Rethinking government debt



There is a huge amount of hysteria about government debt and deficits, not just in the UK but throughout much of the world. As I write, Brazil has been downgraded by Standard & Poors because of concerns about rising government debt and weakening commitment to primary fiscal surpluses in a context of political uncertainty and deepening recession. It is the latest in a long line of downgrades and investor flight over the last few years. The global economy is a very stormy place.

The UK, which has halved its fiscal deficit in relation to gdp in the last five years, is embarking on another round of fiscal tightening, with the aim not only of completely eliminating the deficit but running an absolute surplus by 2020 in order to, in the words of the Chancellor, "bear down on debt". The Chancellor's plan enjoys considerable popular support due to a widespread belief that if we do not eliminate the deficit and start paying down debt, we will end up like Greece. "Dealing with the deficit" has become synonymous with good economic management.

But others argue that further austerity to eliminate the deficit and pay down debt is unnecessary and harmful, especially if it means further cuts to investment spending. A growing number of voices call for the UK to increase investment spending even if it means a rise in headline debt/gdp in the short term, because improved growth from the extra investment would result in debt/gdp falling in the longer term. For many of these people (and I admit I am one), deficit phobia is economically illiterate and failing to invest when interest rates are on the floor is irresponsible management of the economy.

Still others say that government debt is unnecessary: a monetarily sovereign government can fund spending through central bank money creation. Jeremy Corbyn's People's QE gives a nod in this direction.

So who is right? How much debt should the UK have? What is the purpose of government debt?

To discuss the purpose of government debt, we must first consider the relationship between debt and money. Ever since the abandonment of the gold standard in 1971, governments have issued their own currencies. A government bond issued by a currency-issuing sovereign is simply a promise to issue an agreed amount of sovereign money at defined points in the future. The only new money issued is the interest: the principal payment at maturity simply re-issues the money withdrawn from circulation when the bond is sold. Thus, buying a government bond is exactly the same as placing money in a government-insured time deposit account in a bank. We should really regard government bonds as certificates of deposit. They are simply money, in another form.

Debt issued by a monetarily sovereign government in its own currency is the safest of safe assets. A monetarily sovereign government cannot be forced into default on debt issued in its own currency, and it does not have to tolerate inflation either. Default is a political decision. So is inflation.

But the power to issue money does not of itself confer monetary sovereignty. Many governments that are not monetarily sovereign issue money. What then do we mean by "monetary sovereignty"?

Monetary sovereignty means that the government  has full control over both the amount and the value of money in circulation, in all its forms (including government debt). Note that fixing a value is not the same as controlling it. We generally say that a government is monetarily sovereign if the following are true:
  • it issues its own currency 
  • it has a freely-floating exchange rate
  • it has an open capital account
But this would also be monetary sovereignty:
  • it issues its own currency
  • it has a fixed exchange rate or the currency is not traded
  • it has strict capital controls
Note that the definition of "monetarily sovereign" would include some failed states. Monetary sovereignty is not a guarantee of responsible economic management. Sovereign governments can trash their economies if they choose.

There are five principal ways in which governments can lose or relinquish sovereignty.

1. Any country in which the currency used to settle debts ((legal tender) and pay taxes is not issued by the government is not monetarily sovereign. So, for example:
  • Ecuador (uses US$)
  • Panama (ditto)
  • Kosovo (uses Euro)
  • San Marino (ditto)
  • Zimbabwe (anything goes except the Zimbabwean dollar)
This category also includes all Eurozone eountries except Germany.

2. Any country which fixes the value of its currency in relation to one or more other currencies does not have monetary sovereignty UNLESS it also has strict capital controls. So, for example:
  • Bulgaria (currency board to Euro)
  • China (floating peg to a basket of currencies: leaky capital controls)
  • Denmark (ERM II peg to Euro)
Switzerland regained monetary sovereignty when it released its Euro peg earlier this year,  to the consternation of the financial markets.

3. Any country whose currency's value is explicitly or implicitly determined by the value of a commodity does not have monetary sovereignty.

The most obvious example of this is the inter-war gold standard, whose inflexibility prevented countries such as the US from reflating their economies and thus turned a recession into a Depression. But oil exporters such as  Russia and Kazakhstan also fall into this category. They have now floated their currencies, but their currencies track the oil price.

4. Any country that borrows mainly in another currency does not have monetary sovereignty even if it issues its own currency. This includes high levels of foreign-denominated external debt arising from a large trade deficit. Most hyperinflations involve countries which issue their own currencies but have very high external debt: this was certainly true of the archetypal hyperinflation, that of the Weimar republic.

5. Any country which is largely dependent on trade links to a more dominant country does not have monetary sovereignty. This is perhaps the least obvious category, but it is crucially important. The small economies of South East Asia are dependent on trade ties with China. As the external value of a currency is largely determined by trade, their currencies therefore fall or rise with the yuan even without explicit pegs.

The five categories listed above cover the majority of countries in the world, including some of the largest economies. Monetary sovereignty is a very rare breed indeed. The vast majority of governments cannot issue either money or debt without limit. For most of the world, deficits (including external ones) and debt DO matter. Though perhaps fiscal rules don't have to be quite as strict as those imposed in the ridiculously-named EU "Stability and Growth Pact", which are slowly squeezing all growth out of the Eurozone and creating social and political instability.

But there seems to be a select group of countries which do have monetary sovereignty. The most prominent of these is the US, but it also includes Japan, Germany (because it is the Eurozone hegemon and the Euro is really a renamed Deutschmark), Switzerland (now), the UK, Canada and possibly Australia. Oddly, all of these violate one or more of the categories above - but they are nonetheless trusted by investors. Why this is, is a mystery. The key criteria appear to be the following:
  • a history of sound economic management and few defaults (ok, so why is Germany in the list?)
  • a dominant economic position (ok, so why isn't China in the list?)
  • a credible independent central bank
  • reserve currency status
  • long-dated government debt stocks mainly owned by own citizens
  • stable government and low political risk
These countries enjoy privileges that other countries do not. Although they have very low interest rates on government debt, they do not need to fund government spending with debt: they can simply issue money to meet commitments, relying on taxation and monetary policy to maintain purchasing power. They even have unlimited access to each other's currencies through central bank swap lines, thus in effect eliminating their external debt liabilities. But these extraordinary privileges do not mean that their own-currency debt has no purpose. On the contrary, they make it more vital than ever - and there is not enough of it.

The debt of this "Premier League" countries has four main uses in the modern global economy:
  • A safe savings vehicle for  their own citizens (particularly vital in those that have poor demographics, such as Japan)
  • A safe haven for foreign investors fleeing from trouble elsewhere
  • An anchor for investment portfolios
  • An essential lubricant in financial markets
Strictly speaking, only the first of these is "necessary" as far as those governments are concerned. Their primary responsibility is to their own citizens. Enabling those citizens to save safely AND invest productively is a part of that responsibility. For that reason alone, these governments should issue enough debt to meet the saving propensity of the domestic private sector, though they might choose to lean against the pro-cyclicality of saving preferences by issuing money instead of debt in recessions and debt instead of money in booms.

But the other three are also essential, from a global economy perspective. The financial system needs safe assets. The fallout when private sector "safe assets" are exposed as the risky assets they really are is terrible. So too is the fallout when sovereign debt issued by governments that do not have monetary sovereignty is exposed as the risky asset it really is. We have seen both in recent years: the 2008 crisis was a failure of private sector safe assets, and the Eurozone crisis was a failure of government safe assets. We are still paying for the consequences of these failures. To pretend that the financial system can manage without safe assets is folly.

This explains the clampdown on government debt and deficits in "Premier League" countries. There is a terrible fear among financial sector actors that these countries will pursue reckless economic policies that destroy the purchasing power of their currencies and the value of their government debt. This fear has been deliberately communicated to the general public in those countries by captive politicians and media, in order to ensure wide acceptance of the austerity policies that much of the financial sector believes is necessary to maintain the value of safe assets. It is perhaps understandable, but it is economically unjustified. The truth is this:
  • Running a primary fiscal surplus in a recession makes the recession worse, raising debt/gdp and increasing the risk of sovereign default
  • Running a primary fiscal surplus when growth is poor and the private sector highly indebted is likely to cause a recession
  • Running a sustained absolute surplus robs the private sector of its savings
  • Paying off government debt deprives the private sector of a safe store of value
  • Increased growth and prosperity arising from productive investment outweighs the cost to future generations
Sadly such basic economics is lost on credit ratings agencies and investors, who see only rising deficit and debt/gdp and start to panic about getting their money back.

It is indeed necessary that the government debt of the world's "premier" countries should remain "safe". But draining their economies by forcing austerity policies upon them is not the way to keep it safe. On the contrary, it is likely to make it LESS safe. Safety is ensured through investment in the physical and human capital of the country to secure growth and prosperity for the future.

Clearly, even governments of "Premier League" countries can't do entirely as they please. There is bound to be a tipping point at which trust is lost and the country is relegated to the second division. We don't know exactly what that tipping point is. But the message from today's low interest rates is that we are nowhere near that point. For the sake of both their own citizens and the global economy, these countries can, and should, invest.

