Labour – the new official Remain party

Today Labour becomes the party of Remain again.

Labour should bribe voters with £500 to Remain in a 2nd Referendum, and organize General Strikes to ensure the UK remains in the EU.

Why?

Labour’s preferred version of Brexit cannot command a majority in parliament today. It never will. Labour wants to stop a damaging Tory Brexit. These damaging Tory Brexits are either “May’s Deal” or “No Deal”.

The best way to do this is for Labour to campaign all out for Remain.

What can Labour do now?

Officially Labour campaign now for a 2nd Referendum. There is, however, only a slim chance that it might be accepted in parliament, as most Tories are against it.

If they can secure a 2nd Ref, (or even if they cannot) everybody in Labour will, of course, again campaign for Remain.

Is it worth going over the old arguments again? Maybe not.
How best to secure a Remain vote?

Something has become clear now, which many did not believe before the 1st Referendum. Jobs will leave, more jobs are endangered, and national income (GDP) will fall. So the economic impact is real. Lost tax income to the government so far is £250 per person, as in a smaller economy less tax is paid.

This will continue, no matter which Tory Brexit is chosen.

May’s Deal Brexit: It will be at least another loss of £250 in two years time. Then it depends on the further negotiations with the EU, and which deal can be struck with the EU about future relationship.

No Deal Brexit. The loss might well be double that, tax losses of approximately £500 in two years time.

These future losses to government income are, of course, estimates. But the sub-standard performance of the UK will continue outside the EU, as compared with staying inside. So it is reasonable that tax losses would be repeated in the following years, as the economy is always smaller than it can potentially be by staying in the EU.

Labour should use these potential tax savings to bribe voters for Remain. It could offer the following deal to voters:

Vote for Remain, and vote us into office at the next General Election, and we will give you £500 on coming to office.

Cash – no strings attached. That would add £33bn to the deficit in the UK on Labour coming to office, 1.5% additional points in the deficit to GDP ratio.

What if there is no 2nd Ref?

Labour should get everybody to overturn a damaging Brexit and organise one week General Strike to over-turn any Tory Brexit one week before the date we actually leave (which is 29th March, but could be extended.)

Again with the promise of £500 cash if the strike action is successful.

Let us not forget, a Tory Brexit represents

  • the biggest loss of civil liberties to UK citizens (loss of Freedom of Movement)
  • the biggest threat to jobs
  • the biggest threat to future income.

Brought to us by the Tories. The anti-business party. The party cutting our civil liberties.

Brexit: Tories taking money out of our pockets to save their broken party.

Surely any last ditch effort to overturn that Tory disaster is worth it, and should be overcome by any means possible.

LAbouremblem

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Time for a General Strike to halt Brexit?

Things are getting a bit heated, following the news that Theresa May will not allow a vote on the Withdrawal Agreement until the 12th of March, 17 days before the actual Brexit date. Can we do anything about it?

 

Brexit_age

 

In the 2016 referendum, voters for Remain were, in the main, the younger parts of society. (That is still the case in a more recent poll – see above.) These are the ones who are working and actually keeping the country going. If they were to withdraw their labour, the country would quickly grind to a halt. To reinforce the point, perhaps all 4 million Europeans who currently prop up everything from the NHS to Costa Coffee should also join the strike. As should all those who work for European owned companies which are majorly affected by Brexit, such as BMW’s Mini-plant and Airbus in Wales. And the union members who believe that Remain will be better for their jobs.

Everyone who wants to stay in the EU should therefore commit to strike, say from the 20th March to the 27th March, until Article 50 is withdrawn and parliament votes to stay in the EU.

Trying it would be worth a go – only to bring the Brexit nightmare to an end.

That would, of course, go against the “democratic” referendum result. The pensioners, home-county golfers, and frequenters of Weatherspoon pubs might now want to go on a counter-strike. To counteract the working people of Britain. There are of course also those workers who are for Leave. They could join also in a counter-strike.

