Poverty of the progressives

The Federal Liberals' budget rationale is based on the widely held myth that government spending is financed by taxes and should a reckless government spend more than it raises in taxes then loan funds will be required from the private sector which will not only diminish the capacity of the private sector to create jobs and pay wages but will impoverish our children and grandchildren by burdening them with loan repayments that can only be met by higher taxes.

We’ve heard it a thousand times - the incessant Goebbels inspired  drum beat of the rationale of our current predicament.

But it’s not only the Liberals and those on the Right who believe it, but the so called progressives and those on the Left also believe it.

Maybe the latter are prepared to run government deficits for a bit longer and for government borrowings to be a bit higher, but essentially there’s not much difference between the two.

Just like the nuanced differences between Margaret Thatcher and Tony Blair, lost already in the sands of time.

The Liberals’ basic premise is that we are living beyond our means and we’ve got to spend less and stop borrowing so much.

The progressives accept that premise. Who should suffer is the only difference?

The fairness debate quickly deteriorates into little more than slagging off about whether this is the worst government ever or whether the government is fascist, or whatever. Pub arguments after a few beers maybe, but of little use in reaching public policy understanding and possible consensus to be able to move forward.

There is little questioning of the basic premise by all sides and that includes the Greens. Neo liberals on bikes is an apt description.

Progressives might score a few points on the matter of fairness but fail comprehensively when asked by the Right to explain ‘where the money’s coming from’.

Where does it come from?

What happens when the government spends?

When the government spends, its account at the Reserve Bank (RBA) is reduced. The amount is received by the recipient (employee, contractor or supplier)’s bank whose a/c at the RBA is increased.

The recipient’s bank will simultaneously report to the client by recording an additional amount in the client’s bank a/c reflecting the money it has received on behalf of the client, in other words the additional amount owing by the bank to the client/recipient.

From a macro accounting viewpoint, government spending is simply a transfer from the government’s RBA a/c to a bank’s RBA a/c.

When and if the client spends some or all of the amount, it will simply be a shuffle between banks. The overall a/c balances at the RBA, which we call exchange settlement a/cs  (Americans call them reserve a/cs) won’t change. Only the balances held by individual banks will.

Government spending increases these reserve a/cs. Nothing else can.

That’s what happens when government’s spends.

What about when taxes are paid?

When an individual or business pays tax, obviously there’s a reduction in a client’s bank a/c as the bank arranges to transfer the funds to the ATO on the taxpayer’s behalf.

From a macro accounting perspective the bank’s settlement a/c at the RBA is reduced and the government’s a/c, via the ATO, increased.

Pretty simple. The reverse of what happens when the government spends in the first place.

What if there is not enough in the government’s RBA account before spending?

Conventional wisdom and traditional practice is that the government will issue treasury bonds (IOUs) in exchange for the bondholder arranging to transfer funds from his/her bank to the government’s RBA a/c.

In macro accounting terms the same sort of effect as levying taxes. Topping up the government’s RBA with transfers from banks’ RBA a/cs.

The difference of course is that the IOU is an acknowledgment of debt and hence the issue of the Treasury bond adds to government borrowings thereby confirming in the eyes of many, applying conventional wisdom, an out of control government living beyond its means and burdening our grandchildren.

But the government doesn’t need to borrow and issue an IOU in the form of a bond. It could simply pay interest on any balances in the banks’ reserve a/cs at the RBA. From a monetary policy viewpoint, the government/RBA is still able to control interest rates.

It’s a crucially important point to understand. A currency issuing government like the Australian government doesn’t need to raise every last $ in taxes or borrowings.

Why do we all blithely accept the dogma that we can’t spend more because taxes are already too high and more borrowings are akin to stealing from the future?

It’s simply not true.

Take health care for example. Conventional wisdom has every one believing that it is not possible to provide the doctors, nurses, hospitals drugs etc that we all collectively want.

What’s the problem?

There’s plenty of resources but not enough funds it seems.

Does anyone seriously believe that we are not better off as a society with greater use of idle resources to provide welcome healthcare goods and services to the public and consequent enhanced GDP and national income that flows through the economy, not to mention enhanced social wellbeing, using the unique facility available to a currency issuing government ---to be able to spend without having raised every last $ from taxation and borrowings.

