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Who will pay for this Covid catastrophe? Magic money trees do exist but their fruit is poisonous

What will Rishi do next? Credit: Henry Nicholls - WPA Pool/Getty Images

What will Rishi do next? Credit: Henry Nicholls - WPA Pool/Getty Images


April 20, 2020   7 mins

How are we going to pay for all of this? I know, there’s still hundreds of people dying every day — including NHS workers — so it seems wrong to thinking about money. And yet the question must be asked.

For the Government to do “whatever it takes” will require it to spend whatever it takes — both to beat back the pandemic and to revive a devastated economy.

This year it’s projected that the US Treasury department will issue $3 trillion (i.e. three thousand billion dollars) of new bonds (a bond, by the way, is basically an IOU).

In the UK it’ll be hundreds and hundreds of billions of extra borrowing.

In the EU things are horrendously complicated by the single currency, but there’ll be colossal borrowing requirements there too — and across the world.

Interest rates are at record lows right now, but economic recovery implies that that they will at some point come back off the floor. So how will governments cope then? Will public finances be chewed up by the cost of servicing these loans? What if multiple countries default, sending the global financial system into meltdown? One way or another, the recovery could be crushed by the sheer weight of debt.

However, there is a way out: monetisation. This means that central banks, like the Bank of England, will be the biggest buyers of the extra debt. They will simply create new money (by electronic means rather than physically printing banknotes) and use it to buy government bonds.

Given that a central bank is owned by the state, the state effectively borrows money from itself and owes it to itself. So no sovereign debt crisis.

*

That’s how western governments get out of the economic frying pan, but in doing so will they plunge into a political fire?

The radical Left — excluded from power across the West — sees an opportunity here. In fact, it believes that it is on the brink of a historic breakthrough. We were told that there is no “magic money tree” to pay for the lavish spending plans of politicians like Jeremy Corbyn and Bernie Sanders. So how will voters react when neoliberal governments admit that these arborial wonders do exist after all?

If the limits on what a government can borrow are much looser than what we’ve been previously led to believe then the political implications are profound. This is how Thomas Fazi puts it in his recent article for UnHerd:

“All the pain, suffering and misery imposed on millions of people as a result of austerity was entirely a political choice. All the cries of “How are you going to pay for that?” were simply a way to maintain the deeply unequal relations of power in our societies. To dramatically restrict our ability to imagine economic and political alternatives. But “all of these excuses that we have been given as to why we cannot treat people humanely have suddenly gone up in smoke”, as Alexandria Ocasio-Cortez said. If money can be created out of thin air to fight a ‘ war’ against a deadly virus, doesn’t it follow that the same can be done to ‘ wage war’ on poverty, unemployment, inequality, ecological collapse – all of which are much deadlier evils than Covid-19.”

It’s a powerful argument. All the more so because unlike many of his fellow radicals Fazi recognises that the EU is an institutional roadblock to the new economics and new politics he believes in. In particular the Eurozone and European Central Bank mean that member states no longer control their own currencies — and thus can’t monetise their debt without the say so of the other member states (and some countries, like Germany and The Netherlands, aren’t keen).

But though he makes a compelling case, I don’t agree with his conclusions.

Let’s start with austerity. I’m not going to defend the entirety of UK economic policy since 2010. In particular, I think the early decision to stick to the plans of the previous Labour government and slash capital expenditure was one of the great policy mistakes of the 21st century. To cut investment in vital infrastructure doesn’t save anything at all, it just runs up a different kind of debt — while depriving an ailing economy of much-needed stimulus.

But that doesn’t mean we should finance big increases in current expenditure and/or tax cuts through even more borrowing. Think what a no-holds-barred borrow-and-spend economic policy actually means: even if the government in question is impeccably socialist, it becomes utterly dependent on the international money markets.

Those markets have a habit of punishing fiscally unrestrained governments, by charging them higher rates of interest, in effect making further borrowing unaffordable — and even provoking a sovereign debt crisis. Britain in 2010, with its crisis-hit financial sector and depleting North Sea oil reserves, was especially vulnerable.