Would it be undemocratic? Hardly, strikes are a legitimate way to make a political point. The working population will be hard hit by Brexit, as tax revenue will be lower than if we were to stay. If we want to keep services the same, or improve them, surely taxes will have to go up? The government has warned us about that before. The young, working population would be the hardest hit by tax increases or withdrawal of public services. They have every right to strike.

Further, Freedom of Movement, which allows every British person to work, live and retire in every country of the European Union will be withdrawn. This is probably the biggest withdrawal of civil liberties by a government from its population in peace-time. Ever. It is worth striking to retain these rights.

So leaving on the 29th March will hit us in our pockets and (as we now know) give us only the illusion we are now free from EU interference.

A counter-strike would be for still very nebulous benefits which come from withdrawing from the EU. They are very limited, especially as the UK will have to remain on good terms with the EU following the withdrawal agreement. The backstop will tie us into the EU potentially indefinitely (that is why nobody likes it) and a “no deal” Brexit will leave us very vulnerable in further trade negotiations with the EU. There are no pecuniary advantages for Leaving.

Strikers (for Remain) or counter-strikers (for Leave) would both have disadvantages from a strike. They would lose pay, and they might lose their jobs. However, strikers would have, as in any strike, the possibility that their action might succeed and they would ultimately be better off.

The counter-strikers would strike to be worse off – ultimately – if economic forecasts are believed. That would certainly be a first, workers striking to be worse off.

What about the “will of the people”? For a start the will of the people now seems to have changed towards “Remain”, opinion polls show. Remain is now the will of the people. We could always test it to confirm this in a second referendum.

Would a General Strike be successful? The last one in 1926 was unsuccessful. More than 1 million miners downed tools, but after 9 days they conceded defeat. However, strikers succeeded to bring transport to a standstill, even then.

Transport could be brought to a standstill today. How many Remainers would be willing to strike? There are more than 30 million workers in Britain. If 6 million or 10 million were participating in a General Strike for 7 days, just before the end of March, they could cause major disruption. Supermarkets would be empty. Operations cancelled. And coffee shops and restaurants, especially in London, would have to close.

Would parliament then give into the strike and revoke Article 50 and remain in the EU? It would certainly give MPs a fig-leave to vote for Remain, and over-turn the “democratic” result of the referendum. Something they are unwilling to do at the moment.

So perhaps a General Strike is worth a go.

 

Energy, power, money – why not part of economics?

 

Somebody asked on Twitter What is the single most important idea in economics for unconvential economists?

Here are some of the ideas I agree with.

Energy

Steve Keen is my favourite here. “The role of energy in production”. This is clearly ignored, we think we are so rich because we somehow have figured out markets, capitalism and specialisation of production. But we could have the most efficient markets everywhere, if we could not exploit energy (and so far mainly fossil fuels) we would really be nowhere. That is why we were “nowhere” prior to the industrial revolution, prior to the exploitation of fossil fuels. Income did not really rise much over the many centuries before. The world has become really rich only since it uses coal, gas and liquid fuels.

Power

The second important and popular idea is the role of power. As Devika Dutt puts it:

The economy is not driven by market exchange, but by systemically unequal relationships between firms-workers, between countries/ imperialism, between men and women, between white people and other races etc

Danielle Guizzo adds:

Agreed! Power relations in between institutions and groups, inside/outside the market, and the outcomes, conditions and decisions made. Also how it drives change (or not).

So, the question becomes who has the power? This has changed over time, of course, with Karl Marx one of the first to state that the capitalists have control over the means of production, all value comes from production, and the proletariat, the workers get exploited by the capitalists. And that they will be exploited until they themselves control the means of production.

This dominant theory was, of course, the basis of all economic production in all communist countries. However, at the time of Marx writing his theories, it was not the only theory how power could influence the bargaining power of workers. Much more popular, and much more digestible were the theories of Henry George, who suggested a single tax, the Land Value Tax on land, the only resource which is limited by supply. That would shift bargaining power in wage negotiations to workers, and limit rent extraction by landlords.

