Consciousness of Sheep
Related Articles
Money creation became a more widespread concern in the weeks and months following the 2008 crash. Prior to that time, almost everyone assumed (when they thought about it at all) that banks operated like building societies or credit unions – profiting from the spread between interest paid by borrowers and (lower) interest paid to savers. It was a view reinforced by mainstream (neoclassical) economics which, on the few occasions anyone stopped to wonder where money came from, dismissed the idea that banks create currency when they make loans. It was this misunderstanding that led economics graduate Ben Dyson to call for radical reform of university economics courses to include perspectives other than the neoclassical, and later to establish the Positive Money campaign group… whose early work included discovering that just 1 in 10 elected members of parliament had the first idea where money comes from (given the current IQ-challenged intake, it is highly likely that even this number will have fallen).
Understanding the way that banks create new currency when they make loans led to new revelations about the way the banks had used securitisation and unregulated insurance to inflate an unsustainable debt bubble beneath the noses of the central banks and government departments which were supposed to regulate them. Far from being a crisis “caused” by sub-prime borrowers; the real crisis was caused by profligate banks creaming off the top of their unsustainable lending… the sub-prime defaults were merely the trigger for the implosion of the banking system.
The painful – but politically stable – solution for the long term – letting the banks go bust, nationalising their assets, and then using governments’ ability to create currency to recapitalise them – was never tried. Instead, governments took on the banks’ debts – ironically, borrowing the funds to do so from the same banks… which is why the next round of the crisis will involve sovereign debt. The political ramifications were huge. By bailing out the banks, governments ensured that ordinary people would get poorer even as those in the banking and financial sector and those holding asset wealth would get even wealthier. Whatever other factors may have been involved, without this remorseless growth of inequality – and especially growing poverty in the bottom half of the income distribution – the upheavals of Brexit, the rise of European nationalist-populism, and the growth of the US MAGA movement would have been far less likely.
Even more disruptive though, has been the arrival of the BRICS bloc, and its gradual development of an alternative to the Eurodollar system of trade and exchange. In the event that the US dollar ceased being the world’s reserve currency, living standards across the western states would plummet to depths that would make current austerity measures seem trivial. This, it seems, is the driver behind the new Trump administration to cut debt-based government spending to what was previously thought to be an impossible extent. Meanwhile, the proposed audit of the gold reserves at Fort Knox may be part of the global realignment which now seems to be gathering pace… with the USA being obliged to back at least some of its treasury debt with gold.
There is an air of inevitability to all this. We knew that the bank bailouts, quantitative easing, and zero percent real interest rates could only ever be a temporary fix while clever people somewhere else figured out how to row back the debt… even before Brexit, Covid, and the self-harming sanctions on Russia. But nobody seemed able to find a way out which didn’t involve a hard default or the soft default of inflation… and when inflation did put in an appearance, nobody was prepared to let it destroy the value of the outstanding debt.
The UK is leading the charge into the next crisis in this respect. Its economy is going backward, with only the import of new people giving the appearance of a stable debt to GDP ratio. At the same time, its tax take is the highest since World War Two. But despite this, the need to continue securing foreign investment has forced the government into austerity cuts which further undermine the prospect of economic growth… even as the school children on the government benches assure us that aliens will arrive any moment now to build millions of houses, AI databases, wind farms and new airport runways. In short, the living standards of the poor and not-so-poor must be sacrificed to help the wealthy get even wealthier.
Little wonder then, that some on the liberal left have looked for alternative economic perspectives to offer solutions which might reverse the inequality gap. And the alternative which appears most often is a combination of Keynesian monetary stimulus using new currency created directly by the government itself… that is, Modern Monetary Theory (MMT).
One reason why MMT has such a hold is that governments – or at least the central banks – created new currency via quantitative easing. And despite pearl-clutching on the part of right-leaning economists, this was done without the anticipated rise in inflation. More importantly, so the proponents of MMT argue, a sovereign government – that is, a government with the power to create its own currency cannot be bankrupted. Even if, as happened with Kwasi Kwarteng’s ill-fated budget three years ago, foreign investors balk at buying more government bonds, the government can simply print and spend however much currency it needs. The trade-off being that the rate of tax has to be set high enough that it prevents the new currency driving inflation.
