I had a discussion with a friend the other day about the nature of finance and money. It was hard to get into details as there was a lot of ground to cover. I thought it would be useful to summarise my position in a list of atomic propositions. The following is true for the UK but equally true for any country that issues it’s own currency at a floating exchange rate. This is all based on work by people like L. Randall Wray, Michael Hudson, Steve Keen, David Graeber and Robert Shiller.
1) Money is a representation of debt. If you buy a car off someone you could pay them with an IOU to the value of the car. The buyer could then at some time give you back the IOU and get something worth a car (from you.) The debt would be cancelled out and the IOU would disappear. Money is what happens when you implement some sort of system that allows some otherwise normal IOUs to be transferable. I-owe-yous become anyone-owes-yous. This means that the IOU given in payment can be given, in return for goods, to someone else.
2) There is more than one way to make IOUs transferable. Broadly speaking there are only two that I know of. The first is social money. This is based on optional trust. In this system the IOUs are transferable within a set of people who trust each other to honour the idea that those IOUs are transferable. These money systems tend to be small because they can only be as big as human personal social groups allow. The other system is central authority. In this system a central authority issues the IOUs, which are all claims on that authority rather than individuals.
3) If the debt that money represents is repaid then that money ceases to exist.
4) The thing that the government ‘owes’ currency holders is a reduction in their tax bill. The promise the government makes when it issues currency is that that currency can be used to pay any tax bill they issue.
5) The purpose of the tax system is to create demand for sovereign currency. By issuing a tax burden payable in some thing the government creates demand for that thing. From a macro-economic perspective it doesn’t matter how the tax bill is issued. Technically it doesn’t even need to be tax, it could be fines. It doesn’t matter if the tax bill is uniformly divided or levied on one individual, or anything in between. The fact that someone has to pay a tax bill with Xs means that demand for Xs is increased. If X has value even without the tax system, the X will be worth more with the tax system in place .
6) The government does not need to ‘raise’ pounds to spend pounds. The government issues pounds. All tax pounds it receives were issued by it in the first place. The government must issue pounds in order to tax them back.
7) The government cannot ‘save’ pounds. The government cannot save pounds for the same reason you cannot ‘save’ your own IOUs. You can’t have I-owe-myselfs.
8) Money creation is a process that ends with government issuing currency. It isn’t accurate to say that the government creates money. Most money creation happens without the government’s direct consent. The government can pursue policies that aim to issue new currency but only to the extent that the rest of the non-government sector is willing to participate. The only way the government can create money independently is by directly depositing currency simultaneously into a person’s bank accounts and into that person’s bank’s reserves (assuming people are happy to receive it). This, however, is not how most of the money in circulation comes to be. The other two processes are lending and spending. The first process is that people ask banks for loans, the bank choses to oblige or not (without the government having any real say), then the bank tries to get whatever reserves it feels it needs (historically the UK has had no reserve requirements). If the bank can’t get the reserves it needs from other banks it goes to the Bank of England and asks for, effectively, an overdraft. The BoE always obliges because to refuse would cause a credit crunch. At this point the ‘money’ is already in existence and the person receiving the loan could have already started spending it. The government then issues the currency making the money official. The other way the government can issue currency is through spending, buying goods and services, but note that the government can only buy what can be bought and generally can’t force anyone to sell, so it’s spending is limited by reality. It also can only buy things in it’s own currency that are for sale in it’s own currency. It can spend other countries currencies if it wants (and has some), but by doing so can’t issue pounds.
9) The economy is split into three sectors: the government, the domestic private sector and the world. This is a financially closed system by definition. The accounts of these three entities add up to zero (again by definition). From the perspective of the UK a foreign country is a bank that has an account in the BoE. Foreign firms have accounts in those banks. From this the rest of the world can be seen as just a sector of the UK economy. This sector is very similar to the domestic private sector. The main differences is that it internally isn’t subject to the rules of our government but conversely has no say in how our country is run. Our country is also part of the ‘rest of the world’ sectors in other economies (that is the BoE has accounts in other countries central banks).