So taken over part of the means of production by the workers, or land value taxes are now ideas discussed by the Labour party to deal with some of these different power relations. But ultimately both would need to be exploited to the full, to allow for a full shift of power to the workers. So the whole ownership of companies would move to the workers. Or making a Land Value Tax really enormous, and abolishing taxes for workers, such as Income Taxes or National Insurance Contributions.

Labour’s introduction of a Land Value Tax, should they come to power, is unlikely to be as extreme. A limited Land Value Tax and just 10% of shares (given to workers from their original capitalist owners) will only shift the power balance in a very limited way.

And why do we still look to Henry George and Karl Marx to shift power from one class (the capital or land owners) to the other (the workers), ideas which were developed around 150 years ago? Do we still look at medical textbooks or scientific discoveries from the 19th century with a view of introducing them now?

Also, the means of production and or land were seen as the source of all wealth by these thinkers in the mid 1800’s.

Other sources of wealth

Now other sources of wealth are available. Using the internet as a delivery platform, for example, allows for the development of worldwide monopolies or oligopolies for online auctions, online market places, online search engines. We can choose only between a couple of operating systems for our phones and computers. All suppliers of our goods and services are more and more concentrated, be it for our food, cars or large public/infrastructure projects. There are only two electronic worldwide payment services consumers can use to pay with their credit cards.
We are struggling to find anwers for these concentrations of power and wealth. It is not the means of production any more which is the problem, but it is their concentration.

Money

If you had enough money you could, of course, buy these assets and their captive markets. So that makes money as important as the real assets. Owners of money can become owners of means of production, or owners of a large food manufacturer. If you have money you can buy land or Netflix.

Money allows you to try and influence elections via Facebook, or sponsor American congressmen, so they might sponsor a law in your favour. Money is ideal medium for corruption, it can disappear into off-shore tax havens (unlike land or means of production), and therefore the ultimate power tool.

Money can change the public consciousness. That is why rich people love to fund think-tanks and buy media. These billionaires employ millionaire-voices which will share their point of view on things. Thus the media will never advocate higher taxes, and never advocate higher welfare spending. That soft power is invaluable to billionaires who fund these “propaganda” outlets.
If we want to change the way power is exercised, we should look at money (how it is created and distributed) and not to the owners of means of production (Marx) or land (George). The theories of Karl Marx and Henry George, who describe what they saw in the second half of the 19th century are clearly not the only way to describe power relationships.

There are very practical ways of dealing with the distribution and creation of money.

Do not pay interest on government borrowing, for example. That takes literally trillions out of the pockets of the rich. (Around Euro 8 trillion if the EU countries had not paid interest on their government borrowing since 1995. Total EU government debt of all EU countries would therefore be closer to the Euro 5 trillion it was in 1995, and not the Euro 13 trillion it is now)

 

This is one of the policies which Modern Monetary Theory proposes. “Zero Interest Rate policy for government borrowing” and “use of taxes to fight inflation”. They would deprive the rich of some of their money, and therefore rein in their power.

You do not need revolutions, nationalisations, expropriations or (unless you have inflation) even taxes to limit the power of the rich. Initially, just the sensible policies which MMT suggests. If governments do not use higher interest rates to fight inflation, that will limit the wealth transfer from poor to rich, and from young to old.

grace_power

If people on the left argue that MMT does not have a “theory of power”, may I suggest that they look at the compound effect of some of the policies of MMT. It will have the effect to take money away from the powerful. That is a very practical step to take away their power.

Introducing zero interest rates on government debt and ditching monetary policy would not be the only step to get money working for all. The banks have to be reined in further, no doubt. But let the government set out proposals what it can do by itself first, before it goes on to curtail the powers of the other issuers of money, such as the commercial banks.

Dealing with money is dealing with power.

And any new progressive government should take money seriously.