OK, but what if the UK government had monetised its debt instead — borrowing from the Bank of England not the money markets? If this is what’s going to happen in 2020, why didn’t we do it in 2010? The answer is that if we had, Sterling would have crashed in value sending the price of imports surging upwards and causing an inflation crisis. Interest rates would have surged too, meaning mass mortgage defaults, bankruptcy and unemployment.

Now is different because monetisation, if it happens, will happen in many countries not just one. If they monetise their debt to a roughly equal extent, then their currency values, relative to one another, will stay roughly the same.

That’s why we got away with quantitative easing (QE) when we first started using it, in the wake of the global financial crisis. Though it was a novelty back then, Britain was in the same boat as other countries.

*

Quantitative easing, by the way, can be seen as a dress rehearsal for the kind of debt monetisation that’s on the cards now. So, a quick word about how it works (or is supposed to):

First of all, the central bank magics up some new money and uses it to buy government bonds. However, in the case of QE these are previously issued bonds purchased from the money markets, not new debt purchased directly from the government. That’s because the objective isn’t to finance government spending, but to stimulate the economy.

By taking a load of bonds off the market, thus reducing their supply, the government can get away with selling new bonds that offer a lower return. Not only does this cut the cost of public borrowing, it also encourages the money markets to lend to businesses because the return they get from lending to the state is so slim.

Furthermore, QE is supposed to be a temporary measure. As soon as the economy picks up again, the central bank not only stops with the QE, it reverses (or “unwinds”) the QE it’s already done — i.e. it sells the bonds it bought back to the market and destroys the money it gets for them. In other words, the money it created out of nothing (see above) is returned to nothing and everything goes back to normal.

Or at least that’s the theory. In practice, QE has not been unwound. All or most of the money that central banks have created since the Global Financial Crisis (ÂŁ645 billion in the UK alone, and trillions worldwide) is still out there in the economy. And yet it hasn’t caused the inflation that a lot of economists expected.

As for all those bonds that were purchased through QE, the central banks are still sitting on them. The Bank of England, for instance, now owns a third of the UK’s national debt. It’s all deeply weird, but now accepted as the new normal.

So, having got away with permanent QE — and faced with the urgent need to stop the Corona-crisis turning into a global depression, why not do debt monetisation directly and honestly — the central banks openly creating money to finance emergency government spending?

Indeed, why stop at a one-off response to the current crisis? Why not make this a permanent arrangement — and finance the anti-austerity policies favoured by Corbyn et al. It could be argued that Labour’s 2019 manifesto, far from being too radical, was in fact overly cautious. If there’s no effective limit to government spending, why not embrace some truly radical policies — like universal basic income (as advocated by the Pope this Easter) or a full-on Green New Deal to stop climate change in its tracks?

*

The most obvious objection is that even if sovereign governments can create as much money as they like out of thin air, the same method doesn’t work with the things that money buys.

Whether it’s energy, raw materials, machinery, goods, services or people’s time — we still live in a world of scarcity. One can certainly argue that neoliberal economics has left the economy short of demand, but the supply of most of the things we want and need is finite. If you give government the power to create unlimited demand, then supply will be overstretched and hyper-inflation will result.

The advocates of Modern Monetary Theory (MMT) have an answer to that. This new school of economic thought argues that central banks should create all the money that governments need to spend, and that the tax system should be used to remove enough money from circulation to keep prices stable.

Modern Monetary Theorists, therefore, want to turn conventional economic policy on its head. Instead of using fiscal policy (e.g. tax) to raise revenues and monetary policy (e.g. interest rates) to control inflation, it would be the other way round.

The great advantage of this topsy-turvy system is that governments would always have enough money to fund their plans (within the constraints of what the economy can produce). It should also be a lot easier to ensure enough demand in the economy to head off the threat of deflation — which has been more of a danger over the 2010s than inflation.

The big problem with Modern Monetary Theory is that it’s just that — a theory. It proposes a radically different way of managing the economy that’s never been tried before. If we tried it now, we could easily miscalculate and send prices spiralling.

Mind you, that’s what they said about QE — and we still went ahead with that.

*

If the coronavirus does force us through the MMT looking glass — and if it doesn’t blow up the economy (two very big ifs) — is there any objection to Thomas Fazi’s argument?

Yes — and it’s precisely the thing that the radical Left most likes about this brave new world: it would give government unprecedented power.