Related reading:

When governments become banks
On the new purpose of government debt - FT Alphaville
Government debt isn't what you think it is






Comments

  1. Govt debt = currency issuer savings
    "Clearly, even governments of "Premier League" countries can't do entirely as they please. There is bound to be a tipping point at which trust is lost and the country is relegated to the second division."
    Could you expand a bit on this point? As long as they do not borrow in a foreign currency, why should they not do as they please, especially if real resources are being wasted?
    Govt spending is limited by real resources. Clearly, high spending from any sector could result in inflation if it expands past the capacity of the economy to produce. If that is what you mean by "do as you please" then yes. If not, I must ask why not?

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    1. Because a monetarily sovereign government fundamentally relies on the trust of its own citizens. If that is lost, then there is no sovereignty any more. It's no accident that failed states are often monetarily sovereign - until they aren't.

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    2. Hmm. Partially right but not really. Did the Pinochet regine rely on "trust of its own citizens."
      I'd say it is to do with power relations. Many revolts have been put down.

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    3. See for instance:
      https://en.m.wikipedia.org/wiki/Hut_Tax_War_of_1898
      I doubt tax revolts would work. It all depends on if the govt has enough real resources to spend, you have to have a enforcable tax system.
      It helps if you design a system with multiple countries such as the eurozone. That way it still has value as a foreign currency and you can add local "democracy."

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    4. Did you completely miss my observation about the Eurozone? None of the countries in the Eurozone has monetary sovereignty except Germany. They are all effectively using a foreign currency instead of issuing their own.

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    5. If a government loses the trust of its own citizens, it cannot tax them. And if it cannot tax them, it cannot guarantee the value of the currency or the debt. That applies in currency unions too.

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    6. Yeah, I was talking about the ECB.
      "That applies in currency unions too."
      Yeah I might not have stated it clearly. I meant if one nation loses trust it is still in use as a foreign currency.
      For example, the Greek govt does not enforce tax properly, but the euro is still used due to tax in Germany, Spain, etc...
      "If a government loses the trust of its own citizens, it cannot tax them. "
      You pay tax or you go to prison.
      My point is it can - through brute force.
      The British Colonial example (Hut Tax) is an example.
      Of course in democracy you just change parties to say a low tax party. Perhaps why democracy is more stable?
      Of course if you mess up the supply side (Venezuela, Greece, Zimbabwe) your economy cannot produce goods and services.

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    7. I don't really agree with this.

      Firstly, the Euro. It has come close to disintegrating twice, and in each case the reason was loss of confidence in one or more of the member state governments. First in 2012, when yields on Spanish, Italian and Portuguese debt spiked: the ECB eventually intervened to restore monetary sovereignty by agreeing to act as buyer of last resort for sovereign debt. This is why a credible independent central bank is crucial for monetary sovereignty. Second, and more worryingly, in July this year when Greek broad money became almost worthless as Greeks dumped it as fast as they could. That is hyperinflation, and it is the closest the Euro has come to disintegrating. Tje reality is that the Euro does not have credibility unless its member state governments do.

      Secondly, taxation. If a government loses the trust of its own citizens, it can confiscate money and assets with brute force, but people react to that by hiding goods, money and profitable activities. More and more activities end up in the black economy and if possible out of the country. I saw an extraordinary example of this when I visited the USSR in 1982. There were shortages of food in the cities, because the government had lost control of food redistribution (ie taxation in kind) from the bread-basket economies of southern Russia and Georgia. Food that should have gone to the cities was freely sold in local markets with the connivance of local officials.

      Lower tax is not necessarily better tax. Trusted governments can tax highly - look at Scandinavian countries, for example. It all depends on the priorities of government and people.

      Third, supply side. Messing up the supply side is usually associated with losing the ability to tax. Greece doesn't tax its population properly because of a long history of corrupt and untrustworthy governments.

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    8. True, but the ECB is in control.

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  2. the interest on Bonds isn't new money either , it transfers deposit credits from tax payers to bond holders, its not new money.

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    1. Yes it is new money. Taxation does not precede spending.

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    2. Taxation can precede spending - for example the private sector goes into deficit when the government taxes, and then back into balance when the govt spends.

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    3. No, the precedence is still spending first, taxation second for a sovereign currency issuer. Think about it - people cannot pay taxes in a currency that has not yet been issued.

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    4. the private sector can borrow from the government.

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    5. actually that's what dinero was saying, whether he was aware of it or not. If the government taxes away a private sector bank deposit, the private sector loses the asset but the bank is left with the liability (i.e. it is borrowing from the govt).

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    6. Dinero see
      http://heteconomist.com/government-spending-or-lending-logically-precedes-tax-revenue/

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    7. Yeah people can run down savings.

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    8. Those savings were due to discount window lending and/or prev spending though.

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    10. The government doesn't issue the currency being taxed. The currency being taxed is created by banks and their customers.

      For example Person A creates £50K with a loan.
      Person B is payed that £50K.
      The government taxes £20K of the £50K.
      Government pays that £20K to person C.

      At the end of the process Person B has £30K and C has £20K and taxing and spending has been completed.

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    11. Banks act as agents of the state in the creation of money, Dinero. That's what a banking licence means.

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    12. Have to agree with Dinero here. The money is created in the private sector, government is taxing that private sector and after that spending that money. So taxing first, spending second.

      Saying that because the banks get a license from the government to do their business (creating money) means government creates all money first is far fetched and distorting reality. That's like saying government does all medical operations because it gives licences to hospitals or does all plumbing because it hands out plumbing licenses.

      Of course sovereign governments could create money if they would instruct their central bank to credit their accounts (in most countries forbidden currently), but that's a different situation.

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    13. dinero,

      at the end of your process person B has a promise from a bank to pay him (or others on his behalf) $30K of government-issued money on demand.

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    15. dinero,

      the government does issue the currency being taxed. This is a basic and obvious fact. A bank deposit is simply a bank debt denominated in that currency.

      Here's a simple example of how taxation usually works: Say the government taxes you $100. Your bank reduces your account balance by $100 and then pays $100 in (government-issued) base money to the Treasury.

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    16. Matt,

      no, that's not how it works. And what you are saying is illogical. Money is created in the private sector in the form of bank deposits. But these bank deposits are promises to pay government-issued base money. They are bank debts denominated in government-issued base money.

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    17. Philippe, you say:
      "But these bank deposits are promises to pay government-issued base money. They are bank debts denominated in government-issued base money."
      The important issue is that the money - the thing that everybody uses to pay things with - is created in the private sector. The "denominated" part is just the "name" of the money. Sure, an American bank will create US dollars and a UK bank will create UK pounds. But that's just the -name-. It's not the actual thing itself (even if they are just numbers in a computer).

      The reality is that the money is created in the private sector. And the debt can be paid back in the same private sector created money. There's no reserve constraint, those are always provided by CBs as needed. It's not like if I take out a loan or mortgage from a bank, that I have to turn to the government, do some work for that government to earn some "government money" to be able to pay back my loan to the bank. That's not how it works.

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    18. May I jump in?

      Matt, the money created by the private sector is 100% guaranteed by the government. By this I don't mean deposit insurance, which is limited, but the government's guarantee always to exchange bank-created money for government money at par. It is this government guarantee that gives bank-created money its value. Without it, bank-created money would be worthless. In effect, therefore, bank-created money is government money.

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    20. "The "denominated" part is just the "name"

      No, it's not just 'the name'.

      The denomination of a debt tells you what is owed.

      If a debt is denominated in dollars, this means that the debtor owes dollars. If a debt is denominated in euros, this means that the debtor owes euros.

      A bank deposit is a bank debt.

      When you have a $100 bank deposit, this means the bank owes you $100.

      The bank owes you 100 dollars. Or in other words, the bank's debt to you is denominated in dollars.

      Do you understand this point?

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    21. Frances,

      what exactly do you mean by this?:

      "the government's guarantee always to exchange bank-created money for government money at par."

      can you give an example of what you mean?

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    22. When you go to an ATM and withdraw £50 from your bank account in cash, you have exchanged £50 of bank-created money for £50 of government money. Similarly, if you deposit £50 cash (notes & coins) in your bank account, you have exchanged government money for bank-created money. Exchanges of bank-created and government money go on all the time and it never occurs to anyone that government could change the exchange rate. Suppose, for example, government decided to set the exchange rate between government and bank-created money at 1:2? If you went to the ATM and withdrew £50 in cash, £100 of would be debited from your account. Government's par guarantee thus sets the value of bank-created money.

      For a real-world example of government NOT honouring an unlimited par guarantee, see Greece during the recent bank closures. Greeks could only convert limited amounts of bank-created money to government money. Greece of course does not have its own currency, so by "government" in this case I mean the ECB, which is the de facto Eurozone government since there is no federal authority. The "government" reneged on the unlimited par guarantee to a particular group of its citizens for entirely political reasons. In doing so it fatally undermined the value of bank-created money in that jurisdiction. Greek bank deposits became effectively worthless.

