There is a common fairy tale about money that goes something like this:
Once upon a time there was a magic money tree which periodically rained money down onto households and businesses. Businesses used this money to pay the wages of workers and households used the money to buy goods and services from the businesses.
In order to facilitate this process, banks were created as a safe place to store unused money. To bolster trade and to grow the economy, banks loaned out some of the money deposited with them. By charging a higher rate of interest to the borrowers than was paid to the depositors, the banks were able to make a profit too.
Unfortunately, some of the things needed by businesses, households and banks – like police forces to protect them all from robbery – had to be provided by the government. In order to pay for these, the government had to levy taxes on all three. So long as the government didn’t spend too much on public services, there would be plenty of money circulating between businesses, banks and households to allow the economy to thrive. But if the government spent too much money it would have no choice but to raise taxes. This would deprive businesses, households and banks of the money they need; causing the economy to go into recession.
And so governments must always balance their books.
It’s a fun story of the kind that a five-year-old might believe (in the same way as they might believe in Santa Clause, the Easter Bunny or the Tooth Fairy) but it is complete and utter horseshit. Which is another reason why we should demand that the BBC repay the licence fee (the tax levied on British viewers to fund the broadcaster) when they print drivel like this:
“The deficit [from the Covid-19 crisis] leaves the government with a choice: increase borrowing, raise taxes, or cut spending. In the end, it may well do a mixture of the three – but those decisions haven’t been taken yet.”
This misleading pronouncement – which is undoubtedly designed to start softening the public up for the austerity cuts to be imposed once the lockdown is lifted – makes two crucial errors. The first concerns the way in which money is created. The second is a far darker error concerning the nature of economic growth itself.
The money error
The government can do any or all of these things. But they are not the only three options on the table – unless you believe in the magic money tree theory of money. That is, you are clueless as to how money is created and how money can be created.
In the real world, there are – broadly – three money circuits. First, there is the special currency called “central bank reserves” or “M0” which circulates between the banks and the central banks. This is the currency that banks use to settle accounts with each other – for example, when you purchase something from a supplier who uses a different bank. This currency does not leave the banking sector, but it provides the banks with the reserves needed to allow them to make loans.
Bank loans are the primary means through which money is created. New currency is spirited into existence at the stroke of a keyboard when a bank adds a loan amount to a borrower’s account. No currency is removed from another account to achieve this; all that happens is that the amount is recorded as an asset on the bank’s accounting ledger and as a liability on the borrower. Eventually, the currency will leave the economy when the borrower pays off the loan with interest.
The final – and far smaller – source of new money is the notes and coins which the government prints. In Britain these account for less than 10 percent of the currency in circulation and less than one percent of all transactions. Eventually these leave the economy when they become worn out.
It is a social convention that the money supply operates in this way; not a law of physics. And one of the things which distinguished Britain from Greece and Portugal during the sovereign debt crisis in 2011 – itself a consequence of the 2008 crash – is that the British state is free to create its own currency. Despite being more indebted than Greece, the UK government was in no danger of needing a bailout because (within some international limits) it could print or borrow as much new currency as it needed. It was an entirely political choice of the Cameron government to impose widespread austerity on those least able to afford it. Ironically, that choice resulted in Cameron losing his job in 2016 when those on the receiving end of austerity voted to leave the European Union; an option that was only available to them because Britain had not joined the Euro.
As it happened, the British government chose to borrow rather than print currency to fill the post-2008 gap between spending and tax receipts. That is, it issued investment bonds which would give investors – such as pension funds and insurance companies – a return effectively guaranteed from future taxation. Despite the interest rate being low, there were plenty of takers simply because the government debt of a leading sovereign state is among the safest assets in the system (the US dollar – at least for now – being considered the safest of all).
The monetary system as it currently operates is a product of the crisis of industrial civilisation in the 1970s. The combination of oil shocks, inflation and the collapse of the nominally gold-backed Bretton Woods post-war monetary system undermined the previous governmental focus on maintaining full-employment – itself an attempt to prevent a re-run of the crisis of the 1930s which saw the rise of political extremism which led to World War Two. From the mid-1970s the focus shifted to controlling inflation in an attempt to end the wage-price spiral (which benefited workers at the expense of investors).
Low and stable inflation marked the heyday decade of neoliberalism between 1995 and 2005; but broke down in the face of another oil shock. Rising interest rates caused debt defaults, particularly among American sub-prime borrowers. These defaults, in turn, unravelled the derivative superstructure that the banking and finance sector had built upon them.
The fundamental monetary problem since 2008 is that governments have been operating a system that prevents inflation at a time when we desperately need some inflation in order to inflate away the (value of the) debt. This is why some central banks are now looking at higher government spending being at least part of what will be needed in the aftermath of the emergency.
Even within the current arrangements for creating currency via debt, there is nothing to stop the government from issuing a special long-term “Coronavirus Bond” similar to the bonds used to finance wars. These can be paid off over centuries, as has been the case with the bonds for the Napoleonic and First World Wars; both of which are still being repaid to this day. The government could, though, tear up the existing rule book and print currency out of thin air – in the same way that banks do every day – to finance the recovery. Indeed, there are several benefits to doing so:
- The new currency would be issued without interest attached; removing the need for economic growth to repay the interest
- The new currency could be used to fund socially necessary investment rather than the private whims of the rentier class
- The ensuing inflation would benefit ordinary people (so long as their incomes increased accordingly) – who would see the value of their debts fall – but could not be avoided (as would be the case with taxes) by the billionaires at the top.
