Describing the Spending Cycle

It's always important to remember that the economy is a cycle like the carbon cycle, or the water cycle. Everything moves in a circle. Spending becomes income, income becomes spending.

You can start a description of the water cycle with rainfall if you wish. And it is very useful since you can show the water coming out of the clouds into rivers and rushing down to the sea. That is after all the functional part and reflects our personal experience.  We notice the rain first (and if you're British you then talk about it endlessly).

However a moment's reflection reveals an important question: how did the water get into the air in the first place? Then you realise that although the 'rainfall first' model reflects our experience of the system, the more accurate starting place in the cycle is evaporation since without that there can be no water in the air. That switch of viewpoint then leads you to realise that evaporation happens throughout the cycle due to the action of the Sun, and suddenly you have a new insight into the system.

So the system didn't change, and the 'rainfall first' description is correct as far as it goes. But by switching your focus to 'evaporation' you describe the system from a different viewpoint - which lead to a new insight that was clouded (sorry!) by the original position.

So it is the same with government expenditure in a nation. You could start with borrowing, follow it through spending and onto taxation. Then you would start using terms like 'debt' and 'deficit' and worry about whether tax levels are high enough because the numbers don't add up.

Yet if you are in a nation with a free floating exchange rate and its own non-convertible currency a moment's reflection would reveal two questions.

Firstly since the government is borrowing in its own currency, how did that currency end up in somebody else's hands so it can be borrowed?

Secondly why is the government issuing 'corporate bonds' to borrow rather than just going to its bank and asking for a loan like everybody else does?

To answer these questions simply requires that you start your description further around the spending cycle. For currency to get into the private sector the government has to spend it first. Where does that come from? A loan from the government's bank - the central bank.

So the government has a rolling loan facility at the central bank. The central bank extends the loan when requested and creates the corresponding deposit and because it is the central bank for a non-convertible sovereign currency that deposit is currency. (The central bank doesn't have to fund that loan with gold or anything else). The government then spends - hopefully on something counter-cyclical and/or advancing public purpose. The spending bounces around creating transactions and taxation. The taxation comes back to the government and reduces the size of its loan.

And fiscally that is the end of the matter. That is the cycle. Nothing else is required. The government is obviously good for the loan because, well, its the government.

However the government also decides as a matter of policy to offer higher rates of interest to long term savers in its currency. It then has an office of government issue savings deposit bonds to holders of currency who want to save. The currency retrieved from this operation reduces the government's loan at the central bank. In this way the government 'borrows' back the currency it originally spent.

It's the same system, and again the 'borrowing' description is one viewpoint. However a different viewpoint focusing on the spending first leads to fresh insights into the system and a whole load of new policy possibilities.

And once you see it, the clouds part.

Taxpayers Money - myth and reality

Just discovered this post on Taxpayer's Money over at labour list of all places.

Surely the Chartalist ideas have got to go viral soon.

How the government's super-platinum credit card works.

Image: Michelle Meiklejohn / FreeDigitalPhotos.net

Modern Monetary Economics shows us that monetarily sovereign governments (like the US, UK and Japan) are able to spend money before they receive any tax. That's what puts the 'fiat' in fiat currency, but it appears at first glance to be counter intuitive. How can that be?

If you think about it most of us come into contact with this concept every day - its called a credit card. So if you imagine that a government does all its spending on its credit card, then you'll have the structure about right.

There are differences though. A monetarily sovereign government is able to get the best credit card deal in the world. It is a super-platinum credit card with the following benefits:

It has no spending limit

Certain individuals can get 'no pre-set spending limit' cards, so its hardly surprising a sovereign government with full tax raising powers and it own currency can get one (unlike the Greeks who have a spending limit set by Brussels).

It can repay itself

The government issues its own credit card (unlike the Irish, who effectively have a German one) so it can settle the credit card bill and any interest charges with the same credit card. If you had the ability to settle your credit card bill with a credit card you'd never have to fund it with anything real either.

It has the best cashback deal in existence

The key benefit though is the cashback system. You might get a measly percentage when you spend money at Tesco, but when the government spends at Tesco not only does it get a percentage, but when Tesco pays its staff the government gets another percentage, and then when the staff buy beer at the pub the government takes another chunk. And so on until the initial government spending turns entirely into cashback.

For the government it is a cracking cashback deal - for every £100 it spends, it always gets £100 back in cashback. For everybody else it is known as taxation and besides death it is the only certainty in life.

So with this in place the only time they will run a balance on the credit card would be if people out there haven't spent everything they've earned. In other words a balance on the credit card is caused by people saving.

That balance on the credit card would then be known as the 'national debt' and the change in the balance as the 'deficit'. But the cause is still the same - people saving.

If only I had one of those...

Now just think what you could do if you had one of these cards:

• you could spend as much as you like anywhere where the card is accepted.
• you'd never have to fund your spending.
• you'd never worry about the balance because you don't have to pay it off, it doesn't affect your credit limit and you know you'll get the cashback to cover it anyway when people spend their savings.

So what's the catch?

"the possession of great power necessarily implies great responsibility"
(Spiderman fans may prefer this of course. No it's not me doing the acting - I have a doppelgänger)

Although you can never run out of money on your super-platinum credit card, you can run out of real things to buy. So you have to make sure you use the money wisely in a manner that encourages to production of real stuff. That way there is more for you to buy.

If nobody tends your garden, then hire somebody without a job to do that for you. It doesn't cost you anything - you have a super-platinum card - but it gives somebody without one the means to support their family.

You might trim back the cashback percentage a little. It doesn't cost you anything - as long as the rate is positive you'll get all your spending back eventually and you have unlimited balances anyway. But it does put money into the pocket of people and allows them to buy more real stuff for their family and perhaps keep paying the mortgage or rent.

You might pay for the upkeep of universities and training colleges. It doesn't cost you anything - the colleges already exist and keeping them up gives people without work jobs. You might also fund students to go there. It doesn't cost you anything, and those students will be able to use their greater skills in the future to generate more real output for you to buy.

You might decide to create a high speed rail link across the country. Again it doesn't cost you anything - you have a super-platinum card - and engineers short of work like nothing better than a big project to get their teeth into. And that infrastructure would last a century or more - bringing great benefits to all (and not an insignificant amount of accolade to those who created them).

Or you might be really bold and fund everybody who makes a contribution to society so that they can do that work yet still live free from poverty. You can encourage the use of more machines to produce real output more cheaply with less labour so that a reasonable standard of living is provided for all by right - without the current problem of the job losses causing a collapse in income and a recession. That might sound a bit Star Trek, but without an evolution along those lines we'll end up over-consuming the planet.

But I haven't got one of these cards

No you don't, but your government has one, or certainly could obtain one. You might like to ask them "what's in their wallet" and why they're not using their plastic more effectively.