The modern state already has a monopoly on the use of violence. By and large that’s a good thing , ensuring law and order. Yet tyrants throughout history have turned it against the people. The ability of free societies to constrain that power has been hard fought.

The reason why that struggle was won isn’t just down to the courage of those that fought for it — or to their sources of ideological inspiration. It is also thanks to the fact that governments depend on their people for money. As soon as rulers can’t enslave the ruled anymore — or make us their serfs — they have to persuade us, bargain with us, make concessions to us.

And so, step-by-step, our rights have advanced. Sure, things like education and urbanisation have also helped to solidify the power of the people — but ultimately it comes down to the fact that our leaders need our money, and for that we’ll have our say. No taxation without representation!

Indeed, it’s striking that where governments don’t rely on their people for revenue — perhaps because the economy isn’t developed enough for a modern tax system or there’s a state monopoly on the exploitation of valuable natural resources — there’s little or no democracy. Think Russia or the Middle East or much of Africa.

This is what worries me most about a state that gets its money from the central bank, not the general population. It’s what especially worries me about the idea of the state providing people with universal basic income or some equivalent system. As soon as we depend on them, the power relationship is reversed.

Democracy is what happens when the people pay the government, not the other way round.


Peter Franklin is Associate Editor of UnHerd. He was previously a policy advisor and speechwriter on environmental and social issues.

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nickandyrose
nickandyrose
4 years ago

One thing that has been overlooked in the argument is one of trust. Our currencies only survive because of trust, because they aren’t backed by anything else. What is outlined above would erode trust in money not only nationally, but globally too. When that happens, you see a general drift towards tangibles, such as gold, other precious metals, minerals and so on. Government bonds won’t be appearing on that list, even though at the moment, major investors such as pension funds consider gilts a “safe” investment. If the government can’t sell its debt, it cannot raise the extra funds it deems are required, and then the whole house of cards comes crashing down.

No happy ending for that brilliant idea, methinks.

Stuart Palmer
Stuart Palmer
4 years ago

Fantastic topic to chew on here. Essentially we are discussing how we all maintain faith in fiat currencies it would seem to me? They’re only really useful for paying taxes with. Outside of that, who is to say what value they actually have when they are not backed by any clearly defined assets? I am sure I sound like a dinosaur but history teaches us that fiat currencies regularly fail. It seems to me that the whole global system of fiat currencies will now come under immense pressure. Will we not enter into a sort of global game of “chicken” as nation states wait to see who blinks first?

Diarmid Weir
Diarmid Weir
4 years ago
Reply to  Stuart Palmer

Paying taxes is pretty important! So-called ‘fiat’ currencies are not really fiat at all. You want a fiat currency? Try Bitcoin! https://www.futureeconomics.org/2010/08/the-role-of-a-central-bank/

Fraser Bailey
Fraser Bailey
4 years ago

Whatever…this particular burst of money printing simply brings Paper Money Collapse a few years closer. What is quite remarkable, notably with reference to the US, is that despite the fact that governments have been printing money like crazy since 1971, nobody has any money! Well a few people have enormous amounts of money but most people have none whatsoever. Even more remarkable is the fact that despite this manifest unfairness, left-wing parties in most countries are failing to gain power and even collapsing (France, the UK, Germany etc).

Of course, we all know that this is because even those who don’t pay too much attention to history and economics know that the leftists will inevitably create something even worse than the status quo.

Ralph Windsor
Ralph Windsor
4 years ago
Reply to  Fraser Bailey

Venezuela, to name just one current example.

M Blanc
M Blanc
4 years ago
Reply to  Fraser Bailey

Minor amendment: Most people have just enough money to survive day to day, or just about.

Graeme Hunt
Graeme Hunt
4 years ago
Reply to  Fraser Bailey

Like the Atlee Government?

David Booth
David Booth
4 years ago

It is really good that this discussion is happening on UnHerd, making clear that the kinds of policies MMT suggests are not just relevant to left-liberals.