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    23. Frances you write:
      “It is this government guarantee that gives bank-created money its value. Without it, bank-created money would be worthless. In effect, therefore, bank-created money is government money. “

      Philippe you write:
      “The bank owes you 100 dollars. Or in other words, the bank's debt to you is denominated in dollars.
      Do you understand this point?”

      I understand both points perfectly fine. Banks create loans in the currency denominated by the government. Dollars in the US, etc. So if Citi bank would suddenly give out loans nominated in “Dineros” (a non-existing currency), nobody would want to take out those loans or accept that money.

      But both points are different from the thing I object to, which is:
      “Taxation does not precede spending” (by the government)

      The idea that government spending precedes taxing is backwards. If I take out a loan at the bank to start a business, it’s the private sector creating the credit/money. Not the government. And only after that money/credit created in the private sector goes around in the economy, it is taxed by the government. So even though the government sets the framework and rules of its monetary system (including naming the thing which banks are allowed to create), it is the private sector creating the money and the government taxing that private sector to be able to spend that money. Or borrowing from the private sector to be able to spend. Only in exceptional circumstances (and possibly by bending or breaking some laws) could a government pull some tricks with its central bank in financing the government directly.

      Saying “government spending precedes taxation” is implying that people and businesses are sitting and waiting around for the government to spend some money, before getting hold of that money and be able to spend it. After which it is taxed away by the government. That (MMT) idea turns things around completely.

      It really distorts reality. I don’t get why that is done. A government in a country with its own currency already has enough sovereign power as it is, compared to for example eurozone countries which haven given up their own currency. Countries with their own currency and a well managed, reasonable healthy economy (like the US or UK) already have more then enough scope/room to do the monetary and fiscal policy they want. CBs can set interest rates, the governments can borrow at super low interest rates, in exceptional circumstances a central bank can buy up bonds (indirectly financing the government), etc. No need to distort reality, trying to put government completely central in the money creation process.

      Appreciate the discussion by the way.

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    24. Matt,

      It's very simple. You cannot pay taxes in money that doesn't exist.

      The private sector does not create sovereign money. As I explained earlier in a reply to Philippe, private sector money depends for its value on the willingness of government to exchange it for government money at par. Therefore bank-created money is effectively sovereign money. You may pay your taxes in money created by the bank, but the guarantor of that money is government.

      Government spending absolutely precedes taxation in any reasonable model of the world. Government spends by crediting private sector bank accounts, thereby creating for itself an overdraft, either at the central bank or at private banks, which forces money creation through the fractional reserve system. It then recalls that money, first temporarily in the form of bond issuance, which withdraws money from the private sector, then permanently in the form of taxation. Thus Government spending creates money in the private sector.


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    25. The value of deposits is the obligation from the borrower who created them to supply economic resources in the future.

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    26. Frances, I'm surprised by your position. If you say
      "You cannot pay taxes in money that doesn't exist"
      Sure. But who creates the money? The private sector first. Not the government.

      "The private sector does not create sovereign money. As I explained earlier in a reply to Philippe, private sector money depends for its value on the willingness of government to exchange it for government money at par. Therefore bank-created money is effectively sovereign money. You may pay your taxes in money created by the bank, but the guarantor of that money is government. "
      Again, I find this a very weird way of putting it. "guarantor of that money", what does that mean? The government of the US has for a very long time decided that the US Dollar is the money to be used in the US, sure, but the actual creation of the money/credit does take place in the private sector. But apparently you have a different operational view on that, since you say:
      "Government spending absolutely precedes taxation in any reasonable model of the world. Government spends by crediting private sector bank accounts, thereby creating for itself an overdraft, either at the central bank or at private banks, which forces money creation through the fractional reserve system. It then recalls that money, first temporarily in the form of bond issuance, which withdraws money from the private sector, then permanently in the form of taxation. Thus Government spending creates money in the private sector."
      I don't believe this is true. Looking at balance sheets of banks and credit creation, the money/credit is only and first created in the private sector. Only after that can a government tax or borrow that money/credit. That is the order, looking at the balance sheets. Turning it all upside down by imagining money is only created if a government spends doesn't make sense. Here is a more elaborate critique on MMT
      http://www.pragcap.com/modern-monetary-theory-mmt-critique/
      http://z822j1x8tde3wuovlgo7ue15.wpengine.netdna-cdn.com/wp-content/uploads/2015/06/Modern-Monetary-Theory.pdf
      "The reality is that inside money dominates our financial system. The state has essentially outsourced money creation in our financial system to private banks.  This means that outside money (state money) has been rendered secondary to inside money (bank issued money).  Although the state could change this by nationalizing the banks it does not change the current reality of the financial system in which we reside."

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    27. Frances,

      when you withdraw cash from an ATM, it's not the government which exchanges your deposit for cash, it's your bank which does that. Your bank bank deposit is a promise from the bank to pay you money, so when you ask for that money, they have to give it to you in order to keep their promise. It's your bank which maintains the "fixed exchange rate" between its deposits and base money.

      The central bank can lend base money to your bank, or buy assets from your bank with base money, but it isn't obliged to give your bank base money. Banks can go bust. Banks can fail to redeem their promises or to pay their debts. Depositors can lose their money. There is no guarantee from the government to "always exchange bank-created money for government money at par".

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    28. Matt,

      the central bank is part of the government in the broader sense. You seem to be arguing that money isn't created by the government, it's created by the central bank. But it's the same thing.

      You could argue that the division between the central bank and the treasury, or the rules regarding government spending, are important. However that doesn't change he fact that the central bank is part of the government.

      When I refer to government-issued money I am referring to government in general, which includes the central bank.

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    29. Matt,

      I repeat, the private sector does not create sovereign money. You can only pay your taxes in bank money because it is fully exchangeable for sovereign money. If sovereign money did not exist, then you could not pay taxes.

      Cullen Roche describes banks as "agents of the state" in the creation of money. They have been authorised to create money on behalf of the state, and the state guarantees its value. Does it help to think of it this way?

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    30. Philippe,

      this isn't correct, I'm afraid. The guarantee is maintained by the government, not the bank. The bank could not haircut ATM withdrawals in the way I have described.

      You are confusing deposit insurance, which limits the losses faced by depositors in the event of bank insolvency, with the exchange guarantee, which ensures that a pound has the same value whether it is issued by a bank, the Bank of England or the Royal Mint.

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    31. Seems like we're talking about different aspects of the process. You talk about "sovereign money", with which you mean (I think) something different from what I'm talking about, normal money/credit, endogenously created by the private banks. You seem to emphasise the importance of some sort of state guarantee, I'm talking about the importance of private money creation. But I guess this is the more abstract discussion and I don't think we will make progress that way.

      Better to look at the actual process of what is happening. I'm no economist or banker, but having read some books about banking and economy and many articles, my understanding is that just looking at the balance sheets of banks, what actually happens with money creation is that starting with zero, a loan made in the private sector creates both a deposit and a loan. That is the absolute first step. Only after that comes the spending, the transfer of reserves between banks (in case of different banks being involved). And the way the government gets money is by taxing people in the private sector. The government first has to get the deposits by taxing (or borrowing by selling bonds). The government taxing and borrowing is a separate entity from the central bank (even though that last is of course created and regulated by the government). I know in MMT they are consolidated, but that distorts the reality of the actual operations/transfers of money.

      It's not the case that starting with empty balance sheets, the first step is for the government to spend. As if a Ministry of Infrastructure is creating deposits out of thin air when it pays a contractor to build a road. That's not what is operationally happening.

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    32. Matt,

      a bank deposit is a bank debt. When a bank creates a deposit, it is going into debt to the depositor. It is promising to pay money to the depositor, or to pay others on the depositor's behalf.

      The money that the bank owes to the depositor is base money. Base money is government-issued money.

      So, when a bank creates a deposit, it is creating a promise to pay government-issued money. It is saying "I owe you, the depositor, this amount of government-issued money".

      As such it should be obvious why it's illogical to say that taxes are paid with bank deposits.

      How taxation basically works in practice is as follows.

      (1) you owe $100 in taxes.
      (2) your bank reduces your deposit balance by $100.
      (3) your bank pays $100 in base money to the Treasury. i.e. it transfers $100 from its account at the central bank to the Treasury's account at the central bank.

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    33. Frances,

      "The guarantee is maintained by the government, not the bank"

      So you're saying that the government guarantees that it will pay all bank depositors with cash on demand?

      That is not the case. Bank deposits are bank liabilities, not government liabilities.

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    34. Philippe,

      I made it completely clear. The government guarantees that the value of a pound is the same whether it is a note, a coin or a deposit balance. That has nothing to do with the solvency of banks.

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    35. Philippe, I wrote another reply but that got lost.

      What you are doing wrong is putting the "government money" central, while it's not. It is the money created in the private sector that comes first and is central. By choice (in US and UK), the government has put the money creation inside the private sector. The CB is merely facilitating that proces, functioning as a clearing house for the banks and lender of last resort. The government itself has placed the CB separately from itself and does have to tax and borrow to procure the funds which are first created in the private sector. As Cullen Roche explains in his paper Understanding the Modern Monetary System and book:

      "the US Treasury can only settle funds in its reserve account by first procuring funds from the private sector (taxing) in the form of inside money (the US Treasury cannot legally run an overdraft in its Fed account). It is best to think of this process whereby the government can only spend from its account at the Fed if it has already obtained credits via inside money transactions involving taxes or bond sales. This procurement of funds allows the government to then redistribute pre-existing inside money back into the banking system completing the flow of funds that starts with the banking system’s creation of inside money (in the form of loans which create deposits) and ending in a private bank account user being credit with the government’s spending."
      The paper can be found online.

