Highlighting news stories important to the Civic Republican
particularly those that are overlooked or little covered in the main media.
Peter Kellow, DRP Leader, writes
It has been a while since the last newsletter. This is partly due to the lull in politics following the General Election, partly due to my lecture trip to Moscow (not on politics) and partly due to my moving house – a major commitment and disruption. I am now almost back to normal
With the Labour leadership contest drawing to a close and the summer recess over, domestic politics at least will get more interesting, particularly if Jeremy Corbyn wins. His success is surely due to his lack of moulding by the media or of makeovers designed to drain conviction and personality which the other contestants are subject to. Politics watchers will be thankful to see him elected. Things will get more fun.
As for him being unelectable, I am not so sure. However, I am certain none of the other three clowns would get in.
Corbyn’s plan for people’s QE caught my eye. A lot of rubbish has been written about this and so I decided to put the record straight in a newsletter. It is a bit long but it is the real deal.
The ideas are contained in my book that is work in progress called
Political Economics: The History, Theory and Future of Progressive Capitalism
As leader of the DRP, I have been invited to appear on Sky TV News next Wednesday to discuss whether the monarchy has any relevance to the 21st century. So I will go to the Studio in central London for a 10 minute live discussion.
Broadcasters and journalists have a habit of being leaned on when they go near the subject of the monarchy’s existence, so don’t hold your breath.
On the face of it QE for the people might sound like an entirely reasonable and good idea. We had QE for the banks when the Bank of England created money out of thin air to buy government bonds held by banks. The theory was with the banks then sitting on more liquid cash they would release this to businesses to enable them to finance investment. This in turn would create growth in the economy and so benefit all. As we know the reality has been that the extra money the banks have had they have used to lend on assets, property, shares and bonds. The stock of these has not increased proportionately and so the effect has been to increase the price tag on the existing assets. You see this tangibly in the prices of houses in your area, in the low yield on bonds making your pension pot less valuable, soaring rents and an overpriced stock market.
So QE for the banks has benefited asset prices and little else. So why not have the Bank of England create money in the same way but instead of buying government bonds, use the money to stimulate the economy directly. This could be done by expanding public services, making cheap loans available to businesses or quite simply by giving the money to people. This latter aim could be achieved by scattering ten pound notes in all the streets or more tidily by say increasing pensions or reducing taxes. The effect would be very similar.
I want to explain why QE of both types are a bad idea. To be sure QE for the people is preferable and would achieve the stated aim for both type of QE – of stimulating the economy. Creating additional money in the economy should be a necessary part of the management of a healthy economy, but it has to be part of an orderly process and it has to go with certain other reforms to the way we run the country’s economy. And it has to be backed up by some real understanding of how money works. The theory has to be spot on.
The economic orthodoxy under which we live has no idea of how money works. It is under the spell of the so-called ‘quantity theory of money’ which is centuries old. Like most – yes, most – pieces of orthodox theory it does not work in theory and does not work in practice. This double refutation does nothing to shake the faith of economists and economic journalists in the fairy story.
The quantity theory of money tells us that if there is more money in the economy this will result in ‘more money chasing the same number of goods’ leading to a rise in prices – inflation. In fact, the theory is quite correct in respect of one part of the economy – the operation of asset prices –although ironically the orthodoxy does not apply it there. The problem is that it is applied to only consumer goods, what we buy in the shops. The reason why there is this difference is that for the consumer good economy the speed of circulation of money is highly flexible. If there is more money around, it will do less work, that is each unit will be used for fewer transactions – or as economists say the ‘velocity of money’ slows. This has no effect on prices for these are determined by a whole load of other factors – wages, commodity prices and above all competition between suppliers. A stimulated economy can bring more entrants into any sector and so more competition. Also economies of scale occur and so prices fall again. There is absolutely no correlation between more money being available and rising prices. If anything the converse holds.
However, let us come back to asset prices. Asset prices will rise if too much money is created for the needs of the consumer economy. The money has nowhere else to go. The effect of this is to create more inequality between those who own assets and those who do not making the jump from being one of the latter to one of the former more and more difficult. This has been the deliberate strategy of the Tory government and it works for them as they create a hard core of support amongst the asset owners. (Incidentally it was because of this understanding I was able to correctly predict a Tory victory in the 2015 election.)