 

 

 

 

 

 

 

 

Why did government not bribe us to Remain?

Simon Wren-Lewis blames David Cameron in his latest blog post for losing the Brexit vote “… his ruinous austerity policy and his immigrant scapegoating ensured he lost the referendum”

He makes a good case to support his point, but I think that is not why Remain lost.

Ultimately Cameron did not bribe the electorate enough.

What do I mean?

On the one hand we had the Leave vote promising “an extra £350 million for the NHS” on the side of a bus. We all remember it, we all still talk about it, that must have been the most efficient advertising campaigns ever, for anything.

On the other hand the Remain vote tried to scare us into voting for Remain, as otherwise the economy might collapse. That was enforced just weeks before the vote by a further dire warning by George Osborne, warning of tax rises to come to meet the black hole in public finances.

Now, 2.5 years later, the numbers are in. In a previous post Simon Wren-Lewis states that the loss to the government coffers so far are £17bn, due to a loss of GDP overall. The loss to the economy is about what was forecast. The £17 billion missing tax revenue is about £250 for each of the 65 million living in the UK.

Now the government obviously knew that if we were to remain, the situation was to be economically favourable. It had the forecasts. It also knew it was in grave danger of losing, hence the further threats by Osborne briefly before the vote.

Against this, there was the hope by the Leave camp that even if the economy was worse off, the NHS would be better off by £350m a week. Clearly leaving the EU meant leaving the EU contributions, as well, which would have paid for the extra money for the NHS. (Many knew it would be more complicated, of course, but many did not believe the experts either.)

So what should Cameron/Osborne have done instead, knowing they were just about to lose?

They should have promised £250 for each man, woman and child by the end of 2018. So £1,000 cash for a four person family, paid into each person’s bank account in the country.

Straight choice:

£250 in cash for myself  and every one in my family – Remain
£350 million for the NHS a week – Leave

I know we all love the NHS, but I am pretty sure I know who would have won.

bribe

 

After winning and paying out the money in 2018, the government tax situation would have been exactly the same as is now. But we would have a lot more GDP. And we would still be in the EU.

Krugman wrong about “deficits leads to inflation”, too

Paul Krugman says in this article that replacing private medical insurance in the US (6% of GDP) with government paid healthcare will lead to 9% increase in GDP and inflation if not paid for by tax increases.

I think it is very, very unlikely to lead to inflation.

Who is right?

What does Krugman mean:

Krugman is using basic undergraduate economics as it is taught in the Introduction to Economics Course for first year students.

He says before with private medical insurance economic output was:

100% GDP = C+G

C=private consumption and G = government spending,
(the formula includes + I= Investment , +X = exports and – M = Imports but they do not change in this instance, so we do not include them for our analysis)

Now he is saying after the state paying for medical expenses

106% GDP = C+(G+6%)

How does he come to 9% GDP growth? He assumes a “multiplier” of 50%. That means each $ of government spending will generate 50% extra growth, as people who receive government money spend it themselves, and generate further growth.

109%GDP = C(+3%) + (G+6%)
He then says 9% growth of GDP reduces unemployment by 4.5%. That is according to Okun’s law. But unemployment is only 4%, so we have a problem. Inflation.

That is basically Krugman’s argument. Very crude, very rudimentary.

What will happen in reality:

My view is after the state pays for medical cover (if health care prices do not change)

100% of GDP = (C-6%) +(G+6%)

So private medical expenditure goes down (private consumption reduces) if the state pays for it, by exactly the same amount as state expenditure increases

However, there is a chance that

  • lower admin expenses (no more insurance paperwork – save 16%) and
  • lower costs of medical care (the state now acts as monopsony buyer- save 16%)

make health care costs cheaper. Perhaps 1/3 cheaper than before.

The whole medical care sector will have to move to government funded health care, there will not be any other buyers. So the health care sector will have to work for the money offered by the government or go bust. Government can practically set the price for health care.

