Thursday, 24 June 2010

What if modern government is unaffordable?

Heaven knows, I’m not a deficit hawk – though I have Victorian Liberal’s horror of waste, especially wasteful public expenditure that is destructive: encouragement for buying cars, subsidised air travel or supermarkets, accountants employed by NHS trusts to code each treatment or to challenge each coding for each PCT.

But I have begun to get depressed by the rhetoric of the cuts debate. Has any modern economy actually managed to balanced their budget? Do we actually need to be in deficit just to operate these days? Isn’t it time we had a proper discussion about how, in practice, we can run a civilised nation when we can apparently no longer afford it.

Of course, there are still conversations to be had about why we allow our corporations to avoid paying their share – it may be that up to a third of the world’s money is now hidden offshore. But what if modern IT makes it impossible to collect now? What if we fail?

I have struggled for years about what I thought about future policy on money creation. There are radical voices – which rarely if ever reach the mainstream – which suggest that banks should now be prevented from creating money, as they currently do, because of the corrosive effect of the interest which they demand back on 97 per cent of the money in circulation.

I don’t believe this is practical or desirable. But the National Debt is a different matter. Why should a modern nation state have to pay £80,000 a minute, as the UK currently does, on interest – when it can create that money itself free of interest?

This is the stuff of heresy of course, but what is the argument against creating it rather than borrowing it? It is that governments cannot stop themselves from borrowing too much, and that is bound to create inflation. It will not create inflation in itself, any more than allowing commercial banks to create the money will do so. It is the failure of government control that we need to beware of.

So is it really beyond our skills to devise a branch of the independent monetary committee of the Bank of England that can decide each month – as they have been doing with quantitative easing – how much they can safely create?

At least this should be part of modern debate. Because it is quite possible that civilised government, that heals and educates, may become impossible without it.


NomadUK said...

One is led to the uncomfortable conclusion that failure to maintain civilised government is, precisely, what those in charge currently would like.

Adam Bell said...

Printing money inevitably leads to inflation. This is because public sector demand will rise without a commensurate increase in supply from the private sector, which will allow them to raise their prices. Supply will inevitably begin to rise to meet this new demand, but to maintain the new level of public services reached following the printing of money when prices begin to rise, the Government will need to print more money. It becomes a vicious cycle.

Davidboyle said...

I don't think you're right, Adam. It isn't the business of creating money that leads to inflation - whether it is done by the government or the banks - the problem is when you create too much of it. That's why governments, even our government, will do so if there isn't enough money in circulation. There is a tendency for governments to print too much, of course, but that may not be the end of the discussion. All I'm suggesting is that, if modern government is unaffordable, then we may have to find ways of doing exactly this in a controlled way.

Niklas said...

Actually, Adam Bell is pretty much right, although as you say some money creation happens naturally without causing runaway inflation.

An important point is that the "money" created by the central bank and commercial bank is different. The central bank creates "high-powered money", i.e. cash (banknotes and bank reserves). Commercial banks increase the supply of "broad money" by lending. Broad money is not liquid, whereas high-powered money is (just consider how much difficulty banks had trying to sell their duff loans and bonds in the crisis; everyone wanted cash).

The high-powered money that the central bank creates is "multiplied" through the banking system to cause a bigger increase in the supply of broad money. So for the Bank of England to effectively lend £1 billion to the government by printing money to buy a government bond is NOT the same as HSBC lending £1 billion to a big British company (for example).

Historically when governments have relied on "monetising" their debt (i.e. getting the central bank to print money to buy it) rather than selling bonds to savers the result has always been runaway inflation. (Weimar Germany is a case in point - the hyperinflation was only stopped when the government slashed spending to get rid of the budget deficit and created a new central bank that was forbidden by law from lending to the government.)

Also, while printing money gives the government seignorage (or an "inflation tax"), the revenues from this "tax" depend on how much cash people hold. If the government prints money people will want to hold less of it because they fear inflation, so soon the government finds itself printing ever more money but raising ever less seignorage.

Apologies for the length of this post, but this particular question has been gone into in quite some length!

Niklas said...

P.S. There are a number of countries that have a sustainable budget deficit or have even been running surpluses despite having higher public spending than the UK, for example Sweden and Denmark.

I suspect the difference is that in the UK we have had two long periods of government by parties that wanted to pretend that we could get something for nothing: Thatcher slashed taxes using the dubious logic of the Laffer curve in the hope that faster economic growth caused by lower taxes would lead to higher tax revenues; Blair and Brown used creative accounting (e.g. PFI and shuffling the debts of National Rail off the national balance sheet) and excessive borrowing to fund a spending splurge while pretending that we could spend like Scandinavians while enjoying Maggie Thatcher's tax rates.

In both Denmark and Sweden earlier fiscal crises (1980s and early 1990s respectively) forced politicians to tax and spend responsibly, and people are honest enough to understand that if they want higher spending they will have to vote for higher taxes to fund it.

Davidboyle said...

Niklas, I think you are absolutely right - but not so sure about the distinction between money created by governments and money created by banks, both of which seem to me to have equal potential for inflation. Money created by banks gets re-circulated no less than money created by governments. It is also created with interest on top, which also has to be extracted from the economy to pay the banks, which is bound to be inflationary. The distinction, as I said, is in the discipline that borrowing the money from the banks can give governments.