So why cannot asset prices be held in check by an adjustment to the velocity of money as we saw was the case with consumer prices. The reason is simple and obvious. The big difference between an asset and a consumer good is that once it comes into existence it, in general, does not go away. Yes, properties can be destroyed, shares can be wiped out, but overall the stock of traditional assets is relatively fixed in comparison with consumer goods which by their nature are disposable. The stock of assets has a huge inertia. Yes, we can build more houses, we can create more businesses with share value, but this is a slow process and so an increase in money manifests itself in an increase in asset prices. You have seen this in practice since the 2008 crash where massive money creation with QE has resulted in massive inflation in asset prices but something close to deflation in consumer prices.
This has had orthodox economists scratching their head as to why their precious theory is not working. How many times have I heard Evan Davis on Newsnight refer to the ‘dog that does not bark’? He just cannot understand why the quantitative theory of money is not working. Of course, this does not lead him to admitting it is wrong – there must be other factors at work.
The bank QE we have had to date has given the extra spending power to banks. So what happens with the people’s QE where extra spending power is given to consumers. The orthodox economists are horrified – they see hyperinflation around the corner. The example of Robert Mugabi’s Zimbabwe is cited endlessly – as if the Zimbabwean economy and the British economy are in any sense comparable.
As I have shown the increase in money introduced directly into the consumer economy will not in itself produce consumer inflation. But this does not mean we can supercharge spending by consumers willy-nilly without reference to other factors. Although the velocity of money is subject to huge swings it is not infinitely variable. If there is too much money in the consumer economy people will increase their savings. If there is way too much then people will become very rich. But what is wrong with that?
If people accumulate excessive amounts in their savings then asset prices will go up – because there is nowhere else for the money to go. Note there is no reason for consumer prices to go up. If anything they may go down for the following reason. As I remarked when asset prices go up excessively, as is now happening, society becomes more unequal and so those without assets will be more vulnerable and will consequently be forced to accept less wages. This is the evil associated with rising asset prices. And, as I have shown, rising asset prices result from excess money in the economy.
So the people’s QE, if excessive, will, like the banks’ QE, result in excessive asset prices – prices that bear no relation to the operation of the real economy. The difference will be that the owners of those assets may be more widespread than asset prices resulting from bank QE. That may be considered preferable, but it is not desirable in itself – and it would play nicely to the Tory election strategy. People’s QE would work initially in the way intended but it is not a long term solution. This is not the way to run an economy.
In fact, the whole idea of QE in general is wrong. To understand why we have to look at how government finances work and how the Bank of England works and at the relation between the two.
The government, as we have it, is run essentially like a private corporation. It trades like a private corporation with income (in the government’s case almost all taxation, now there are no longer profits from state enterprises as there were before Thatcher) and expenditure (public services, including the military, subsidies and the running of government in general). The source of income and the type of expenditure may be unique to the government but in terms of accounting there is no difference from a private company. It has a profit and loss account and a balance sheet just like a private company. It generally makes a loss on its ‘trading’ year to year, ‘government deficit’, and so it correspondingly shows a debt on its balance sheet, the so-called ‘national debt’.
The debt it covers, in exactly the same way as a private company – by borrowing. A private company can borrow in two ways, one, by getting a bank loan and, two, (if it is big enough) by issuing bonds, ‘corporate bonds’. Likewise the government can run up an overdraft with its banker, the Bank of England, but the vast majority of its debt is covered by the issuing of bonds. In effect, as regards its finances, we see our government as an independent private corporation. There really is no difference. Sometimes people talk about the government printing money as if it had control of the money but this is a misunderstanding. The government prints bonds, IOUs, which it then has to sell on the private open market. A private company can print bonds, which in exactly the same way, it has to sell on the open market.
So in principle we can say that the government’s activities do not affect the money supply for it does not create money. So who does increase the money supply? Remember we are talking here pre-QE. Monetary reformers like Ellen Brown or Positive Money, will tell you it all comes from one source - the private banks creating money which they loan out. This view comes with the corollary that if all the loans were paid off there would be no money left in the economy, except notes and coins (which are a very small percentage of the whole) and everything would come to as standstill. This view ignores the fact that people have savings and not all the savings are used for lending. Some savings just sit there. Without going into the technicalities of it, these inactive savings correspond to what are called ‘central bank reserves’ which are massive. Effectively these saving backed by central bank reserves constitute money in the same way as notes and coins do. So if all loans were hypothetically paid off there would still be a lot of money around to keep the economy moving to an extent.