However, that 1/3 reduction is ambitious, and it would still leave the cost of US cover one third more expensive than the UK (as percentage of GDP), when currently it is twice as expensive.

So private consumption goes down by 6% (loss of spending on private medical insurance) and state funded medical costs are up only 4%, (rather than 6% of GDP, due to cost savings.)

98% GDP = (C-6%) + (G+4%).

However, the 6% of GDP which paid for health insurance is now in consumers pockets. That is equivalent of saying that consumers got a tax cut.

How do people spent tax cuts?

There is no empirical evidence that tax cuts lead to growth. You can read about it here.

“[I]t is by no means obvious, on an ex ante basis, that tax rate cuts will ultimately lead to a larger economy,” as the Brookings Institution’s William Gale and Andrew Samwick wrote in a 2014 paper. Well-designed tax policy can increase growth, they wrote, but to do so, tax cuts have to come alongside spending cuts.
And even then, it can’t just be any spending cuts — it has to be cuts to “unproductive” spending.
“I want to be clear — one can write down models where taxes generate big effects,” Gale told NPR. But models are not the real world, he added. “The empirical evidence is quite different from the modeling results, and the empirical evidence is much weaker.”
If tax cuts do not lead to growth, they will certainly not lead to inflation.

That is because tax cuts will be spent on a multitude of ways. Each family will have on average $400 extra available a month, but will that all be spent on other goods/services? It might be saved, it might be used to pay off loans.

Let us assume on average the 6% will be it will be used for all three.

2% for extra debt reduction: That will take demand out of the economy. It will decrease GDP.
2% for savings: That will take demand out of the economy. It will decrease GDP.
2% extra spending: That will increase GDP by 2%.

That means that private consumption is 4% lower than before.

Lets write our formula again following these assumptions.

100% GDP = (C-4%)+(G+4%).

So in summary, I predict that there is no change in GDP. The increase in Government spending is counterbalanced by a drop in private consumption.

So I predict 0% increase in growth, Krugman predicted an increase of GDP of 9%. For Krugman to be right, that would assume that every family in the US would now spend the $400/month saved on medical insurance and use that money on other goods and services. All families would have to spend all of it. They would not save, they would not pay back loans, but just spend. That would generate so much economic activity that another 50% would be generated by this spending frenzy.

Remember, there is absolutely no empirical evidence that tax cuts lead to higher growth. But Paul Krugman is telling us that what amounts to 6% more in the family budget (equivalent to a tax cut) leads to 9% growth. And after all that, only after he projected 9% growth, will it lead to inflation. Because then the US will run out of workers to do all the jobs. When is the last time that ever happened? When has the US last seen 9% growth? Krugman’s assumptions are bonkers, frankly.

krugman_1

Inflation, the bogeyman he is trying to summon through his simplistic reasoning, is the last thing anybody should be worried about really. That is what I think. Deficits have never led to inflation, outside disaster zones and foreign currency crisis areas, and they will not lead to inflation now.

(We should add for completeness sake that the MMT economists he is trying to attack would be very worried about any increase in inflation, and would of course set measures in place, such as tax rises, to stamp out inflation)

  • Paul Krugman ignores that cost of healthcare might drop.
  • Paul Krugman also ignores that people might not just spend, but also paying back debt or  save.

In fact Krugman ignores real life and, like many economists, mistakes his very basic economic models for reality instead. That they are completely unsuited for the complicated world we live in.

Politics without policies – a disaster

Had he stayed, Brexit would be dead by now. But David Cameron resigned after the Brexit vote. The only thing he would have had to do is appoint Gove and Johnson to set up a detailed Brexit strategy. A detailed Brexit Policy, published and agreed by the Conservative party first and then voted on by the public. Nobody could have agreed on which Brexit we had wanted (same as now), and, in the end, Brexit would have been cancelled. And Gove and Johnson relegated to the backbenches for ever more.

As it is, we have a failing government, a disastrous Brexit situation, and a fair chance that an election will be called soon. Labour might win, and be in government two months after a vote is called, so what can we expect?