At a time when economies across the west are stagnating, and governments have no clue how to make economic growth return, dispensing with the current practice of borrowing currency into existence in favour of simply “printing” new currency (and spending it on things which reduce inequality – and thus political instability) is likely to become more popular with the masses and with at least some political parties and factions. There is though, a fundamental flaw in the MMT proposition that a sovereign state cannot be bankrupted. Actually, not only can a sovereign state go bust, but it has already happened… and to a modern state not so far from home.
*****
The date is 22 August 1940. The Luftwaffe has been pummelling British airfields and radar stations for more than a week. Although, thankfully, the current spell of low cloud and intermittent rain has dampened German activity to little more than a handful of solo raids and reconnaissance flights. Nevertheless, one of the least known, but most far-reaching events of World War Two is taking place in the Cabinet room at 10 Downing Street. As Clive Ponting writes:
“The agenda for that day was not crowded but it illustrates the multitude of problems facing the war cabinet in the summer of 1940. The minor items were a report on the previous day’s air battles, which had been no more than raids by individual aircraft; a report from Yugoslavia of a possible Italian attack from Libya into Egypt and another discounting rumours of a similar attack on Greece. Instructions for the Governor of Singapore about the action to be taken to intern Japanese civilians in the event of hostilities or warlike action by Japan were agreed, as was the text of a message from Churchill to President Roosevelt about the exchange of old United States destroyers for bases in British colonies in the western hemisphere. They even found time to discuss the setting up of ‘hospitality committees’ by MPs for the armed forces of the various governments-in-exile now in Britain.
“But the main item on the agenda was a Most Secret seven-page paper circulated the day before… entitled ‘Gold and Exchange Resources.’ The number of copies was highly restricted and even the ministers present had to surrender their papers before leaving the meeting. It was perhaps the most sombre and devastating paper ever taken by a British cabinet; it forecast Britain’s imminent financial collapse and inability to continue the war.”
The UK’s gold, dollar and other liquid assets had fallen from £775 million at the beginning of 1940 to just £490 million at the beginning of August. Even if the government “borrowed” the gold of the governments-in-exile and pilfered the Vichy French gold held in Canada, this would only tide them through to the end of the year. The cabinet considered – but rejected – commandeering all gold held privately, including jewellery and wedding rings. But this would only add some £20 million… Churchill suggested doing it as a last resort as a propaganda exercise to shame the Americans into providing support. Other ministers proposed increasing British orders for American equipment and munitions, arguing that this would force the US government to underwrite the orders rather than see American companies go bust.
In the end, no conclusion was reached – because no option was palatable – and the UK government agreed to continue lobbying the US government in the hope that aid would arrive before the UK was bankrupt. Adding to the problem though, was that Roosevelt was up for election in November 1940, and was pledging not to get involved in European affairs – a position reflected in the Neutrality Acts which were themselves designed to prevent a repeat of Britain’s default on its First World War debts in 1934. In short, if Wendell Willkie won in November, the UK would be bankrupt before he took office on 20 January 1941. But even if Roosevelt won, the best the UK could hope for was some hard negotiations if it was to avoid making peace with Germany.
What followed was far worse than mere hard negotiations. Following Roosevelt’s victory, Britain’s ambassador in Washington told reporters: “well boys, Britain’s broke; it’s your money we want.” – a remark that got him fired for his trouble. But it is one thing to say you are broke, it’s another thing to convince the liquidators. And Britain faced one of the most hard-headed liquidators of them all in the shape of US Treasury Secretary Henry Morgenthau Jnr – a man who had become decidedly Anglophobic as a result of his painful attempts to negotiate trade terms between the USA and a protectionist British Empire in the 1930s. Morgenthau insisted that Britain prove that it was bankrupt before a single cent of lend-lease aid could be approved. As Peter Hitchens explains:
“It was a kind of means test. Before Britain could become what it has been ever since – the USA’s pensioner – we had to prove that we had nothing left to sell, no precious jewels sewn into our national underwear, no gold under the national mattress. It was during this period that Britain was stripped almost completely naked by the ‘cash and carry’ system under which we were allowed to buy war supplies, for hard cash only, from the USA before the later introduction of ‘Lend-Lease’…
“Morgenthau told the sceptical senators, who were unconvinced that Britain had really sold all its assets, that of course Britain had resources all over the world. But it could not turn them into dollars, so they were of no use in buying weapons. ‘I am convinced,’ he assured the suspicious old gentlemen, that ‘they have no dollar assets beyond those they have disclosed to me. Lacking a formula by which Great Britain can continue to buy supplies here, I think they will just have to stop fighting, that’s all.”