In a successful economy, people accumulate savings and so the money supply grows regardless of how much banks are lending. Now here is the rub. If there is an oversupply of money in the economy, as I have said, this goes into asset price increases - and savings are assets. So, quite simply, the excess money ends up in people’s bank accounts. They may just keep it, as money sitting there, and in a properly run economy that would not be bad for them as interest rates would be at a reasonable level. Or they might buy government bonds. They won’t do that directly probably but by putting money into a pension fund the pension operator will do it for them, for that is where most of pension money is placed.
Now with the invention of QE back in the 1990s a third form of money creation arrived. In this case the central bank simply prints the money and spends it. Here is it legitimate to talk of ‘printing money’ which as we saw the government never does. The government is run as a private company and private companies do not print money. The Bank of England has always printed money in a sense as it has had to respond to private bank lending and to increase in savings. Both of these have to be represented on the central bank’s balance sheets. What is different about QE is that the bank is not creating money due to a demand in the economy but creating it out of its own initiative. Well, we can argue about whether it decided to do QE itself or by instruction from the government. The reality we know is that the bank is not and has never been independent. The government of the day takes the decisions.
The QE money until now has only been used, at least in Britain, to buy government bonds held by private banks. This keeps the central bank’s balance sheet tidy for it has an asset (the bonds) to balance the money created. It means that the bank collects the interest paid out annually by the issuer of the bond, in this case the government and so we have the rather absurd spectacle of the government passing money to the Bank of England. It is rumoured that these interest payments are not always truly made and so if this is the case the bank has created the money to finance government expenditure – a situation that horrifies the orthodox economists.
So how would people’s QE work? Here the Bank of England would create the money and give it away for whatever causes the government decided on. The money could not be considered as loans to be repaid with interest for then the central bank would be doing the job of the private banks, in competition with them. No one is advocating that, and so people’s QE would create a debt on the banks balance sheet that would never be repaid. From the point of accounting the whole thing is very messy and it is difficult to see where the controls and checks on the operation would come in. Positive Money advocates people’s QE and puts all its faith in an ‘independent’ committee to regulate the thing. The problem is these committees are never independent. They can only work if they are given a very limited job to do and not one that involves crystal ball gazing and highly political judgments.
So what should be done? There is something in the idea of people’s QE that seems attractive and that is the idea of creating money to help people and stimulate entrepreneurs. The problem is no form of QE represents the right approach. If the experiment of people’s QE were tried it would have to overcome the actions of many in positions of strength who would want to sabotage it, which, because the idea is basically flawed, would not be difficult. The guns would be out for Jeremy Corbyn if he was the implementer, and it is not certain he would be the match for them.
The essential problem is that we are viewing all money creation as happening through the central bank while leaving the government to be run as a private corporation having to account for itself exactly as if it were one and being punished for running up debt. Now this may come as a surprise but there is nothing wrong with the government running up debt in principle. And, no, this is not a left wing, or Keynesian, casual attitude to debt. But there is one big proviso on the nature of this debt – it should only be debt to British citizens, resident in Britain, or their proxies, ie, British jurisdiction based pension companies. You see, if the government owes debt to its own citizens who work and live within the British economy, from the international point of view there is no debt. British citizens, as represented by the government, owe money to British citizens, as represented by pension funds or as represented by themselves. The government may have a debt but the nation does not
Ever since governments have gone into debt they have often looked beyond their own shores to sell the debt, to sell the bonds. This practice is horribly disruptive for the currency and for international trade. The big advantage historically of borrowing abroad is that defaults are easy and usually go unpunished but this is hardly a good reason for the British government to be selling its debt overseas today.
To move to entirely British owned government debt, we should give foreigners three years notice that they will have to get rid of their British bonds or they will forfeit them. The immediate result would be a fall in value of these bonds making them cheap for British pension funds to purchase. The yield would corresponding go up and so British pension fund investors would see a very marked improvement in their situation. They would be richer and this in turn would be good for the domestic economy. The losers would be the foreigners holding the bonds but in reality the possibility of this policy coming would be flagged up a long time before enabling them to plan accordingly. Orthodox thinking would raise a well-rehearsed objection to this – no British government would ever be able to sell its bonds abroad again. And so the age old mentality of getting hooked on debt to others rears its head. If we cannot borrow abroad again, so much the better.