So how does the opposition, Labour, make policy?

Labour policy forum website:

 

LAbourPF

 

The main document which is up on the Labour Policy forum website is the 2017 manifesto. There seem to be only one policy documents (about pensions) from previous meetings of the 8 different policy forums. And eight only very specific discussion topics scheduled for 2019. For example, in the Economics area, there will be a discussion solely on “democratic public ownership” for 2019. That is great, but what if you want to discuss something else, which you, and perhaps others, find more important and more urgent?

You have the chance to leave some ideas on the Labour policy website, and in 2019 so far it yielded about three dozen ideas, and has some suggestions which range from cranky to sensible. There is no detailed or official feedback on many of them, so if I had some really good idea and entered in on the policy forum site, I do not know what would happen. Also, given that Labour has 500,000 members, and millions of voters, the yield on the website for good policy ideas seems pretty slim.
How else do we get to hear about policy?

You can always buy a book. Economics for the Many, edited by John McDonnell, the Labour shadow chancellor. It has a number of good ideas at a very high level, but if you are looking for detailed policies it is not the right book.

What do I mean? As an example, everybody knows that Labour promised to abolish university tuition fees at the last election. That popular policy will be on offer again. But how will it work in detail? There is nothing in the Economics for the Many book. What about students who are half way through a course, how about the ones who already paying off their student loans, what about the ones whose parents paid for the course? What will be the offer for young people not going to university?

Labour has had all the time in the world to put some proposals together to address these questions, but nothing I have seen is available.

Social Media

You can of course follow some announcements on social media or the press and make sure you do not miss proposals.

For example having had twitter discussions/press I have learned about

The cool thing here is that you actually get to speak, via twitter, to the the advisor to the Shadow chancellor, James Meadway. He will answer reasonable questions and you could make policy suggestions to him. So if you persuade him, perhaps he can persuade the next chancellor of the UK. (Note: James is not easily persuaded!)

What you cannot do, and that is very much less cool, is actually go on the Labour website or the Labour policy website and find out how any abstract plans will be implemented and expanded in detail.

So, to summarise:

Nothing for existing policies: So there is no database on proposed policies, say, on how to deal with existing student loans. Or on how the ownership fund will work. Ideally there should be a website with “Work in progress proposals” so that policies be commented on as they are made.

Uncertain website for new policies: And there is the uninviting looking policy proposal website, where suggestions seem to fall in a black hole. So if I were to suggest “It is time to scrap monetary policy?” what happens then? Will I just be considered to be the typical crank? Will it be discussed by the Economic Policy commission this year, or will it be delayed? Remember, this year’s discussion topic is “democratic public ownership”. What year will monetary policy be discussed, I wonder?

Maybe there are not any policies: There is also of course the possibility that policies do not exist. This is not an outrageous suggestion. After all, we are leaving the EU in a few weeks and 2 ½ years after we voted to do so, we still do not have a policy on how to do it. Or what comes next. (Ok, that is the Tories – not Labour.) But where are Labour policies on anything?

Is there a shortage of good policies? There seems to be. James Meadway, the advisor to the shadow chancellor said himself that rather than criticising, people should make policy suggestions. It is a fair comment, but why do not more policies come out of the shadow chancellor’s office? I suspect it is a man-power shortage problem. I am not sure how many people work with John McDonnell on economic policy generation, but I suspect not many.

Setting out good policies, reviewing them and making sure that they make sense will take a lot of time. So if you are organising reviews of alternative ownership and alternative ownership funds, and review how the Preston model would work somewhere else, maybe there is not enough time for anything else.

(That raises the question: If you are potentially in charge of the economy of the UK two months from now, should you not have at least half a dozen economic advisors to crank out good proposals? Or have unlimited access to the resources of think tanks?)

How easy is it to come up with good economic policies? That is also a good question. Maybe people do not find it that easy. You have to have a good understanding of economic concepts, and of the real world of finance. And you have to be creative and innovative.