Peter’s most interesting point about political dangers is the one that says MMT may be technically right but its practice would undermine the political economy of democratic accountability. That sounds like a serious problem but is it really? As Wilfred insists, and MMT economists have exhaustively shown, it is technically untrue that people have to pay taxes BEFORE governments spend. That’s a sequence issue. But as the rest of the discussion makes clear, the government still DEPENDS on people paying their taxes if it is to succeed in both spending AND controlling inflation. That’s the political economy issue. So the foundational liberal-democratic idea about the relationship between taxation and accountability just needs to be reworked a bit to make it consistent with the technics.

What we are not discussing yet, and should discuss next, is how MMT-inspired policy might be more effective at getting genuine full-employment (regionally balanced, with decent jobs) than George Osborne’s policies were. And what will be the penalties from continuing to let our economic life be regulated entirely by the obscure rigmarole of incurring, paying off and/or buying back public debt.

d.tjarlz
d.tjarlz
4 years ago
Reply to  David Booth

Absolutely right about genuine full-employment, or whatever we want to call it. This will require a shift in the way that we think about efficiency. I think we’re going to have to curtail the use of labour saving machines (replace them with human power) and/or accept that we need to pay people a UBI to “self-actualise” in some socially acceptable way.

Mark Corby
Mark Corby
4 years ago

Britain has been shaking the Magic Money Tree, MMT (violently) for over a century.
We fought the Great War on this basis, grovelled before the US to shake it again in 1940, and continued to shake it ever since.
The result was the loss of Great Power status, the fall of the British Empire, and the rise of crypto communism, otherwise know as socialism.
It is in fact the British way, borrow and forget.
This time we shall probably uproot the MMT, and future generations will, quite rightly, curse us.

namelsss me
namelsss me
3 years ago
Reply to  Mark Corby

Actually, it caused the Rise of the British Empire and the gain of Great Power status in the 18th century. Government expenditure increased 16-fold. Of course the expenditure was designed for the naval and military protection of trade and conquest, which mostly paid.

Mark Corby
Mark Corby
3 years ago
Reply to  namelsss me

I was referring to massive borrowing from the US in the period 1915-18, a point not missed by Paul Warburg of the newly formed Fed’. Thus we went from the greatest creditor nation on earth in 1914, to a supplicant beggar by 1920.

Alex Camm
Alex Camm
4 years ago

Have we really got away with quantitative easing?
Pension funds are facing enormous deficits as a result of the decline in the gilt yield which is as a result of this policy. This may be hidden to the general public but may yet prove to have a significant negative impact on pensions and the companies which are having to make up the shortfall.
There is no free lunch

bob alob
bob alob
4 years ago

There is no such thing as free money, no matter how much those on the left would like to believe there is, no economy degree required to work that one out.

Diarmid Weir
Diarmid Weir
4 years ago
Reply to  bob alob

An economics degree would teach you that creating money has an opportunity cost, like everything else – but working out what that is… then it gets complicated…

d.tjarlz
d.tjarlz
4 years ago
Reply to  bob alob

Inheritance seems pretty much like free money to me.

bob alob
bob alob
4 years ago
Reply to  d.tjarlz

Even the money inherited has been earned by someone through their labour or the labour of others.

d.tjarlz
d.tjarlz
4 years ago
Reply to  bob alob

Free money nonetheless

bob alob
bob alob
4 years ago
Reply to  d.tjarlz

Not in this context, even with a lottery win the money has been earned by someone else’s labour, but I think you already know that.

d.tjarlz
d.tjarlz
4 years ago
Reply to  bob alob

You stick to your ideological distinctions, and I’ll stick to mine. That way can we talk past one another indefinitely. 🙂

By “free”I mean unearned precisely in the sense that an inheritance is unearned; it is largely a matter of accident of birth. There are other variables of course, but the broad argument stands.

If by “free” you mean not the product of any specific or even generalised act of labour (very broadly defined), e.g. “printing money”. The broad contour of the argument stands.

A government could “print money” for an open lottery in which every citizen is enrolled, and winning that lottery would be “free money” in at least one sense of the term. I think we can agree on that?

bob alob
bob alob
4 years ago
Reply to  d.tjarlz

Late reply, just seen it, I am talking about free money with regards the topic of the article, so I would say that even government printed money still doesn’t make it free, without the economy to back it, it’s just paper.

