would it go?), banks, in aggregate, would have reserves in excess of their liabilities. This would push down the interbank lending rate to zero, because the BoE doesn’t pay interest on excess reserves. So, in order to stick within the BoE’s interest rate target, and pull out these excess reserves, the Govt sells (usually at an interest rate – called the “yield”, which is usually higher than the base rate) a savings product called a Treasury Bond, or a Gilt.

    Now this *looks* like Govt “borrowing”, because it is indeed a liability at the Treasury, but its only “borrowing” in the sense that NatWest or Barclays are “borrowing” your salary every month – and you certainly don’t lose sleep that they’re in massive debt to everyone at the beginning of the month as a result! The Govt could just as easily instruct the BoE to pay interest on excess reserves, and it wouldn’t need to issue Gilts at all. It’s partly as a favour to the financial institutions, providing them with an ultra-safe savings product that need never be defaulted on, and partly to maintain the pretence that the Govt has no money of it’s own – which is Thatcher’s”Govt as Household” myth.

    The beauty though, is that even if the Govt *didn’t* issue Gilts (a liability at the Govt owned Treasury), there would instead billions of pounds of excess reserves sloshing around… which would be a liabilty at the Govt owned Bank of England!!! So either way – Gilts or no Gilts – for as long as the private sector net-saves, there will always be a Govt liability of one type or another, until the money is spent and consequently taxed out of existence. So all that the purchase of GIlts is, is just an asset swap for one type of govt liability for another – for as long as there are any kind of Sterling savings – even the tenner in your wallet – the govt is still “in debt”, even if it weren’t to sell any Bonds at all.

    If the govt were to – god forbid – tax more than it has spent, there would be a budget surplus. At any time other than a boom, this would be dreadful for the economy – the private sector (ie us) would, in aggregate, have to raid our savings, or worse, borrow, in order to pay the tax that the govt was sucking out of the economy. In a nation like ours, with a persistent trade deficit, this would be a recipe for recession – which is why Ed Davey’s economic plans are illiterate.

    There is no fundamental need to issue bonds – and the government can always spend without recourse to prior taxation.
    For example, did you or anyone else in the UK get an extraordinary tax bill before the Govt bailed out the banks to the tune of £800bn? Before it then instructed the BoE to conjure up £435bn to buy up a third of all available Gilts under QE? When it decided to spaff away further billions on various foreign wars?

    No of course you didn’t because that’s not modern money creation works.

    The link you refer to tries desperately hard to separate the Treasury and the Central Bank (Fed Reserve in its case), but it’s a smokescreen, and solely a function of highly artificial, arbitrary, and functionally unnecessary, rules. The reality is that they *are* consolidated into one government function – which is to run the economy and provide the necessary currency in order for it to operate, and to tax in order to enforce currency use, and drain excess funds in order to combat inflation. The idea, as described in that blog, that MMT presents “moral hazard”, and that unelected committees, or independent central banks should decide fiscal and monetary policy is pure, undemocratic, neoliberalism.

    Believing all this neoliberal economic propaganda is actually *imprisoning* otherwise progressive people into the Thatcherite narrative of scarce money: the sense that we have to keep public spending low because no-one will vote for higher taxation, or that the rich (who we absolutely *don’t* depend on for their taxes) will run away, and leave us without functioning services. That we cannot trust democratically elected governments to spend the money that a civilised society requires for a more equally distributed economy, so instead we need unelected managerialists and bureaucrats, to protect us from ourselves.

    MMT itself is politically completely agnostic – it merely offers a lens to see how the modern monetary system functions, but unless you happen to be a Tory, a billionaire, or a banker, why wouldn’t you want to end this “Govt as Household” charade? But MMT *is* your “Get out of Jail Free” card, and yes, in a developed economy such as ours, we actually *can* all have nice things – up to the real capacity of all of us to provide them, and not by how much we pay in advance in tax, or borrow from rich people.