      Delete
    36. a deposit balance is a bank debt denominated in pounds. If you have a £100 bank deposit, this means the bank owes you £100. If you tried to withdraw that £100 and the bank said to you "sorry, we're only going to give you £50" that would be a default. The bank would have defaulted on its debts. If banks can't pay their debts they are insolvent. Banks are responsible for paying their own debts. If they issue a £100 deposit (a £100 debt), they are responsible for paying that debt. They are responsible for paying £100 in cash to the depositor as per the contract between the depositor and the bank. They are responsible for maintaining the "fixed exchange rate" between what they promised to pay and what they actually pay.

      You can have a deposit in a bank which is worth £1m one day and zero the next (or £85K thanks to deposit insurance).

      If banks are currently solvent, that means by definition that they can pay their debts, so if you have a £100 deposit you can withdraw £100 cash or make a £100 payment to someone else.

      Delete
    37. Matt,

      "the government can only spend from its account at the Fed if it has already obtained credits"

      Firstly, the Fed is part of the government.

      But ok, the Treasury and the Fed are separate. The Treasury is legally supposed to have a positive deposit balance in its account at the Fed before it makes payments. And in order to get a positive balance in its account at the Fed, it has to receive payments into that account via taxes, bond sales or other sources.

      However, Fed deposit balances are base money. They are government-issued money.

      So in order to spend from its deposit account at the Fed, the Treasury has to receive payments of government-issued money into that account.

      Now, I go back to my basic (simplified) example of how taxation works in practice.

      (1) you owe $100 in taxes.
      (2) you instruct your bank to make a payment to the Treasury from your account (or the payment is made automatically)
      (3) your bank reduces your deposit account balance by $100. In other words it deletes $100 from your deposit account balance.
      (4) your bank pays $100 from its account at the Fed to the Treasury's account at the Fed.

      Step (4) is a payment of base money (government-issued money) from your bank to the Treasury. Your bank pays $100 base money to the Treasury on your behalf. Your $100 bank deposit is simply deleted in the process.

      Delete
    38. Goverment spending does not create money, the DMO (uk) website is clear on this. Transactions are cleared at the end of each day, any difference between speingdng and taxes in a day is made up with "market instruments" .There is no money created by government spending. The DMO website is very clear on this it - it states that the DMO conducts its operations in a way as to not disrupt the "monetary conditions of the economy."

      Delete
    39. Philippe, I don’t understand what your examples show or would proof. You seem to take only a small part of the process, distorting what happens for real. The operational reality is that the private sector creates deposits together with the loans. I assume you know this. Reserves (what you call government-issued money) is always provided by the CB *after* the fact. That is important. After the private bank created the loan and deposit. Thus the causality is: loan creation > deposit creation > reserve creation (if needed). That’s how banking works and which is explained more elaborately in the paper from Cullen Roche.

      Saying it is the other way around is wrong. That’s the mythical money multiplier idea of a CB providing reserves to the private banking sector, which that sector is “multiplying”. That is just not the way it actually works.

      Since the government cannot (legally) just call the CB to create money, it first has to procure funds to spend: it first has to tax or borrow. That’s the operational and legal reality.

      The way the CB is put on ‘distance’ from the government is on purpose, supposedly to constrain governments from just “printing” and spending. The fact that CBs have an obligation to keep the economy going and therefore influence interest rates (including sometimes buying government bonds) does mean that in practice governments with their own currency have a lot more room then governments without their own currency. But that doesn’t mean you can put the whole process of money creation upside down.

      Delete
    40. > Phillippe

      If the tax payer and the recipient of government spending were at the same bank then there would be not net movement of reserves over the day, and yet the tax payer would have $100 less and the recipient of government spending would have $100 more. And so it is shown that the government taxes and spends deposits.

      Delete
    41. Philippe,

      This is not about the solvency of banks. It is about the fungibility of different media of exchange. A pound is a pound is a pound, regardless of the form it is in, who holds it and whether or not they are able to pay it back. That's what government guarantees.

      Delete
    42. Matt,

      I'm talking about taxation, not about bank loans. What I am saying to you has nothing to do with the ‘money multiplier’. I don't know why you think that is relevant.

      "Since the government cannot (legally) just call the CB to create money, it first has to procure funds to spend: it first has to tax or borrow. That’s the operational and legal reality."

      As I said, the central bank is part of the government. When you say 'government' I suppose you mean specifically Congress. When I say 'government' I am referring to government in general, including government departments and agencies. The Fed is a government agency, which is part of the executive branch of the Federal government.

      Delete
    43. Frances,

      a bank deposit is only fungible with base money if the bank is solvent. Let's say you have £1m on deposit at a bank. Then the bank goes bust. Is your deposit still worth £1m? No.

      You said that the government guarantees that bank deposits exchange at par with base money. But clearly deposits in an insolvent, bankrupt bank do not exchange at par with base money. The government does not guarantee the solvency of banks, therefore it does not guarantee that bank deposits exchange at par with base money.

      Large wealth holders often prefer to park their money in short term government bills rather than leave it in a bank overnight. This is because they're well aware that a bank deposit does not have a guaranteed exchange value. Banks can fail, and deposit insurance only covers a limited amount.

      Delete
    44. Philippe,

      You are still confusing the fact that deposits in a bank are at risk with the fungibility of money. They are not the same thing. If I store banknotes in a cardboard box under my bed, I am placing them at risk of fire and theft: but that does not mean they are worth less than banknotes in a safe or deposits in an insured bank account. Risk of loss has nothing to do with exchangeability at par.

      Delete
    45. Philippe, I'm saying that because it's relevant to look at the whole picture. How the first money a.k.a. credit comes into existence in the private sector, goes around, is taxed or borrowed by the government (indeed congress, not including the CB) and only after that is spend by that government. That's a completely different picture then "spending by government creates money, taxes destroys money". The way MMT theory and you want to put the government and central bank together is distorting reality. You cannot just pretend two institutions are one and turn the flow of money around. The central bank is put separate from congress/government for a reason. Here everything is explained in a paper by the Bank of England itself
      "Most of the money in circulation is created, not by the printing presses of the Bank of England, but by the commercial banks themselves: banks create money whenever they lend to someone in the economy or buy an asset from consumers. And in contrast to descriptions found in some textbooks, the Bank of England does not directly control the quantity of either base or broad money. "
      http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf
      So it's the private sector creating the money first. It's the central bank providing reserves on demand. It's the government taxing and borrowing from the private sector to fund itself (to be able to spend). That's the reality. If you have proof otherwise, I'd be interested to see it, but so far this is how I understand and see it.

      Delete
    46. This comment has been removed by the author.

      Delete
    47. Matt,

      I don't disagree with what that Bank of England paper says. However, you are getting things very mixed up.

      Let me try to clarify some things.

      Under a simple classical gold standard, gold (or gold coins) is the base money. Bank deposits are IOUs for gold or gold coins. If you have a bank deposit, this means the bank owes you gold or gold coins. In this system, there is a small amount of gold, and a very large amount of bank deposits, which are all IOUs for gold. Banks can create deposits 'out of thin air', or even print their own notes, but these deposits and notes are all IOUs for gold or gold coins.

      Agreed?

      Under the 'fiat' money system we have today, the base money is notes, coins and reserve balances issued by the central bank or treasury, i.e. issued by 'the government' (the central bank is part of 'the government'). Bank deposits are IOUs for government-issued base money.

      If you have a bank deposit, this means the bank owes you government-issued base money. In this system, there is a small amount of government-issued base money, and a very large amount of bank deposits, which are all IOUs for government-issued base money. Banks can create deposits 'out of thin air', but these deposits are all IOUs for government-issued base money.

      Agreed?

      Now, to come back to this point about the government and central bank. As I said, the central bank is part of the government in the broader sense of the term. In the US, the central bank is a Federal government agency which is part of the executive branch of the Federal government. This is a fact. So when I say 'the government', I am not referring only to Congress. I am referring to the government in general, which includes government departments such as the Treasury and government agencies such as the Fed.

      Delete
    48. Philippe,

      I understand your story and have read it before (am familiar with MMT). However, it's just not the way it works and puts the government central just to fit the story. The same way you consolidate the government and central bank to fit your story. Why can't you just look at what's happening at the balance sheets, just look at the facts, how deposits are created in the real world? The way the actual proces and transactions works, as I explained and is being explained in the papers I referenced. How is the explanation of balance sheet transactions and money creation in the paper of the Bank of England wrong, according to you?

      The point is: nobody cares about central bank reserves. Those are just a clearing mechanisms for the banking system and a tool for the central bank to influence interest rates. Until a few years ago I never heard of them. Ask any random person on the street or regular business owner if they know what reserves are, you will get a blank stare. But ask them if the money they have in their account is real money and they will say yes.