The idea that it’s all a zero sum game is a con. Fairies at the bottom of the garden and a flat earth are more credible. That there must be winners and losers, lifters and leaners, is nonsense.

There can be winners and winners.

There is no need to issue IOUs to drain bank reserve a/cs every time the government runs short of tax revenue. It’s not necessary. In fact it’s a form of corporate welfare, specifically advantaging the already bloated finance sector. And as Smokin’ Joe has told us the age of entitlement is over.

One only has to consider what’s happened in the USA over the past few years where the growth in US government borrowings resulting from the issue of IOUs or Treasuries to drain bank reserve a/cs is now being reversed via what’s called quantitative easing.

So why issue the bonds in the first place? Why not simply pay interest on the reserve a/cs?

Why don’t the progressives try to understand a bit of macro accounting. For every debit there’s a credit. For every plus there’s a minus somewhere. Except ….. and this is crucial…….in the unique case of a currency issuing government being able to spend without raising every last $ in either taxes or borrowings. Old accountants may recognize it as the Holy Grail of their profession – the one sided journal entry.

Belief in the zero sum game is widespread. Recently an editorialist writing for one of the Fairfax regional dailies opined: “It is a pretty simple equation when you look at a budget through the eyes of basic economics – whatever a government spends it must first collect in tax.”

Basic economics indeed. He should’ve stuck to sports writing.

Where does the money come from?

Where do the points come from at the footy?

From a click of a mouse.

Will the scorer ever run out of points?

Nope.

It’s not like the old days when the scorer had a pile of numbers he kept adding to the scoreboard hoping the Saints don’t get whipped too badly and exhaust his pile of numbers.

Since Nixon’s abandonment of Bretton Woods agreement in 1971 when the US$ ceased to be a convertible currency there’s been no chance of the USA every running out of numbers.

There’s been a comprehensive failure to understand where money comes from. Any belief in the quaint notion that banks require deposits before lending was  debunked in a recent Bank of England paper: “Money creation in practice differs from some popular misconceptions – banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits…….. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.” There it is, money from thin air.

The US has been buying bonds and other IOUs from banks over the past few years at the rate of $85 billion per month, about $3 trillion just for the latest round of quantitative easing. All paid for with a click of a mouse at the Federal Reserve, the US central bank. Hand over the bonds and the Fed simply credits a bank’s reserve a/c.

Given that the US economy is, say 15 times the size of ours that means $200 billion in Australian terms (ignoring exchange rate differences) created with the click of a mouse. No inflation. Imagine what a difference a fraction of that amount would make to health care in Australia.

The fact that the US economy hasn’t taken off as hoped is testimony to the fact that as noted above by the Old Lady of Threadneedle Street, banks create money out of thin air and anyway don’t require deposits in a vault or reserves at the central bank.  Quantitative easing was designed to rescue banks not to rescue the economy.
 

 

Governments however can learn from the experience. They don’t require all spending to be financed by taxes and borrowings.

Quite the reverse in fact, spending drives taxes, not the other way around.

To paraphrase Mr Churchill, capitalism as currently practiced is probably the worst form for an economy except all the others that have been tried. It is certainly not self correcting as the market triumphalists insist.

What has evolved as Thomas Pitketty has recently chronicled is growing inequality. Goodness gracious, even some of capitalism’s more prominent apologists are acknowledging that increasing inequality might be making the system less sustainable. Gosh we better do something about it then? Hey let’s tax the rich, the premise of course being a zero sum game exists.

Fairness is an important contributor to the glue that binds societies together, but it is a mistake to believe that the current  ownership distribution of existing wealth holds the key to our future, rather than how we decide via our government to finance future expenditure, how we decide to use our increasingly idle young labour resources and how we decide to fund health education and infrastructure spending to benefit all, not just those few who have persuaded the overwhelming majority that a zero sum game leaves no alternative but austere times ahead.

A failure to understand how the system works and the future options available means any solution is well nigh impossible. It’s almost past the time for everyone with the slightest progressive disposition to question the prevailing paradigms that restrict our view of the world and prevent us from seeing the alternatives to what we are now confronting.