Wednesday, 18 June 2014

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?


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.


  1. John, unfortunately the media gets in the road of a wider public understanding of this and many other issues. It does so for many reasons, but two are of rather more importance, imho. One is that it is decidedly lazy and spruiks the story largely as written by government spin doctors, the other is that its largest practitioner is entirely part of the globalist cabal whose clear objective, based on their actions alone, is the elimination of the middle class and the instigation of class warfare based on artificially imposed definitions of an individual's worth. Wage earner = good, unemployed =bad, etc, etc.
    Whatever action addresses the problems ahead of us, it must address the problem of the media failure to inform and hold to account. Without that, knowledge like yours will remain out of the public reach for far too many, potential leaders included.


    Simon Warriner

  2. John could I ask that you hold an education session on this so I that I and others can fully understand.

    1. I'm happy to keep contributing where I can.

      I think most people are loathe to fully embrace the mainstream view as to the causes of the GFC and that all necessary steps have been undertaken to ensure it never happens again.

      The role of debt, money and how money is created by private banks inevitably leads to questions about the role of money, how governments finance their expenditures and any ensuing government debt that may follow.

      The economics blogosphere on the fringes is full of chatter.

      But it is slow to filter down to the mainstream.

      I glad you recognise

  3. I enjoyed your recent article about how our tax model is failing and decided to follow your blog. I was surprised to see that you advocate a US style QE program as being a model to follow.
    if you follow bloggers such as Mike Shedlock or David Stockman or even more local commentators
    such as The Daily Reckoning published in Melbourne, you will find more subdued or even negative enthusiasm for QE style intervention.
    It would seem that taking the general consensus from these, that QE merely waters down the dollars in the system, where those with the first use get good value but as the dollars distribute more widely their value diminishes to a point where we do indeed see inflation. This is easily seen by looking at what $100 would buy today as compared to even 10 years ago. As older Australians we have been beneficiaries of inflation, i.e. rising value of housing and shares as a store of wealth. As time goes by and the population drops, there will not be the store of what some call "greater fools". That is those who will be able to buy the inflated priced assets that we are relying on to fund our old age.
    This is when the poo hits the fan, when taxation is not able to keep the promises made in the past to the degree Joe Hockey's budget will seem a dream in the light of the then reality.
    There seriously needs to be a group of clear thinkers come together to try to find a way round this mess or while we might struggle through, our descendents will have a really hard time and may even come to curse our generation.

    1. I didn’t mean to imply that QE was the recipe to follow, but rather central banks in economies like Australia and the US are able to spend if need be without raising every last $ in taxation or bond issues.

      The point I was trying to make was that QE is simply a reversal of bond issuance so why issue all the bonds in the first place?

      In any event, QE although popularly termed money printing is really just a swap of longer term government IOUs (bonds) for short term government IOUs (cash). There is no change in the quantum of financial assets in the private sector, merely a change in the maturities of IOUs.

      When QE first started a lot of people, no doubt influenced by the thoughts of Milton Friedman and the monetarists, foresaw inflation as inevitable.

      There may be lots of money about but no one bothers too much anymore with all the various measures of money as the monetarists did (M0, M1, M2 etc) ‘cos it seems that inflation is caused by too much money chasing too few goods, and one feature of the modern globalised world with unemployed resources and excess capacity everywhere is that the world can produce anything that is demanded.

      Aggregate demand is the problem.

      With nil bonds on issue and balanced budgets, government balance sheets will have few assets.

      Prudent spending without first raising funds via taxes or debt maybe is an option we should consider.

    2. On the subject of prudent spending by Government, I couldn't agree more. Over time Governments have fostered the attitude with the populace that all things good flow from Government to the extent that most now see funding from Government as the first port of call when trying to get a project up and running. What is needed is to ween non core activities from the Government tit and get Government doing what it is supposed to do, providing essential services, both social and infrastructural.
      Good governance is currently seen by political parties, as being all things to all people rather than as being a servant of the people, one who has guardianship of the peoples funds, to be spent in a manner that enhances the lives of all citizens.
      Unfortunately, there is no likelihood of either of the main Tasmanian parties abandoning their spendthrift ways as there are no votes in this approach.
      The State election before last was a perfect time for good governance to result where we were given a 10, 10, 5 result where the Green party held the balance of power.
      If at this stage the Greens had held to a bi partisan line and supported good legislation from either side and only supported one party on matters of confidence and supply, we would have had a chance to break the cycle of dependence.
      Unfortunately the Greens chose to dip into the trough and both they and us were the losers.
      I believe most who go into politics do so for the right reasons, but because it is necessary to form alliances to see ones pet program through, one has to compromise on other legislation that one may not normally support. It is a pity we lost the 10,10,5 opportunity.
      Other than that, I have little problem with borrowing where there is a long term payoff for the taxpayer but no time at all for continual borrowing to pay back old loans.
      The first priority for governments to attack should be to balance the budget, cut all waste and then and only then, decide on future projects to be funded over time.
      A classic example of utter waste is the demolition of 10 Murray St. This could only be contemplated by Government as no private organization would waste such an asset, especially when there is no money in kitty.
      sorry to waffle.

  4. It is important in this discussion to clearly distinguish the different roles of the State and Federal governments.

    The blog was about the Federal government which has much enhanced powers re taxation, borrowing and currency issuance.

    The Tasmanian State government can’t issue currency, can’t borrow because it can’t service loans and is self constrained on the matter of taxes.

    I agree the best and only course of action is for the State government to do what it is supposed to do, providing essential services, both social and infrastructural.

    But the Fed government is able to provide a much more enlightened and proactive role.

    Perhaps not with the current crew?

    1. David McMillan9 July 2014 at 22:45

      True, Governments,both State and Federal have different roles to play. Perhaps this Blog is not the best forum to debate the best outcomes for Tasmania from State resources. Perhaps you have a better forum to discuss these issues from that perspective, or can start one.
      I have high hopes for your championship of Tasmanian issues above all else.