The protests and public demonstrations which have engulfed many of Europe’s largest cities over the past month are a reminder that the fallout from the 2008 financial crisis never subsided. The banks may have been bailed out, and the global economy may not have entirely collapsed, but the political dynamics embodied in Western governments’ responses to the crisis endure in our current discourse on sovereign debt.
As citizens grow worried and frustrated at their economic precarity, governments are being pressured to give in to global financial markets and substantially cut public spending to balance their budgets. In a repeat of the anti-austerity debates of the 2010s, centrist governments argue that ‘tough choices’ must be made to prevent public debt from spiralling out of control. Tough choices which, almost invariably, fell and will fall on the most vulnerable in society.
Progressives, of course, offer a different solution to this seemingly intractable problem. This involves, generally, greater economic redistribution for the poorest in society via levying taxation on the wealthiest. In a similar vein, powerful corporations have also been the subjects of scrutiny by progressive politicians looking to meet their debt-to-GDP targets. In his Autumn budget, Chancellor John Healy timidly raised the surcharge on Bank profits by 3% for less than 2 years to offset his spending to reduce household energy costs.
All of these debates are extremely complicated and involve a headache-inducing level of mathematical detail which seems excessive for the often pitiful sums up for grabs. Even worse than the tediousness of this budgetary obsession, however, is its pointlessness.
I use the word pointless neither because the government’s spending decisions are pointless, they are obviously not, nor because I think bond investors’ reactions to these decisions are inconsequential, they are obviously not. I call the recurring debate surrounding where the government will get the money to fund itself pointless because it is based on faulty premises which prevent it from evolving into something more constructive. The premise I am referring to is the idea that money operates like a commodity, that it must be sourced much like bullion from another part of the economy, and that its value, and hence inflation, is subject to the laws of supply and demand. These premises are at best incomplete and at worst completely false.
The Bank of England explains it plainly: “In the modern economy, most money takes the form of bank deposits. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money”. Money is therefore not a commodity that must be taken from somewhere before it can be spent on something else, since it is created by the magic of double-entry bookkeeping.
Conversely, when a debt is paid, money is taken out of the economy just as credit brought it into being. Indeed, if everyone paid off all their debts, the entire economy would immediately collapse since approximately 97% of money in developed economies is created through the process of issuing loans. To say that a government needs to balance its books, therefore, is to say it must take money out of the economy which could have been in a productive capacity.
On the second issue of inflation, the idea that the value of money is subject to the laws of supply and demand is centuries old. However, this fundamental claim was most recently and most influentially espoused by the monetarist school of economics developed by Milton Friedman. The value of money, the monetarists claim, “is always and everywhere a monetary phenomenon” caused by the money supply growing faster than the output of goods and services in the economy. Simply put, as the supply of money overtakes the level of production of goods and services, simple supply and demand will cause the prices of these goods and services to increase, thus reducing the purchasing power of money.
While plausible, Friedman’s theory of inflation has repeatedly been proven wrong. Take the NICE years, for example, or the period of non-inflationary constant expansion in the decade spanning the late 1990s to the mid-2000s. During this period, the money supply grew as banks gave out loans to finance expanding production and, as a result of this expansion, inflation was consistently low. After 2008, the inverse was true, where central banks digitally created billions of interest-yielding central bank reserves to prop up the commercial banking sector but failed to energise economic activity or boost inflation. Inflation is therefore a product not only of the quantity of money in the economy, but where it is being used and by whom. It is no coincidence, given the spending proclivities of the financial sector, that the legacy of Quantitative Easing in Britain has been to inflate asset prices while the real economy stagnates.
The debates around fiscal sustainability in the UK and abroad are severely hampered by adherence to these beliefs about the nature of both money and inflation. Successive governments hold onto the belief that they must tax before they can spend despite the fact that commercial banks, and indeed central banks, have been creating money out of thin air for decades. Simultaneously, governments are repeatedly told that they must not spend too much or risk setting off an inflationary spike, a prospect that may worry bond investors and trigger a costly sell-off.
Both these axioms, as I demonstrated above, are ill-conceived and prevent political debate from evolving into a conversation about who has the power to determine the actions of government, whose money benefits in a neoliberal financialised economy, and whether structural change is required to avoid a vicious cycle of economic stagnation and state paralysis. Most fundamentally, they obscure the political dynamics of policy debates by presenting them as objective and technical economic dilemmas.
It is imperative that we scrutinise these assumptions or risk missing the bigger picture at a time when the challenges faced by governments across the world require thinking outside the box in order to be solved. Before we move past them, however, we will all be condemned to watch as nothing changes and everything gets worse.
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