It is usually said that the government being it debt is a bad thing. After all, no one likes being in debt and so as owners of our government we don’t want it to be in debt, do we? Well, yes, actually we do want our government to be in debt – as long as it is to our own people. It is debt to foreigners that is the problem. If the debt is internal then all that has happened is that those who have more cash have moved this cash to those who have less – with a payment of interest, naturally. Anyone who has a private pension, which should be most people, lends money to the government. In fact, it should be a duty of government to provide a safe place for people to place their savings. I repeat: it should be a duty of government. So the government being in debt to its own people in a properly run progressive capitalist system is a good thing and a natural thing.
This fact is seldom appreciated for according to orthodox economics (and indeed modern monetary reformers like Positive Money) the savings of normal citizens provide the source of investment for companies. You can read over and over in orthodox textbooks, of any persuasion, Keynesian, Smithian, Austrian, etc, the fallacy that savings equals investment. This nonsense is, like so much orthodox economics, theoretically flawed and empirically disproved. In reality, investment for industry comes from three sources; bank loans (which are created by the banks augmenting their balances sheets and nothing to do with any savings), government subsidies and, last and, least important, venture capitalists. This last group are gamers who can afford to lose the money they put up, that is to say, Dragons’ Den types. The normal savers cannot accept risk with their capital and do not ever invest in industry developments or startups.
They may hold shares but that is not investment in the real sense. Unfortunately the phrase ‘to invest money’ is used for ‘to place money’ as if there is no difference. When you buy a bond, by a share, buy a property, except in exception circumstance, your capital is reasonably safe. It may go up and down but you will not get wiped out. If the economy was properly run you would almost always gain, not lose. When a bank makes a loan, it may lose the whole lot and it can take the loss, thanks to the magic of fraction reserve, but let’s not go into that, I have covered it before. A venture capitalist likewise knows they may lose everything.
This distinction between investing and placing is essential but orthodox economics runs them both together and this allows them to adhere to the absurd fallacy that aggregate saving equals aggregate investment.
So let’s go back to the government. I envisage a government in debt to its own citizens and tax payers and this is desirable and natural. But what happens if still the government does not have enough money to pay its way, financing all the public services, etc. It cannot use the age old solution of seeking foreign debt. So what does it do? Go to the central bank? Certainly not. The central bank is not there for substantial loans to the government. It is not a commercial bank so does not make loans to anyone. It is just there to oil the works.
The solution to this situation for the government is in creating ‘sovereign money’. Positive Money advocates ‘sovereign money’ but their idea of sovereign money is exactly the same as people’s QE as they make abundantly clear. But ‘sovereign money’ is not an appropriate term for QE. Sovereign money is created by the sovereign. In the old day this meant created by the monarch. Today it means created by a sovereign government which we assume is democratic to a reasonable degree. To create sovereign money the government has no recourse to any external body like the central bank. The government treasury simple adds the money to the asset side of its balance sheet and proceeds to spend it. No debt has been created. The people will benefit from the spending. It seems like free money.
Well, it is free in a way, but it is not as simple as that. If too much money is created then asset prices will inflate, with the problems of inequality that that induces, and so society will suffer. As I have been at pains to point out, the extra money will have no effect on consumer retail prices and may actually decrease them due to more competition and economies of scale. There are also consequences for the currency international exchange rate which we will not go into here.
How do we ensure that not too much sovereign money is created? We will need a government agency that will monitor just one indicator. As I said before, this idea of these independent committees or wise heads that take a view on things (like the monetary policy committee of today) cannot work. It will never be independent and it stands very little chance of being wise. But monitoring just one indicator is feasible.
This one indicator is asset values. In a strong healthy economy there will inevitably be asset price rises and this is only good and right. The problem is when those rises are due uniquely to an increase in money supply as has been the case in Britain, the USA, and other places since the 1980s and before. This increase in money has come from private banks who have been deregulated and so that needs to be sorted out to return the situation to sanity for any other reform to work. With that carried out (and I have written elsewhere how it should be) and if no or little sovereign money is being created but asset prices still rise you can be certain that the asset price rises are due to benign factors. In this way you can monitor and adjust the amount of sovereign money created. On the other hand, if you increase sovereign money and there is no observable increase in asset prices you know the money was needed and will do good not harm.
To recap, these are the reforms we need
There are many other economic reforms that | propose that, hand in hand with changes to monetary policy I have described, would make Britain a leader in the world again. But nevertheless the above proposals could be carried out in isolation to great benefit to the nation.
And they would work.