Here is an example: During the Eurocrisis of Greece vs the EU a number of different suggestions could at each stage have ameliorated the crisis. They would have involved compromises, tweaks in policy, or quite frankly quite unusual policy proposals. Were they publicly available and discussed? Yes (on my website here) and no (maybe a few dozen people read the site).

All my suggestions would have been policies which would have helped in the crisis. There was a total of some 20 pages of different innovative policy suggestions, all different from the usual two suggestions which you could read elsewhere (ie., Greece has to leave the Euro, EU has to cut the outstanding debt). Plenty of people wrote blogs about Greece at the time, but very few, if any, presented any policy solutions. Maybe good policy proposals are more difficult than they seem to me.

Of course, good ideas seem to get developed by other think tanks, and many should be picked up as detailed policy proposals by Labour. And volunteers want to contribute too. Fantastic.

Ideally, Labour’s policy writers, (if there were any), should take up all sensible suggestions and present them as proposal to Labour members, (or voters?), who can then comment on them further. These potential policy proposals, even if they are competing with existing policy, or with each other, would show up on the site.

The party would vote on them in the normal policy decision process, once they have been out there for comment for a period of time, a similar process seems to exist for Labour already, but there seems to be a dearth of proposals. I would love to see for each of the 8 policy areas of Labour twenty or thirty different competing proposals, and everyone could get stuck in then. (Not just the one paper on Pensions I could find.)

Maybe something to consider for Labour

Money and Trickle Up Economics

If  I ever had to teach money to kids I think I would use the following little story:

Ruritania, a land of agricultural bliss.

100 farmers and 1 king. The king provides the government in return for 10 kg of potatoes from each farmer. That is the tax.

One day the king say: “That is a bit backward, can’t we have some money?” He asks two professors:

Professor 1 (just print the money and tax): “Sure, you can have some money, but you have to run a deficit first, otherwise there is no means of settlement. If you have a deficit of £1,000 in your newly printed currency, each farmer can get issued with £10. You then tax £10, which will be enough to buy 10 kg of potatoes from the farmer. But you have to run a deficit first.”

Professor 2 (create bank to lend money and tax): “There is no need for a deficit. You can get 1 farmer to run a private bank and get the other 99 farmers to borrow from the bank. If they each borrow £10 at an interest of 10% the government does not have to go into debt. You can still tax them £10 then, and buy 10kg of potatoes, at £1 each, from each farmer. You have avoided the government deficit”

Right, says the king, I can see some problems. I have two questions for Professor 2:
1) Where will the farmers get the money for the interest from?
2) Where does the bank get its equity stake from before it is allowed to open? Because under Basel rules they have to have something like a 10% equity stake?

There are a number points we can learn from this little simple story. These things are also true in our economy today:

Without the Government spending money, the shareholders of the bank could not put their equity stake into the bank, so government money must always be created first.

Money can be created in two ways, either just issued by the government (printed), or through debt (bank borrowing). Nowadays more than 95% of our money is created through bank borrowing and is money in accounts of savers and borrowers. Less than 5% is notes and coins. Although notes and coins do not carry an interest rate.

If we just use money for paying taxes (as in example above) there is no money available for buying and selling goods, trade and commerce. So to have commerce, more money must be issued or borrowed into the economy.

However, the fact that money can pay taxes make money universally accepted, as everyone has to pay taxes.

Banks do not have to have deposits first to lend money. Bank money is just created out of nothing. The bank “creates” it by making a loan to a borrower.

All money created by banks means that the borrower has to pay interest. Here in the example 10% ends up in the bank. In reality it ends up in the bank (which takes a cut) and the savers who deposit money in the bank. Bank and savers share the interest income which is paid for by the borrower’s interest. But the fact remains, the interest money trickles up to the rich.