      The reality is that the whole economy is about bank credit/money. It's being created and destroyed by the creation of loans in the private sector. The government is legally bound by laws which state it cannot just "print" money or something like that. It has to tax or borrow the funds from the private sector first. There's no way to deny that.

      Of course the central bank is an institution created by the government and is an important part of the monetary system. But it is purposefully put independently from the government. Sure a government could decide to change that arrangement one day. The exact arrangement in the eurozone is changed a lot lately. But you have to look at the way things are actually working right now, in systems like the US and UK. At which points are the first numbers created in balance sheets (real money creation!), how are they transferred and how are the destroyed in the end? Looking at that reality,the MMT story just doesn't fit. It's a misrepresentation.

      Delete
    49. Matt, what you are saying is nonsense.

      "just to fit the story"

      What story? I am trying to describe things to you clearly, factually and logically.

      "How is the explanation of balance sheet transactions and money creation in the paper of the Bank of England wrong, according to you?"

      There's nothing wrong in the Bank of England paper as far as I'm aware. Nor does it contradict anything that I have said here. The stuff that Cullen Roche writes on this subject is just nonsense, however. You very clearly do not understand the BoE paper or any of this.

      "nobody cares about central bank reserves. Those are just a clearing mechanisms for the banking system and a tool for the central bank to influence interest rates."

      What does that even mean? Do you even have the slightest clue of what you're talking about? Do you even know what clearing means? 'No one cares' about reserves but they influence interest rates? Huh? What you're writing is meaningless gibberish.

      "Ask any random person on the street or regular business owner if they know what reserves are, you will get a blank stare"

      Who cares? Why do you even think that is a relevant point? 'Reserves' are either cash held by banks in their vaults or deposits held by banks at the central bank. Reserve deposits held at the central bank are basically just electronic cash. I'm sure most people can understand that.

      "It has to tax or borrow the funds from the private sector first"

      You obviously haven't read my comments as I clearly stated that:

      "the Treasury and the Fed are separate. The Treasury is legally supposed to have a positive deposit balance in its account at the Fed before it makes payments. And in order to get a positive balance in its account at the Fed, it has to receive payments into that account via taxes, bond sales or other sources."

      But as I said, the Treasury's account is held at the Fed, so payments to the Treasury are made with base money (money created by the Fed).

      "it is purposefully put independently from the government."

      Central banks such as the BoE and the Fed have certain forms of independence when it comes to implementing monetary policy. That doesn't change the fact that they are part of the government, as I explained above. This is how the Fed describes itself:

      "The Federal Reserve System fulfills its public mission as an independent entity within government. It is not "owned" by anyone and is not a private, profit-making institution.

      As the nation's central bank, the Federal Reserve derives its authority from the Congress of the United States. It is considered an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms.

      However, the Federal Reserve is subject to oversight by the Congress, which often reviews the Federal Reserve's activities and can alter its responsibilities by statute. Therefore, the Federal Reserve can be more accurately described as "independent within the government" rather than "independent of government.""

      http://www.federalreserve.gov/faqs/about_14986.htm

      Delete
    50. Well it seems we're getting nowhere. If you think what Cullen Roche or the paper of the BoE writes is all wrong I'm not sure we will ever agree on something. Let me explain what I'm trying to get across in a different way.

      What I am specifically objecting to is:
      "Yes it is new money. Taxation does not precede spending"
      As if a government first has to spend new money into the economy before it can be taxed away. That's the point I'm going against.

      Now for reality:
      A farmer in South Carolina walks into a bank to get a new loan. The bank manager recognises the man (Paul) and knows he's credit worthy. So Paul gets the loan, say 100k. Now in this instance new money is created "out of thin air" and the economy as a whole has 100k more money. Paul spends 40k on Peter for some work Peter did for Paul. If Peter has his account at the same bank, there's not even a need to transfer reserves at the CB. The bank just credits Peters accounts and debits Pauls account. Peter earned 40 k of real money and is 40k richer. GDP grew by 40k.

      Next if at the end of the month taxes have to be paid, Peter has to pay a certain percentage of his income (say 25%) to the government. 10k is transferred from Peters account to the government. If the government wants more money, it can also sell a bond. It can sell a 10k bond to Peter, at which point another 10k is transferred from peters account to the governments account.

      This is how it works. Money is created in the private sector. Government is taxing or borrowing from that private sector. You cannot just turn that upside down and claim all money is created by the government first.


      Delete
    51. Dinero,

      "And so it is shown that the government taxes and spends deposits."

      You don't seem to understand what bank deposits are. Bank deposits are bank debts. They are IOUs for base money, i.e. IOUs for government money.

      Here's basically what happens when you pay tax:

      (1) you bank deletes numbers in your account.

      (2) The central bank deletes numbers in your bank's reserve account and then types numbers into the Treasury's account.

      You can see that your bank deposit has simply been deleted. It wasn't transferred to anyone, it was just deleted. The central bank then transferred a sum from your bank's reserve account to the Treasury's account. When the Treasury spends, the opposite happens.

      Now let's imagine that instead of paying the Treasury with base money, your bank simply creates a deposit for the Treasury on its books. The Treasury now has a deposit and the bank owes the Treasury base money. Oops! The bank hasn't actually paid the Treasury - it still owes the money!

      Delete
    52. "If you think what Cullen Roche or the paper of the BoE writes is all wrong"

      Christ almighty, do you not actually read anything I write? I said:

      "There's nothing wrong in the Bank of England paper as far as I'm aware"

      Delete
    53. Matt,

      "As if a government first has to spend new money into the economy before it can be taxed away. That's the point I'm going against."

      Logically, the government either has to spend money before it can collect tax, or it has to lend the money to the private sector. I pointed out to Frances that it could lend the money instead of spending it. But logically, it has to be either spend or lend before collecting tax.

      Delete
    54. Matt,

      "10k is transferred from Peters account to the government"

      No, what happens is that Peter's bank deletes $10K from Peter's account balance. the central bank then transfers $10K in reserves from the bank's reserve account to the Treasury's account.

      Delete
    55. You continu to ignore the process I have described a dozen of times now, about how the private sector creates money which is after that taxed or borrowed by the government. It's literally written down in the paper of the BoE you admit is correct. I gave a clear and simple example from the local bank in South Carolina which creates the loan and deposit for its client. Without any government being involved! So "Logically, the government either has to spend money before it can collect tax, or it has to lend the money to the private sector." is just plain wrong.

      But I guess we have to leave it here because we're getting nowhere this way.

      Delete
    56. Frances

      So the government guarantees that bank depositors can exchange deposits for an equal amount of cash - unless the bank runs out of cash/central bank money, in which case you get what it has left over. I don't understand how this is any kind of meaningful guarantee? All bank deposits are not created equal. For example, I would swap a Northern Rock deposit while there were queues in 2008 for less than their nominal value. Can you point to some more information about the "exchange guarantee"?

      Delete
    57. Matt, consider this. Suppose that the government took away from banks the right to create government-guaranteed money.

      Does this stop the banks from issuing money? No it doesn't. The banks can issue their own IOUs (as can anybody) and they could circulate in the economy as a secondary currency.

      Would this stop the government from spending money? No it wouldn't. The government could continue to issue government-guaranteed money in return for goods and services.

      What would the government expect in taxation? Only government-guaranteed money, of course.

      So the two (or multiple) currencies could circulate - they might even have the same "value" - that would depend on the punter's view of the trustworthiness of either government or bank. But government spending doesn't require money to be created by banks.

      Delete
    58. Gastro george, you are talking about a hypothetical situation, which needs a change of rules and laws before it would be reality. Could that happen? Of course, if a big enough majority of chosen representatives want that and puts it into new laws. But I'm talking about current actual laws and processes. And within that current set of rules, money creation is outsourced to the private sector. A loan creates a deposit in the private sector, the money is taxed or borrowed by the government and after that spend again by the government. The central bank is put at a certain distance from the government, with a mandate to manage interest rates etc. but without a mandate from directly handing money to the government. In the current situation:
      - the private sector creates its own money/credit, as shown in all previous comments and references. Millions of businesses and individuals are creating new loans every day and using that money to pay for things.
      - government is taxing and borrowing that privately created money
      - it's not allowed for governments (not the CB!) to just spend new money into existence

      I don't understand why it's needed to turn things upside down and misrepresent actual processes. Seems like there's a political motivation behind this. I know that's the case for MMT folks, to put the government more central and make it seem acceptable for governments with their own currency to spend what they want.

      While in actual fact it is not needed to misrepresent reality. We know that countries like the US and UK have much more room to allow them a lot more fiscal policy. The governments of these countries can borrow much more to obtain more money to spend, without worrying about bond vigilantes, etc. Because they have their own central banks which can always maintain stability and interest rates, by buying up bonds for example. No need to distort reality by saying "government spends first, by taxing destroying the money again".

      Now I'm really finishing this discussion, have to do some work and earn some privately created IOUs ;)

      Delete
    59. Matt, the problem here is that you simply don't understand this stuff at a very basic level. You don't understand the basic logic.

