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Wednesday, 11 February 2015

Oh no...

Once upon a time, a government decided to spend some money on a school. It built it, paid the teachers' wages, etc... These people had to pay a property tax so they needed the money. They couldn't pay it in bitcoin or gold.
But something terrible happened. The teachers and builders, etc decided to save some of the money. As a result, the teachers didn't spend all the money into the economy. And the people who got the money after them saved some too. As a result, after several taxes (VAT, property taxes, etc) the government didn't get all of its money back. Or perhaps people spent money on net imports. This led to real goods and services being given to the country for pieces of paper. The foreign central bank is running export led policy and prints some money and swaps it for our money to keep the exchange rate constant, and then stores the money forever for as long as they have export led policy.

This is part of the 'export led recovery' mantra advanced by the IMF that forgets that for every exports there is an input.

I know this is all terrifying, but that could lead to a deficit in the "public finances" (!!!) It is OK though because politicians say the have the 'deficit under control' and can 'cut useful spending or raise harmful taxes' to get rid of it. If we don't we could end up like 'Greece' (except for the borrowing in a foreign currency part.)
We can't have Scandalnavian spending at American taxes you know. The markets will punish us.

This is the story told by the current UK government since 2010. They have used ridiculous tactics like comparing the UK government to a credit card and say the UK should have ran surpluses (to increase household debt hopefully, along with even more financial deregulation) prior to 2007.

Monday, 2 February 2015

Where money gets its value from

Have you ever stared down at a pound bill and wondered why it has value? Why does a worthless piece of paper have value?

Is it because you can exchange it for gold? This was true until the 1970s, where there was something called the Bretton Woods System, where you could convert other currencies into the US Dollar which could be converted to gold. Some people would say it has value because others think it does. If we all have faith in the currency, it has value. And this is partially true - look at bitcoin for example. Money also has value as legal tender, the only way to pay debts.

But what is the main reason currencies have value. It is surprising. The main reason is taxation. Taxes require people to find money to pay for them. Otherwise, they go to jail. This is not the only thing needed though - governments need to carefully manage their currency and not print too much or it will cause inflation, and there has to be proper enforcement.

This is the real reason for taxation - not to "fund" spending. Where will the money come from? The taxes come first, then when there is demand for the currency, the government spends money on stuff - infrastructure, public sector workers, social programs, etcetera...

Let's take a teacher's wage for example. The teacher pays some income tax and NI on the money. The teacher pays some Council Tax. The teacher will save and spend money. When the money is spent, it attracts VAT. The money goes to a corporation and they pay wages and corporation tax. It is invested, attracts capital gains tax, etcetera... The point is money is a flow.
The only money that the government does not get back as tax is saved. In a closed economy, this is what is meant by the "deficit." The deficit is the private sector's surplus. As long as the government is a currency issuer, there is low default risk (the government could go mad and default) Of course you need to include the external sector (foreigners) and the banking system.
With a foreign sector, a government running a trade surplus (imports less than exports) can run surpluses while a trade deficit nation can't without private sector deficit (going deeper into debt.) You also need to take into foreign investments, foreign aid, remittances, etc to get a current account surplus or deficit.
Banks can create money. Say you borrow £100,000 from a bank. The bank enters it as a "deposit" in your account (a promise to pay money.) Although it does not create any money, the bank's credit money is accepted by most (i.e. non cash only) stores. These Bank IOUs are treated like real money. When you pay back the loan, the money is destroyed.
You get an equation:
Private deficit + Public Sector Deficit + Rest of World Deficit = 0
So for a country with a trade deficit like the UK it is a silly idea to aim for a budget surplus.