In the example above, there is not enough money in the economy to pay taxes and interest if money is borrowed from the bank. Let us assume that taxes get reduced from £10 to £9. Then there is enough money to pay taxes and interest. That reflects the reality. Banks would not lend unless they were reasonably certain that there is money for taxes and interest. Interest is just paid from the income generated, from total economic output. We really do not need to worry where interest comes from.

The perception created by this story is correct: All interest ends up concentrated at the wealthiest section of society. The wealthiest will be the bank and the savers, the poorest will be the ones having to borrow.

These are the points which are very clear from the story, but get often omitted when explaining money.

One last and important point – What are government bonds?

So what happens when the government wants to build a new £100 million hospital? It has already paid for normal government expenditure, which equalled the receipts it had from taxes. It had a balanced government budget.

But as the hospital is built, the government keeps paying for the builders. The government has an account at the Bank of England, and that is where the money comes from. The government effectively has an overdraft (a short term borrowing facility) at the Bank of England.

As the government does its budget again, after the hospital is finished, it turns out expenditure is £100 million more than tax receipts.

The government then declares it is in deficit and starts to issue government bonds for £100 million. It has already paid for the hospital, as it was built, but it now wants to regularize the situation. Pay off the overdraft at the Bank of England. Why? Because just running up overdrafts at the Bank of England is the same as printing money, and no government wants to be seen doing that.  It asks its citizens with money, the rich ones, to buy these bonds. Bonds are just a promise to pay interest for the money which is borrowed from the citizens for a specified time, in return for a specified interest rate.

In the story money only gets created against an interest rate of 10%. That money ends up with the wealthiest in society who receive the 10%. The wealthiest then lend the money back to the government at, say, 4% interest for the government bond.

So the government created more money at 4% interest. So only an additional 4% trickles up to the top.

All the money borrowed from private banks (at 10% interest) is still outstanding.

So government created money is cheaper. Also, the bond  interest rate (4%) gets paid by the government.  The government might increase taxes on everyone to pay for the bond interest. Taxes share the burden.

Money created by banks (at 10%) is definitely more expensive, and of course only the borrower pays the interest rate.

Yet whatever happens, at 10% or at 4%. It is generally the rich who benefit from this automatic trickle up effect.

 

 

Hospital_bond

Can we think of a different way to build the hospital? Yes we can. The government could pay a lower interest rate on the bonds. As the monopoly issuer of money, the government can set its price. The “price” of money is the interest rate. And the government could make sure that rates stay low indefinitely.

That is in effect what we have at the moment. A situation where due to low interest rates relatively little money trickles up to the top. Of course there are still usurious interest rates for credit cards, student loans, etc. But the bank rate, the interest rate on which other rates are based is currently low at 0.75%.

So in reality interest rates for borrowers is perhaps 4%, 2% goes to the saver, and 2% to the bank. And the current interest on a 10 year government bond is 1%.

Hospital_bond2

So this is much better for the economy. Less money trickles up to savers and providers of financial services. More stays in the real economy, with the borrowers. Trickle up economics has not been abolished, but lower rates tame it somewhat.

However, here is the catch. Should the UK follow the US, where interest rates have already increased by 2% from their historic lows over the last two years the situation will worsen. Interest for borrowers goes up, and interest for the government goes up, and again more money trickles to the rich people.

So lower interest rates means less money trickles to the rich, and poor borrowers are better off. Higher rates means the opposite. More trickle up economics, as the rich get richer, and the poor struggle with rising interest payments.

Under current structures there is nothing any government can do to keep interest rates low. If they go up, it will be the Bank of England deciding if they should go up. It decides if there is a danger of inflation and it will increase rates if it judges it prudent to do so.

So perhaps we should change the structures to insure interest rates stay low permanently, minimise trickle-up economics, and find other ways to fight inflation. The structures have been set up through a political decision. And a political decision can change structures.

Maybe tax increase would be better way if inflation should crop up.

Taxes.

Stop inflation.

And stop trickle-up economics.

Maybe a new government should consider it.