      Delete
    60. > Philippe

      By focusing on the reciprocating movements of reserves that facilitate the movement of deposit credits you are confusing a mechanism of a process with the actual process itself.

      Here's another clear and concise example

      A small country has 1 million in reserves . The income tax is 20% . The employers in that country borrow $ 1 Billion and pay it to the employees. The government revenue and spending is $200 Million.


      The following year the amount of reserves is still 1 Million. The income tax is still 20%. and the employers borrow $2 Billion., and pay that to the employees. the government revenue and spending is now doubled due to the private sector creation of deposits.

      That is a clear example that the thing that government taxes , is deposits.

      If the 400 million had not been created the government would not have been able to tax and spend it.

      Delete
    61. Government spending or lending precedes taxation. The “or lending” is the crucial bit that might explain the disagreement.

      The government will only lend central bank reserves out if the private sector has a real asset to post as collateral in return (and commercial bank deposits do not count as a real asset for this purpose).

      Commercial banks might create new loans, but that does not translate into real valuable assets. It might do, it might not – depends what the loans are for and where the liabilities end up.

      The government's capacity to collect central bank reserves depends on how much it spends or lends, and the amount it lends depends on how much real private sector economic activity there is.

      So I think both views above are right. The capacity to tax rests on private sector economic growth. But it also rests on the willingness to transact with the private sector to give them central bank reserves.

      Eddie

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    62. Matt, Dinero. Correlation is not causation. The situation is somewhat analogous to the loanable funds myth wrt banks. The amount of money lent by banks is similar to the amount that is deposited with them. We can see the transactions, and you might assert that banks only lend money that is deposited with them. That doesn't make it true.

      Delete
  3. this could be simplified to:

    'some countries are able to run larger budget and trade deficits without experiencing high inflation'

    much simpler than talking about 'monetary sovereignty', which turns out to only mean that some countries have more fiscal capacity than others.

    ReplyDelete
    Replies
    1. It really is not just a question of fiscal capacity, and it isn't just a question of inflation either. It is a matter of trust.

      Delete
    2. It all comes down to:
      a) real resources
      b) power
      Where b is really about access to a.

      Delete
    3. If there is a lot of saving, you need high budget deficits.

      Delete
  4. “Thus, buying a government bond is exactly the same as placing money in a government-insured time deposit account in a bank. We should really regard government bonds as certificates of deposit. They are simply money, in another form.” Agreed. Just to give credit where credit is due, Warren Mosler and other MMTers have been saying that for some time.

    In contrast, I don’t think most MMTers (me included) will totally agree with the idea that “governments should issue enough debt to meet the saving propensity of the domestic private sector..”. (I assume you mean INTEREST YIELDING debt).

    What MMTers do claim is that the state must issue enough state liabilities to meet the private sector’s demand for those liabilities. Those liabilities come in two forms, base money and government debt. That pair are referred to by MMTers as “private sector net financial assets”. Indeed, that claim by MMTers is entirely consistent with Keynes’s so called “paradox of thrift” point: that is, if the private sector has an inadequate stock of PSNFA, it will try to save, and that brings “paradox of thrift unemployment”.
    As to whether there is an obligation on the state to issue the amount of INTEREST YIELDING debt the private sector wants, MMTers would say “no”. I.e. they say base money – yes. But interest yielding debt – no.

    Milton Friedman actually advocated the same: i.e. he advocated a ban on interest yielding government debt.

    ReplyDelete
    Replies
    1. Ralph,

      You know, I really don't care what MMT-ers think. And to give credit where credit is due, these ideas are mine, not Warren Mosler's.

      Money is not a good long-term store of value. It is designed to be used for transactions. When I challenged Bill Mitchell about this, he suggested something very similar to NS&I - which is, of course, a government savings scheme and issues bonds to ordinary savers. Fully insured bank deposits are also government liabilities - "debt" in the broadest sense.

      I don't agree that government debt should be interest-free. I have not discussed the reasons for that in this post, but I will return to it.

      Delete
    2. Francis
      Even if you got this far without MMT, or any other heterodox group, it does you no harm to point out other tracks on the ground, especially if you take issue with where they might lead. I have followed your blog long enough to see your ideas evolve. To what would you attribute that change.
      P.s if you don't care what MMTers think, why do you turn up at their talks?

      Delete
    3. This comment has been removed by the author.

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    4. Hugo

      I did indeed get this far without MMT. I was therefore somewhat narked by Ralph's implication that I had simply borrowed MMT ideas without crediting them. It was neither true nor fair and I therefore slapped him down.

      I'm not saying anything here that I did not say in the blogposts linked at the end of the post, which date from getting on for three years ago, or indeed in earlier blogposts that I have not linked here.

      Delete
    5. Ralph,
      MMT is just a theory of how to best achieve full employment and price stability.

      Delete
    6. @Random
      Wages add to prices.........if so how do we get price stability ?
      Perhaps slavery is a option !
      Social creditors understand fill employment policies as inflationary war economies.

      Say that to Bill of course and you hit the red button.

      Delete
    7. Just observe Irish and UK energy balances from 1990 and 1970 respectively .
      You can quite clearly see surplus energy being flared on transport in the main.
      These numbers are in reality people inside metal boxes chasing their own tale so as to obtain tokens or escape inflation.
      At the moment we see a tiny increment increase in the UK transport energy expenditure but at a huge cost to personnel consumption.
      The data is very very clear on this.

      Delete
  5. ...though they might choose to lean against the pro-cyclicality of saving preferences by issuing money instead of debt in recessions and debt instead of money in booms.

    When I read this the first thing that popped into my head was QE.

    ReplyDelete
    Replies
    1. QE exchanges existing debt for bank reserves. It has nothing to do with the financing of new government spending.

      Delete
  6. Accepting that austerity in fact endangers value why do financial sector think that austerity is necessary to preserve value of their safe assets?

    ReplyDelete
    Replies
    1. Because economic illiteracy is unfortunately widespread.

      Delete
    2. But..finance sector supposedly creme of brainpower in business, finance & economic understanding. Supposedly take their pick of best brains?

      Delete
    3. They recruit people who think like them. "Best brains" is subjective.

      Also there is a serious reality deficit in the teaching of economics.

      Delete
    4. And of those "Best Brains" could be curing cancer. Wasted resources...

      Delete
  7. Who sets the interest rate in a sovereign currency economy? The government or the bond vigilantes?

    ReplyDelete
    Replies
    1. Government, if it is genuinely sovereign.

      Delete
    2. That is a question I have for you. I don't understand why, in the article, you 'insist' on the central bank being independent (I read that to mean 'independent of the government'.)

      In much of the above commentary it seems that there is agreement that no central bank which issues bonds (in a country which fits the criteria for being genuinely sovereign) is ever independent of it's government. Perhaps the word 'independent' in this context is misleading,
      (given the common understanding of the meaning of 'central bank independence' in the UK and the US).

      Delete
  8. This is a brave effort and treading where angels fear. Ask rich financiers what money is for and you'll get a different answer to that from an unemployed person. Get anyone talking about money and eventually they'll contradict themselves. Classics include making the pie bigger and objecting the government deficits whilst expressing the desire to save. The people with the most influence have won the debate in recent decades which means those with the most money.

    In other words a factual description of money isn't really wanted by some, especially if it doesn't have their vested interests at heart. The problem, politically, is the major parties have stopped representing people and merely present the policies of donors as best for everyone. This example is perfectly being demonstrated in Greece.

    It's time we stopped worrying about rich people and for the left to stop aspiring to tax them to oblivion. represent ordinary voters and let the rich look after themselves. bill40

    ReplyDelete
  9. savings = deferred consumption.
    Increases in debt indicate that current production is used to satisfy the costs of production rather then the previous purpose of production which was consumption.

    ReplyDelete
  10. Final energy consumption in the UK domestic sector declined by 14.4 % in 2014.
    This is not primarily a result of the weather or efficiency gains (if so where is the increase of human level energy use ?)
    This is a long term structural decline seen in the UK since the early 70s.

    The recent dramatic &heavy declines in end use able energy points to a failure of the global supply chain of which the UK and Europe is at the epicentre.

    "Investment" will only further reduce the energy available for end users.

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  11. "We generally say that a government is monetarily sovereign if the following are true:
    it issues its own currency
    it has a freely-floating exchange rate
    it has an open capital account"

    Which is your definition, which is fine. But that is certainly not a universally accepted definition, in fact I would argue exactly the opposite.

    Even a country like Germany and Japan is not able to manipulate the external value of its currency, only countries with a fixed exchange rate can. So Germany and Japan do not have monetary sovereignty as the value of the currency in open economies should also reflect the value vis-a-vis things bought and sold abroad.

    Do you need capital controls to safeguard the value of the currency? Do not think so, you could, for example just tax the buying and selling of the domestic currency. Any transfer abroad of the currency would be taxed with 20% (say, to pay for imports or to pay for investments abroad), any buying of the currency (say, to pay for exports or to invest in the country) could have a 10% subsidy.

    Arguably, Switzerland, when it was trying to defend its peg against the Euro, could have done that.