10) For the non-government sector to run a surplus, the UK government must run a deficit. This is true by definition.
11) If the non-government sector is free to run a surplus then the government is not free to eliminate it’s deficit. This is true by deduction alone.
12) Activity funded with existing currency is repaying an old debt and issuing a new one. If I buy a car and issue an IOU, I owe you a thing worth a car. If that IOU is transferable then the person with my IOU can take it to someone else and exchange it for something, but in doing so they transfer the IOU to a third person. The second person is now settled., I now longer owe them anything, but the third person has a claim on me i.e. the IOU I issued. Spending money is the process of transferring a debt such the original issuer owes the final person in the chain, but the people in between are all left with a balance of zero (denominated in my IOUs). This is how our money works with the exception that my IOUs aren’t very transferable, but the government’s are. My IOUs are a bit transferable, so I can make these types of chains but only very short ones including people I know who trust me; however, I have little need to create such chains so never do. Instead I use the governments IOUs and become just another person in a chain, without having to worry about being the beginning or end.
13) Spontaneous activity requires issuing of new currency. From 12 it follows that the chain has to start somewhere. Someone has to simply issue the IOU from nothing. Linking to earlier points, this is usually how banks work. They start a debt chain then ask the government to insert themselves as the starting link, making the bank the second link in the chain.
14) Barter cannot explain expansion without charity. This is really an implication of 12 and 13. A business can be self-sufficient. It can pay for itself out of its income, but it has to have the income. It can’t generate an income before producing something. And it can’t produce something without capital. By deduction there has to be either a chain of debt that has to start somewhere (which disqualifies the economy as a barter economy) or someone must be simply gifting capital, which ultimately requires someone to be working for nothing. So a barter economy (lacking debt) that adheres to financial basics cannot expand.
15) There are good and bad ways to issue tax burdens and currency but the overall mechanics are the same. The government could choose to issue money by buying whatever it chooses. It could choose how it taxes and why. That will have varying social effects. The effects are an ethical matter not a macroeconomic matter. The choices will change the size of specific markets. For example if the government decided to always buy chocolate then chocolate markets would get a demand boost.
16) There is an optimum value for government surplus/deficit. There are pragmatic reasons to decide what a ‘good’ government deficit/surplus is, but those reasons do not include what the actual figure is. That figure is not always best when it is as low as possible and it is not always better when it is reduced. It is ‘best’ when it has the desired socioeconomic effects, which again are a matter of ethics not macroeconomics.
17) The UK government can not be forced to default on any debt denominated in pounds. It can never become insolvent. It can be forced to default on debts held in other currencies, but it can always issue the currency necessary to meet interest payments on debts in pounds.
18) The government set interest rates and therefor can always service public debt. If the UK interest rates were higher than growth, then the public debt would too quickly. But, again, the government sets interest rates so this could only happen if it chooses to let it happen.
19) Currency denominated in pounds can never leave the UK banking system. Often people talk about foreign held debt or dollars ‘in’ China or held by China. To be precise pounds cannot leave the UK banking system because they literally don’t exist outside of that system . A foreign national bank can have an account at the BoE. In that account it can hold reserves or bonds. The currency can never be accurately described as being ‘in’ the foreign country. Pounds can only be spent in the UK financial system (or in a foreign country that uses pounds, which would be part of our banking system). Cash can be physically taken to foreign countries, but once there it becomes an asset in that country, not a currency. It can’t be paid into a bank account either, only bought in return for local currency if there is demand for pounds there. Virtual currency cannot be transfered to a foreign banking system either, the idea is meaningless. There is no meta-currency in which currency exchanges take place so currency exchange is either barter (floating exchange rates) or an arbitrary agreement to always issue a unit of currency in return for a unit of foreign currency. When a unit of currency is changed through a floating exchange rate it is really traded as an asset. When it is exchanged through a fixed exchange rate it is stockpiled by the foreign country and a new local currency unit is issued. The original unit of currency is still held in the currency issuer’s central bank (in an account controlled by the other country) and still entirely within that countries banking system.