    #49060 Reply
    Magic Robot

    Mr. S,
    @December 3, 2019 at 13:38
    I stopped counting the paragraphs at number 12.
    As usual, promoting his medieval ‘Philosopher’s Stone’ (MMT) theory that will somehow turn base metal (or paper, with funny marks on it) into money – it won’t it can’t and it never has.
    He cannot show one example in history, at all, anywhere, where the magical alchemy for the process took place and survived.
    Alan Greenspan didn’t believe it could and nor did J. P. Morgan.
    With that verbose comment, he even puts John Law in the shade.
    Still, keep trying, eh?

    #49056 Reply
    Mr Shigemitsu

    Indeed it does. But in the case of taxation, as I described above, it’s for our own good!

    We don’t really want to be buying food with tally sticks, cigarettes, or foreign currency; the national acceptance of sterling serves us just fine – as does the absence of runaway inflation.

    #49038 Reply
    Mr Shigemitsu

    @Mark Russell,

    Fiat currency and the abandonment of the Gold Standard and Bretton Woods is a good thing! Please don’t let your anti-establishment leanings push you into the arms of alt-right goldbugs and the sound money brigade – they’re economic views are reactionary, recessionary, and lead to immiseration.

    Since Thatcher, or arguably Denis Healey, economic policy in the UK has been run as if we *were* still on the Gold Standard, or in a currency peg, whereas the truth that we’re not is potentially extremely liberating.

    MMT is really the *present*, and accurately *describes* the existing currency creation process in a nation like the UK – with its own sovereign, fiat, non-convertible currency. It’s *descriptive*, not *prescriptive* (apart from the Job Guarantee policy).

    What politicians – or voters – do with this MMT knowledge is up to them – they can carry on with business as usual, or fully use the power of the State, like the UK, that creates its own currency, in the interests of the greater good.

    #49040 Reply
    Mark Russell

    @Mr Shigemitsu

    “What politicians – or voters – do with this MMT knowledge is up to them – they can carry on with business as usual, or fully use the power of the State, like the UK, that creates its own currency, in the interests of the greater good.”

    QE should have been a wake-up call for the wider public to demonstrate the ease by which money can be created – but I guess the complexities of the financial system would be beyond the attention span, if not the comprehension, of most people. It will make for an interesting enlightenment and transition, if and when the time comes. Would very much appreciate some more of your thoughts on MMT, but I’m reluctant to distract from Craig’s post. I give consent for admin to pass on my email if you are happy to do so.

    Thank you again.

    #49045 Reply
    Mark Russell

    Thank you for that link, that is really helpful. Appreciate you taking the time to post this today.

    #49042 Reply
    Mr Shigemitsu

    @ Mark Russell,

    Thank you, but this blog by economics professor, Bill Mitchell, is a far better MMT resource for you than I could ever be:

    Apologies to Craig – I didn’t mean to hijack the blog post, but this issue is so fundamental to economic justice, that I felt unable to leave the reference to “tax paying for health services” unchallenged.

    It would be great to see Craig “on board” with MMT generally, but it can additionally provide vital knowledge with regard to issues of currency sovereignty, post-Scottish Independence .

    #49043 Reply
    Mark Russell

    Thanks for this – as an aside, I think I’ve already met Bill Mitchell through the dots on a musical score via another academic in Oz with a common passion for John Martyn! Had no idea of his expertise in MMT. Will certainly be in contact. Thank you again for your helpful posts on this subject.

    #49064 Reply

    Excellent Mr S – thanks for the ‘tally sticks’ too. I’d stopped talking about them after having to try and explain to people by starting with Harry Belafonte!

    You have done a splendid job here and it deserves a dedicated post. Thanks again.

    #49091 Reply
    Iain Stewart

    Isn’t Japan the usual example? You’d better let them know they’re magical alchemists before it’s too late.

    #49207 Reply

    Amazing..Because just last night I watched 20 mins of a video on this very subject..Interesting.Maybe some things have changed since this video at the beginning of 2015 –

    ‘ Bill Mitchell: Demystifying Modern Monetary Theory ‘

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