    Ok, a tax on currency movements is very similar to capital controls. But that is the point, only if the government intervenes (through a tax or controls) is there any sovereignty.

    What you define as monetary sovereignty leaves a country vulnerable to the foreign exchange markets, it can always be attacked. What if, for example, the current account deficit will no longer be financed by capital inflows to the UK? The UK has to devalue it currency, which will have all kinds of implications, even if it does not really want to. It might have to get help from the IMF. How is that a sovereign decision?

    Or it could introduce exchange controls. Only then it is sovereign.

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  12. Matt,

    The combination of free movement of capital with freely floating exchange rates does confer monetary sovereignty. Exchange rates adjust with capital movements, and the central bank can use interest rate policy to control capital movements. That applies even if there is a current account deficit provided that external debt is either in own currency or is always exchangeable for own currency by the central bank through permanent swap lines.

    As I said, though, the opposite position - fixed exchange rates AND capital controls - is also monetary sovereignty. You seem to prefer this version. Do remember that capital controls have to be strict, though: if they are at all leaky, then fixing the exchange rate means the economy moves in lockstep with the economy whose currency it is pegging to, and there is effectively no monetary independence. Fixing the exchange rate does not mean you control it.

    Taxing capital movements is a form of capital controls. See Ann Pettifor's book Just Money on this.

    ReplyDelete
    Replies
    1. "That applies even if there is a current account deficit provided that external debt is either in own currency or is always exchangeable for own currency by the central bank through permanent swap lines. "

      No country can increase its overdraft (or swap line) by, say, 6% a year, which is the UK's current account deficit for ever and ever. And a current account deficit has to be financed by foreign exchange inflows or borrowing. Borrowing in its own currency, even abroad, does not help.

      It will run up against the following constraint: Net international Investment Position

      http://ec.europa.eu/economy_finance/graphs/2014-12-08_net_international_investment_position_en.htm

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    2. Matt,

      Nonono. Current account deficit and swap line are NOT the same thing. The swap line is an arrangement with another central bank to exchange unlimited quantities of currency, usually at a preferential rate. The Fed originally created temporary swap lines with the other major central banks after the 2008 crisis to relieve dollar liquidity shortfalls in non-US banks and markets. It has now made those swap lines permanent.

      Since the UK can therefore obtain unlimited quantities of dollars by exchanging sterling issued by the Bank of England at the Fed, it effectively has no FX constraint on its current account deficit. External debt may be in foreign currency, but it can be serviced in sterling.

      I've been meaning to write about the implications of the swap lines. I don't think people realise how important they are.

      Delete
    3. Sorry, it should say, "Borrowing in its own currency, even abroad, does help, but only if there are willing lenders in foreign currency who are want to exchange their currency for the currency of the country with the current account deficit. If there are not any willing lenders from abroad, then the country will have a problem."

      Delete
    4. I am pretty sure that these swap lines are meant to paper over liquidity issues, and not finance an accumulating current account deficit of 6% each year.

      Otherwise, why does the UK not run a 20% current account deficit each year, if we have an unlimited swap line to finance it? That would allow the country to purchase an additional £250bn worth of goods from abroad each year.

      Maybe the official line is the swap line is "unlimited". But maybe in the small print of the agreement, which is not made public, it will say that the UK will have to try to eliminate its current account deficit, and a way to do this would be to eliminate its budget deficit (as the two generally go hand in hand). Maybe that is why we have this obsession to reduce the budget deficit.

      (But clearly I am just guessing here)

      Delete
    5. The swap lines don't "finance" anything. And there is no conditionality attached to them. Central banks do not have the right to dictate policy to their own governments, let alone the governments of other countries. The Fed cannot dictate fiscal policy to the UK govt. Nor - since these swap lines are reciprocal - can the BoE or the ECB dictate fiscal policy to the US govt.

      You are looking in entirely the wrong direction for the pressure to fix the deficit. The UK has been in the EU's "excessive deficit procedure" since 2008:

      http://ec.europa.eu/economy_finance/economic_governance/sgp/deficit/countries/uk_en.htm

      Since the UK is not in the Euro and has not signed the fiscal compact, the EU has no power to enforce deficit reduction. But that doesn't stop it applying pressure. In May this year the European Council decided that the UK had "not taken effective action" to clear its excessive deficit:

      http://ec.europa.eu/economy_finance/economic_governance/sgp/pdf/30_edps/126-08_commission/2015-05-13_uk_126-8_commission_en.pdf

      And it outlined fiscal targets and structural reforms that it thinks the UK should meet in the next three years:

      http://ec.europa.eu/economy_finance/economic_governance/sgp/pdf/30_edps/126-07_commission/2015-05-13_uk_126-7_commission_en.pdf

      Since reading this I've become rather more charitable towards Osborne. By advertising austerity plans that actually exceed the EU's recommendations, he's got them off our backs. We really don't need Brussels monitors in here, do we?

      Delete
  13. All Euro zone countries except Germany. Please enlighten me Frances why is Germany different than Greece. Because ECB is based in Frankfurt?☺

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    Replies
    1. Because Germany's economy dominates the Eurozone, it has a similar relationship to the rest of the Eurozone countries as the U.S. does to Puerto Rico. Despite all the EU trappings and the pretence of ECB independence, the dynamics are those of a German hegemon with satellite states. The Euro is Germany's currency and the other states are users of it. That's what the Eurozone bond yields tell us.

      Delete
    2. germany's "domination" comes from its trade surplus and once it is gone deflation comes and yields explode. Just like in Greece.

      Germans are Euro users not issuers.

      It's strange that you don't understand this obvious institutional arrangement..

      "...it has a similar relationship to the rest of the Eurozone countries as the U.S. does to Puerto Rico..."

      Germany can only be eg. NY state in your mataphor but you seem to insist it is like Federal Gvt.

      Regards

      Delete
  14. "Any country whose currency's value is explicitly or implicitly determined by the value of a commodity does not have monetary sovereignty."

    Take the currencies of countries that have strict inflation targets. We might say that the value of those currencies are determined by the value of a commodity called a CPI bundle. Do they have monetary sovereignty?

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    Replies
    1. That's an interesting idea, JP, and I admit I didn't think of that. I think it would depend how much of the CPI basket consisted of items whose prices were externally determined.

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    2. Not my idea, I think I probably got it from Nick Rowe.

      Delete
    3. Nick comes up with some far-out ideas.

      Delete
    4. The govt has the power to chop and change the basket (and in the UK does often). They can also ignore things such as shrink-flation and lower quality.

      Delete
    5. IF a government tied its currency value to anything, that was an act of monetary sovereignty, and any act of monetary sovereignty can change or eliminiate the conversion.
      CPI futures abound as monetary assets.
      EVERY government is sovereign in money. Period .
      What it can give up through convertibility, borrowing or issuing power is autonomy..

      Delete
  15. But if the economy moves either up (travelling longer for less beer) or down (travelling less for less beer) it always means less individual consumption.
    Growth of GDP is not leading to real raises of consumption as the junk created depreciates ever faster.

    What is the function of growth Francis ?
    Concentration of course.

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  16. Problem is not Germany , at most it is the host ......the banks do indeed own the commons and force you to give them scarce money in return for their use.
    There is currently 200,000 + empty houses in Ireland.
    Deutchbank has more then hinted these should be destroyed so as to maintain scarcity and thus profits.
    The banks are therefore more then willing to destroy and then waste real resources to rebuild them.
    Another option is to fill the units with migrants and refugees which among other things will further reduce the energy intensity per person.
    What is never considered is redistribution towards the existing population.
    Do not fool yourself.
    Sov states are merely state bank hybrids whose goal is concentration at all costs and I mean all costs.

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  17. A fabulous piece Frances,it shows that monetary creation isn't i a free market ii a system that enables a free & fair market to flourish iii that the protection of privilege is the cause of the worlds economic woes / wars When the privilege societies undermine the free enterprise of all other nations by creating money not to offer a fair price for those goods (but one set at a price that protects it privilege then that money distorts the value of those trades & the difference between the price & it's true value is the damage it does to economies.
    The Privilege economies are awash with capital of no use,that can't get the returns needed to keep that privilege going?
    And the more it tries to protect that confidence the more it distorts real values of goods that stop economies growing has they should (include sanctions in that)

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  18. "The Privilege economies are awash with capital of no use,that can't get the returns needed to keep that privilege going?"

    Nope ,they are awash with waste.
    Savings = waste.

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    Replies
    1. I don't agree with your wording,since having some savings isn't bad,having more savings than necessary is a sign of the over valuation of you or your assets & that means others under valuation ie any market works on both customers & traders once a trade is done of being able to return to market with on one side money to repurchase & on the other goods to sell & both need to be able to fall back on some saving in difficult times ie illness or when the price of goods have altered to upset this balance.but ONLY resetting the balance can ever allow the market to flourish failure to do so,results in recessions or if maintained longer depressions
      So surplus savings are a waste but not savings per se

      Delete
    2. Do not get me wrong - in the current system I would advocate the individual hold as much as he can save so as to maintain personnel freedom ,
      I am simply stating the present industrial system is not working as we cannot afford to spend money on the product as obviously the product is raw sewage.