Fraser Bailey
Fraser Bailey
4 years ago

In the short term, millions upon millions of normal people in the productive, private sector will pay for it. Partly through taxes, partly through the ongoing destruction of pensions, as Alex Camm states below. Meanwhile, those in power and in the pubic sector will be laughing all the way to the bank.

In the longer term, the west in general will pay as it all brings us one step closer to Paper Money Collapse. Then the Chinese or the Russians or the Saudis will simply walk in and take everything we have.

Mark Corby
Mark Corby
4 years ago
Reply to  Fraser Bailey

Public Sector Pensions cost the UK taxpayer about £40bn per annum!
The first thing Cummings & Co must do in their forthcoming ‘ Blitzkrieg’ is to slash this to no more than £20bn.
Yes, it will mean broken promises etc, but this is national financial emergency, the like of which we have not seen since 1918 & 1940.
If that method is intolerable, then reintroduce a super tax on all pensions of over say 75k.
Was it not astonishing that the recently retired (female ) head of the London Fire Brigade, is in receipt of a pension of £140k per annum?
Unless this carbuncle on the backside of the British economy is addressed, there will be trouble.
For eons, we have been fobbed off with the mantra that Civil Servants etc are poorly paid, but are compensated by generous, index liked pensions, should they live so long.
Regrettably as life expectancy in the UK is now about 80, this saddles the private sector taxpayer with an unacceptable burden.
Thanks to Chinese Death Flu we should be able to implement such an equitable policy.
As they say, “every cloud has a silver lining”.

David Smith
David Smith
4 years ago
Reply to  Mark Corby

Oh if only……

Wilfrid Whattam
Wilfrid Whattam
4 years ago

Oh dear Peter. You write so enjoyably on many things, but please steer clear of macroeconomics until you know what you are saying.

1. People do NOT pay the Government – it is you who has it the wrong way round. Taxation, for example, does not fund sovereign (i.e. for a state that issues and spends in its own currency) Government spending.
2. A sovereign Government (not one using a foreign currency – the prime example being the Eurozone – or pegging to a foreign currency) is totally unconstrained in what it can buy in its own currency.
3. A sovereign Government cannot spend without limit – there are natural
boundaries of resource availability (labour/skills and production – generally or even particularly) beyond which further demand can be inflationary.

It is shocking that you should be misguiding readers from your position of respect, without first attempting to understand the reality of MMT – which is not some crazy newfangled idea, but a recognition of long standing (especially since the end of the gold standard) financial reality that any central banker, financier or hedge fund operator could confirm.

So, I recommend that you download a free 99 page book (from moslereconomics.com):

Seven Deadly Innocent Frauds of Economic Policy – by Warren Mosler

You need read only the first 67 pages. Warren is very pro-market, so all your concerns about profligate lefties can be scotched. He knows banking and finance inside out from practical experience.

MMT is neither Right nor Left Wing. To be either needs an overlay of social policy. It is just the way things are. You can soundly rest in your sleep.

After the VIRUS, in fact perhaps we should have continued Government stimulus – financial and direct – to get the economy motoring again. For people worried about the ecology as well as the market economy, then Green New Deal actions would be good.

Michael Dawson
Michael Dawson
4 years ago

I think you are misrepresenting Peter’s state of understanding. He does understand MMT. He makes two main points, neither of which you actually deal with.

In reverse order, his main point is that, whether or not MMT will work as its adherents would like, there is a political benefit in the current arrangements. You might say that it is a ridiculous fiction, but governments in the west over the past 40 years at least have acted as if taxation constrains government spending and governments cannot just print money. His point is that these assumptions – this fiction, if you prefer – constrains governments in a way that he feels is beneficial. Obviously, you may disagree, but you do actually have to engage with what is a perfectly reasonable argument. At the very least, you need to argue why MMT will be operated by the equivalent of an omniscient philosopher king, not the sorcerer’s apprentice let lose with financial tools that they do not really understand and cannot properly control.

His secondary point is that MMT has not really been applied successfully in practice anywhere in the world, so there must be a big risk here … But if all countries are doing it to more or less to the same extent, the consequences for an individual country are likely to be a lot less harmful, as the money markets cannot isolate the country and crash its currency. I think most people would agree with this.

I do think traditional economics is failing to explain the current weird situation of mass QE and low interest rates, so using it to predict the future is pretty worthless. But that’s a different point – so apologies for the digression, but I wanted to make it clear that I am not trying to defend the status quo here.