So long as government balances the new currency entering the economy with taxes to prevent inflation running out of control, the only potential threat – which for economies like the UK is not really a threat – would be a decline in the value of the currency on international markets. This would make imports more expensive and exports cheaper. In the short-term this would be a problem for countries which – as the pandemic has revealed – are dangerously dependent upon imports. In the longer-term, though, a weaker currency would encourage localisation and greater resilience.
The growth error
Re-localising the economy and making ourselves far more resilient than we were going into the Covid-19 pandemic will be welcomed in many quarters; particularly by those favouring some kind of Green New Deal. After a decade of austerity policies which have failed to deliver growth in the “real” economy, and have destroyed productivity, some form of Keynesian “People’s QE” aimed at kick-starting the economy by investing in a new zero-carbon energy infrastructure would appear to resolve many of the issues revealed by the pandemic. And if the cost of such a new monetary policy is that the gangsters in the Wall Street and City of London casinos are forced to take a haircut by having their wealth inflated away, this is no great hardship.
The mistake with this line of thinking – which the left is as guilty of as the right – is that it regards money as the driver of growth when the true driver is energy. There is more than enough energy in the universe to do almost anything that we can imagine. The problem is that for all of our science, knowledge and understanding, when it comes to energy we have barely progressed beyond knowledge held long before the industrial age. Almost all of the electricity generation behind the supposed project to “electrify the economy” involves boiling water into steam to spin coils of copper around a magnet. While the Romans would not have understood the trick with the magnet – that would have to wait until the eighteenth century – they would have understood the power of steam. And for all of the potential energy in the nucleus of an atom, the best that our brightest contemporary minds have so far achieved is the construction of multi-billion dollar pressure cookers to produce super-heated steam to drive steam turbines that would have been easily understood by engineers in the late nineteenth century.
In the meantime, 86 percent (probably more if the Chinese government honestly reported its carbon emissions) of the economy is powered by fossil fuels; with oil – because of its easy storage and high energy density – providing us with the most important component – driving more than 90 percent of our transportation and heavy machinery.
With a handful of notable exceptions, economists simply fail to grasp the importance of energy. Instead, they rely on the religion of “substitutability” to provide the reassurance that if enough new currency is thrown at a shortage, someone will find an alternative:
In the centuries since the dawn of the industrial revolution, this has appeared to work because we have both substituted high-grade energy sources for lower grade ones and because we have refined technologies to make them more energy-efficient. Trevithick’s 1804 steam locomotive is the same basic technology as Gresley’s Mallard; but the former trundled down the Taff Valley at walking pace (and had to be pulled back by horses) while the latter pulled a passenger train at 125mph. This is “productivity” in action – essentially using technology to convert as much energy as possible into motive power while minimising the amount of waste heat. It comes, however, with diminishing returns. The Pacific Class of steam engines were a government-subsidised vanity project operating at the limits of steam technology. Further refinements could only be achieved at enormous cost while providing no more than a few extra mph off the top speed. With the outbreak of war in 1939, slower but sturdy engines were of more use.
Something similar happened with aviation. Making use of a more energy-dense fuel – oil – powered flight became possible from the early twentieth century. The Wright Flyer plays a similar part to the Trevithick engine, while Concorde provides the state-funded vanity project equivalent to Mallard at the end of the process of diminishing returns. With conventional oil supplies becoming constrained from the 1970s, air speed became less of a priority as commercial airlines pushed for slower but more fuel-efficient engine designs.
The point is that while new fuels – coal then oil – have provided the economy with bursts of growth, the productivity gains which allow humans to efficiently exploit the fuel come with diminishing returns which make further attempts at productivity impractical. Worse still, fossil fuels are a finite resource which humans have extracted on a low hanging fruit basis; exploiting the cheapest and easiest deposits first. The reason we have spent the past decade spending billions of dollars to extract millions of dollars’ worth of oil from bitumen sands and shale deposits is that we have run out of accessible new conventional oil deposits.
While geologists assure us – correctly – that there is more fossil fuel beneath the ground than we have burned since the beginning of the industrial revolution and while economists – incorrectly – proclaim that energy doesn’t matter; the reality is that we are caught in a net energy trap in which we are obliged to spend an increasing volume of the energy available to us to secure new energy with the result that the energy available to the wider economy is bound to shrink:
Worse still, a proportion of the energy which does remain to the wider – non-energy- economy must be spent on maintaining the infrastructure that we have already constructed:
None of the three conventional monetary solutions to the post-pandemic depression – borrow, tax or cut – can work without an abundant supply of accessible energy to back them up, because each is based on the assumption that economic growth can be restarted once the emergency is over. A large part of the coming crisis, though, was already visible in the months before SARS-CoV-2 got loose. Peak oil production – conventional and unconventional occurred in 2018. Growth outside the financial economy has stalled since 2008. Living standards across the developed economies have been declining for half a century. Retail businesses have been collapsing in ever greater numbers. And, of course, productivity – the means by which our debts are supposed to be paid off – is more elusive than a safe coronavirus vaccine.
In financial terms we can borrow and tax to our hearts’ content; but only by inflating away the currency that we borrow into existence. We can also cut in the deranged belief that taking currency off people will somehow encourage them to spend more. But without real growth – which will only return in the highly unlikely event that someone figures out how to unlock the energy potential of the nucleus of atoms – is probably a thing of the past.
This is good for the planet; which is entirely indifferent to the fate of industrial civilisation and to humans as a species. It might prove to be good for the humans who survive; since the things which give meaning and enjoyment to life are seldom the things that currency buys. But for a complex, global industrial economy, it is a disaster. Sooner or later it will become apparent that none of the debt that we have been running up over centuries – still less the currency being thrown at the pandemic – is going to be paid off save by a massive bout of inflation coupled to an equally traumatic fall in asset prices… by which time conventional economics will have been exposed for the fraud it always was.