One reason why you probably don’t know that the UK was bankrupt in all but name in 1940, is that it doesn’t fit with the post war narrative about the special relationship between democracies determined to destroy the Nazi beast. But in 1940, Americans tended to view the UK more as a monarchical empire than a democracy. Moreover, having been dragged into the First World War, few wanted to repeat the process. And that was bad news for a British government presiding over a war economy which, as Ponting explains:
“… was incapable of producing the range and quality of armaments required to win the war. Even those items which could be manufactured domestically were heavily dependent on imports of raw materials and products such as steel. Most of these imports came from the United States and had to be paid for either in gold or in dollars.”
If Modern Monetary Theory was correct, the British government should have been able to use its sovereign right to print new currency to pay for the armaments it needed. But, of course, this is the flaw in MMT… you cannot print someone else’s currency. The UK government could – and did – print pounds to pay for entirely domestic transactions. But it could print neither the dollars nor the gold needed to keep it in the war. Indeed, given the American insistence upon post-war decolonisation as part of the terms of lend-lease, the real surprise is that the UK government didn’t negotiate a peace with Germany in the spring of 1941 (before the invasion of the Soviet Union, a year before the Wannsee conference, and with no likelihood of the Americans being drawn into the war).
*****
You might argue that events in 1940 were so extreme that they could not compare to a peacetime economy. But in the event of the kind of sovereign debt crisis some believe is coming, we could see a freezing of international lending in the same way we saw interbank lending collapse in 2008. It is also worth considering that in 1940, the British still had an advanced industrial base along with the raw resources of an empire which spanned a quarter of the world’s landmass. It also had a small enough population that, with rationing of foreign foods, could be fed by British farms and fisheries. That this didn’t prevent Britain going bust should be a warning for those considering MMT today. This is not to suggest that some currency creation for entirely domestic purposes might not be a useful corrective from the current stifling austerity and tax. But merely to point out that contemporary Britain no longer has that industrial base or that massive empire to draw upon. And somewhere between 70 and 75 percent of Britain’s economic activity today depends upon imports which have to be paid for in other people’s currencies… especially US dollars.
In this, at least, we see some similarities with 1940. Print too much new currency, and the government will devalue the pound, making it a little easier for UK companies to export but at the cost of rising prices of imports. At the same time, a weakened pound may deter the foreign investment that is essential for paying for those imports – which include a growing proportion of our food and energy. On the other hand, using high interest rates, austerity cuts and higher taxes to maintain the attractiveness of government debt to foreign investors risks stagflation which, ultimately, will deter foreign investment anyway. Nor does the option of rejoining the EU or the customs union make much difference because Europe – and Germany in particular – has got itself into a similar mess for much the same reasons.
Only if the UK is prepared to engage in a massive programme of import substitution coupled with severe austerity measures when it comes to those things that cannot be substituted, could a UK government adopt MMT on anything more than the fringes. And even then, the political backlash against those measures would sound the death knell for any government which embarked upon them. In short, like net zero and kinky sex, MMT is best when you don’t try it for real.
As you made it to the end…
you might consider supporting The Consciousness of Sheep. There are seven ways in which you could help me continue my work. First – and easiest by far – please share and like this article on social media. Second follow my page on Facebook. Third follow my channel on YouTube. Fourth, sign up for my monthly e-mail digest to ensure you do not miss my posts, and to stay up to date with news about Energy, Environment and Economy more broadly. Fifth, if you enjoy reading my work and feel able, please leave a tip. Sixth, buy one or more of my publications. Seventh, support me on Patreon.