RD Allred
RD Allred
4 years ago

Best reply here. Everyone should read Mosler’s book. (Has Mr. Franklin read it?)

Re: “This is what worries me most about a state that gets its money from the central bank, not the general population.”

What Mr. Franklin doesn’t comprehend is that the general population (the private sector) gets the money to pay taxes from the government through federal spending. Central government outlays are the only source of persistent money in the private economy.

Bank loans & credit cards”higher consumer debt”become the only alternative for private citizens when government spending falls too low.

Jonathan Karmi
Jonathan Karmi
4 years ago

A truly brilliant article. Thought-provoking stuff.

Andrew Baldwin
Andrew Baldwin
4 years ago

Great op-ed. Fergus Cumming of the Bank of England (“Helicopter money: setting the tale straight”, August 5, 2015) concluded: “For helicopter money to work, households and firms have to believe that all future central bankers and governments want to abandon inflation targeting.” Why would any government or central bank with an inflation targeting regime want to do that? The situation would have to be desperate indeed. Let’s hope neither the UK nor Canada ever get there.

d.tjarlz
d.tjarlz
4 years ago

“Yes ” and it’s precisely the thing that the radical Left most likes about this brave new world: it would give government unprecedented power.”

If by “radical” left you mean authoritarian Left, then this statement might have some truth. But where is the authoritarian left these days?

I’d consider myself fairly “radical left”, and like Australia’s MMT exponent Bill Mitchell, my politics are decidedly anti-authoritarian (http://bilbo.economicoutloo….

What we’re seeing in Australia is a creeping neo-liberal authoritarianism that is taking power away from the people. If the security of MMT based UBI gave people the courage to resist the Right’s power grab then all the better in my view.

Diarmid Weir
Diarmid Weir
4 years ago

That the people have to pay the government (in money) is mainly an accounting arrangement. That the government enforces (by way of its money) its acquisition of goods and services is most oppressive to those with the most goods and services. A government without power to do that is to no purpose. As such – opposition to the government’s right to tax and spend is always the agenda of the rich.

Fraser Bailey
Fraser Bailey
4 years ago
Reply to  Diarmid Weir

Well I am not particularly rich and I generally oppose the governments right to tax and spend, because it is my observation that they spend the money very badly, invariably achieving precisely the opposite of that which they intended to achieve.

David Gavine
David Gavine
4 years ago

Beyond the confines of this very well informed discussion group here, there is a semantic problem in the wider community. People are wont to use the word money in statements like, “the NHS needs more money” because we don’t have a simple term to convey the concept of economic resources such as labour and capital. So,whenMMT people say we can make as much money as we like, I see people on the left taking that as support for their contention that,for example, austerity can be reversed by political will. I think people opposed to MMT are using this misunderstanding to oppose it.

David Booth
David Booth
4 years ago
Reply to  David Gavine

I think that’s right. It’s a challenge to express MMT policy thinking in terms that are not going to be misunderstood in everyday language. I am not sure the main MMT gurus have done terribly well in this respect.
Maybe the best entry point is that public spending has the purpose of getting the economy’s real resources working again and as efficiently and equitably as possible. This should be limited by the need for measures to stop the real economy ‘overheating’ (a metaphor everyone understands), not by an arbitrary limit on the size of the deficit spending or by an arbitrary norm of matching every pound of deficit spending with a pound of borrowing.
By the way, in the present context a government commitment not to pile all the costs of the pandemic and recovery onto future generations via debt, and only to increase taxation to the extent necessary to stop overheating, ought to be politically attractive.

Will D. Mann
Will D. Mann
4 years ago

Wealth gives immense power to some, individuals and corporations in much the same way that armed millitias give power to warlords in failed states.

On a smaller scale differences in access to wealth allow unscrupulous landlords and employers to exploit ordinary people who often can not afford to enforce what ever legal rights they might theoretically hold.

Maybe there is something to be said for giving much more economic power to governments who are at least subject to democratic control by the people, unlike the wealthy.

M Blanc
M Blanc
4 years ago

It won’t be paid for. They’ll pretend to pay for it. Our grandchildren or great-grandchildren will pay for it.