      All societies saved in the past for very good reasons (autumn storage) but the current level of savings suggest a very different dynamic.
      I also do not suggest the robbing of savings in Ireland is a good thing ( we still have negative domestic credit after all these years) so as to bail out a global system that is far more then flawed.

      Delete
  19. This blog although good fails to truly grasp what the banks are trying to do in Europe.
    Obviously the goal is through "investment" the banks increase scarcity of basic goods.

    They then attempt to resell our surplus back to us , you typically get a increase in transport inputs in return for grossly negative human outcome.


    This is not a design flaw, this the design - to create waste
    .https://irelandafternama.wordpress.com/tag/planning/

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  20. https://irelandafternama.wordpress.com/2015/08/17/windfarm-wars-the-energy-debate/

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  21. Notice near the end of the article he again falls into the socialist trap (of which I embarrassingly believed in at one time) - a call for even more Dirigisme rather then a major drive towards reducing costs via a process of distribution.

    This from a former Catholic collage !!!!!!! albeit infested with Jesuits.


    As recently as 1990 40% + of Ireland's energy inputs was coal yet we had a far lower imprint.
    In 1990 ,( the beginning of the last phase of capitalism in Europe) the Irish had far more local spending power despite coming out of the first euro money depression of the 80s - a so called structural adjustment with multiple goals of which one of the primary was increasing profitability of the corporate sector.

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  22. I hope this isn't too radical for you, Frances, but I'd say true monetary sovereignty is not possible if a) the value of a country's unit of account is arbitrary and dependent on the economic behaviour of private interests (particularly external ones) or b) its medium of exchange doubles as a store of wealth.

    I've been arguing for years that there is a fundamental incompatibility between the different functions of money; its value as a medium of exchange depends on it circulating freely but its value as a store of wealth depends on it being taken out of circulation. In my view, a healthy society can't have a monetary system which allows the medium of exchange to be hoarded.

    It's only comparatively recently that I've started to see the arbitrary nature of the unit of account as a serious problem: how can we hope to have a stable economy when we measure it in a unit which is impossible to pin down and incapable of properly representing it?

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  23. This is an incredibly good and important post - thank you very much!

    There is however one aspect I take issue with: It is the definition of government debts as being money. I disagree and this has implications for your points. Money is a means of payment - and "payment" can be defined as the act of redeeming debt (by either payment of principal or interest).

    That means money is the financial asset which is used to make good on the payment promises of all other financial assets (loans, bonds etc.). Since a bond can (mostly) not be used to make a payment (redeem debt) a bond is not money.

    I have a problem if I have debt but not the money to make good on my payment promises. This is of course the situation of most of us - but not of a government that has monetary sovereignty.

    Because if a country issues debt which gives rise to payment commitments in the form of exactly the money the country's own central bank can produce - then we can say the country to be sovereign in monetary terms - since it can never default.

    This does not fundamentally change your analysis but I think some clarity as to what is what is important.

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  24. LSE man and Fabian agree..........yee guys crack me up.
    Thinking of money as a means of exchange only makes sense when I trade my labour in say a medieval market at most.
    Think of money as a flow of industrial energy today.
    We currently have real deflation for people with large stocks of money or access to inside credit channels.
    How about deflation for all ?????
    Anyone anyone ?

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  25. https://m.youtube.com/watch?v=uhiCFdWeQfA

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  26. A couple of questions, Frances:

    1) Why wouldn't any country, even if small/medium sized economically speaking, if it has a powerful open and diversified economy (let's say Finland if it left the euro or Denmark if it abandoned the peg) not be monetary sovereign?

    It feels to me the "Premier League" is small by choice, rather than rarity and most western advanced economies could be monetary sovereign if they so chose.

    2) I understand from your post that you consider the "market discipline" of auctioning bonds quite irrelevant in itself, because a truly monetary sovereign government will always be able to service the interest payments anyway--and under this mechanism, do so at the "market rates" that correctly reflect private sector demand.

    But would it do any harm to go back to a "tap system" in which the government sets the yield and the central bank buys the bonds that weren't purchased by the private sector? It seems to me it would prevent any irrational market speculation (more relevant for smaller countries) and would give the public sector greater control over the yield curve as a whole.

    Thanks!

    ReplyDelete
    Replies
    1. 1) The "Premier League" countries are distinguished by the fact that they are monetarily sovereign even though on objective measures they shouldn't be. It's sort of an exclusive club rather than a sovereignty measure.

      There are some small open economies that have monetary sovereignty. New Zealand springs to mind.

      2) I like the tap system. And actually we are unconsciously heading that way. Japan and OMT teach us that markets will accept very high levels of debt if there is a credible central bank underwriting the issues and effectively setting a floor on the price. That's in effect the tap system, is it not?

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    2. This comment has been removed by the author.

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    3. 1) Right, now I get what you mean by "Premier League", I'd missed the point about them being exceptions, sorry. It feels any country not too dependent on exports of a single or narrow range of commodities should be able to get monetary sovereignty though, just by exerting credible inflation control (not necessarily narrowed to a single target figure). In this sense I feel MMTers are kinda right.

      2) Fully agree with you, it's what I personally lean towards defending as MO. But it always helps to run one's ideas through smarter people.

      Thanks much, Frances.

      Delete
  27. So sov countries are free to increase their claims on the banking sector.
    However the Surplus is ours (cue sinister banker beginning to laugh )

    Does not sound like freedom to my jug like peasant ears.

    ReplyDelete
  28. https://m.youtube.com/watch?v=CSZ5WbTdaOo

    ReplyDelete
  29. May I?
    While I feel that Ms. Coppola has completely mis-defined monetary sovereignty and also mis-stated a number of sovereign currency understandings, including about public debt.

    With regards “monetary sovereignty”, it is an inherent national right, not something that can be given up without national “surrender”. What Ms. Coppola is obviously confusing with monetary sovereignty is the second order of governmental monetary authority, that of monetary autonomy, whereby nations use their sovereignty to abandon some aspects of national autonomy. This takes on many forms, the European Monetary Union is one example of sovereign nations giving up their monetary autonomy. Another is nations pegging their currency to another currency. Another is in joining any agreement where any aspect of sovereignty is limited, and this of course includes the Bretton Woods Agreement, where joining nations “agreed” through an Act of sovereignty, to settle international contracts on a basis of cooperation that used the $US as a peg to an “exchange value” of gold.

    Another example of the loss of monetary autonomy would be to abdicate that sovereign national right to a private corporation system of money issuance as we have done in the US, also in the UK.

    May I also take issue with the premise of this discussion, given here.
    “” Ever since the abandonment of the gold standard in 1971, governments have issued their own currencies.””
    First, any national government can only abandoned the gold standard relative to its internal currency operations, as when that government negates the right of its citizens to exchange their currency for gold. In the US , this was early in 1933.

    What happened in 1971 was merely the US abrogating its commitment to have enough gold to settle current account balances across borders, no big deal really, and while an Act to restore greater autonomy, had nothing to do with sovereignty being at play.

    Finally, this :
    “” A government bond issued by a currency-issuing sovereign is simply a promise to issue an agreed amount of sovereign money at defined points in the future.””

    LOL. As if either of our government could in any way PROMISE to create and issue any amount of national currency in relation to any government debt.
    Sorrry, but both of our countries have adopted the Bankers-school money system, where “bankers” create and issue ALL of the money supply, except in insignificant amount of coins in the US and Bills in the UK.
    A government bond would never need to be issued by any sovereign government that had maintained also full autonomy and independence of its money system.
    And, thus “”A government bond issued by a currency-issuing sovereign is simply ….”” a figment of someone’s imagination in discussing our modern monetary economies.
    Thanks.
    For the Money System Common.

    ReplyDelete
  30. I discovered your blog just a few days ago, and I am very glad about it. I have been jumping around and have been delighted to read your posts and your conversations with your readers.

    Your blog is more thoughtful and drills deeper than the many I have been following for the past eleven years.

    I am a retired designer of hardware and software systems for large business enterprises and for large government programs. In the latter case I was on the teams that designed and implemented the first Medicare and Medicaid systems in the US. I retired in 1995 and started working on a redesign of America's government and economic systems in 2004. The government redesign was easy to do and easy to explain. But the economic redesign has been extremely difficult, owing mainly to my lack of economic training (I am a mathematician), and also due to the incredibly nonsensical nature of the economic conversation in the US.

    I find your discussions to be very helpful, and I already see ways to include your ideas in my design. In that case, the questions of debt and sovereign currency are very important. My economic system, which I call "democrato-capitalism," increases US debt considerably in order to finance better lives for our citizens, and in order to provide a large, well-trained, well-equipped work force to deal with the onrushing catastrophe of global warming. I have some work to do with respect to the possible reactions of other nations, and your blog posts have already helped me.

    I know that my assertion that I am redesigning our systems sounds silly, but it is what I do. We need them and somebody has to start the ball rolling. I planned to publish my design ideas by year-end, but now I will take a little longer to acquaint myself with the ideas your present here. Thanks.

    ReplyDelete

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