20) A trade deficit does not export pounds. Following on from above, if the UK has a trade deficit (meaning it is at a net financial loss through trade, referred to as a current account deficit), this means that reserves are flowing into accounts in the BoE held by foreign central banks from other accounts in the BoE (usually mostly from domestic private accounts).
21) The UKs trade deficit is subject to interest rates that are set by the UK government just like domestically held public debt. Foreign central banks have accounts in the BoE, which pays interest just like any bank account. Higher interest can be earned by buying bonds (which are just like saving accounts). Those bonds, too, are just entries in an account at the BoE. Some think that this means foreign debt puts the UK government at some kind of default risk because of interest costs. The interest rates are, however, set by the BoE.
22) Refusing to issue currency to meet the non-government sector’s demand for it always translates into unemployment. Unemployment can be caused by there not being enough things to do or by a lack of demand but it can happen when there is plenty of both, which is usually the case in the real world . Should the economy be in a position to expand its operations it needs finance. It needs finance for purely abstract reasons. It doesn’t ‘use’ finance in production. it can’t turn finance into anything. Because financial systems need to be tractable, that is they need to make mathematical sense, balance sheets need to add up etc., finance must be made available to allow new activity. In this case debt must be issued from nothing. If there aren’t enough pounds in circulation then, regardless of intentions or business models or demand or ingenuity, no new ventures can be undertaken without making our financial accounts mathematically nonsensical. Employing the unemployed, without taking wages from existing workers, requires new economic activity to happen spontaneously. This requires issuing currency, which in turn is the same as increasing the deficit (or reducing the surplus). Refusal to do that, through government policy, creates a situation in which the economy can’t employ more people regardless of any other factors .
23) The government pays interest on BoE accounts and charges interest on reserves it lends out in order to control interest rates. Reserve accounts at a central bank can pay interest, if the government decides to. It will also charge interest if a bank wants to borrow reserves. It doesn’t do this for fiscal reasons. It doesn’t need to profit off lending nor is it required to pay interest payments (often central banks pay zero interest on reserves). And it can ‘afford’ to pay as much interest as it likes. It does these things purely to control interest rates.
 This is why gold coins almost always circulate at prices above gold’s bullion value. There is an exception, however, which is when the material the currency is issued in is mixed. If the government issues coins in gold and copper, that both have the same nominal value (meaning the both count equally against a tax bill or fine), then people will obviously pay their tax bills in copper coins before gold ones. This extends to virtual currency that is just spreadsheet entries and has no real value.
 There is actually a very weird but accurate analogy: money is a unit of measurement of debt. In that sense it’s no different to meters or kilograms. Imagine that, for some bizarre reason, creating a road would require you to ‘have’ enough meters in the bank. Roads could be built only when old ones are ‘liquidated’ back into meters, or when new meters are issued. It’s easy to see what would happen if the government tried to ‘balance’ their meter account. It’s also bizarre to imagine a government stressing about having a ‘meter deficit’.
 I would argue that in the real world there is always something to do. ‘Bad times’ are identified by the very fact that there is a lot to do. Everyone always needs to eat and people always need shelter and security. Further, if modern life shows us anything it is that we can condition ourselves to demand literally anything.
 This is exactly the same as saying “points can’t leave a football tournament.” The points scored in a football tournament are meaningless outside of the tournament. You can ‘transfer’ a football point to a rugby point if tournament operators arbitrarily decide to honour the idea. In this case what would really happen is that the football point would disappear and the rugby point would be created. Or the two tournaments could use some kind of floating exchange rate by allowing bartering of points from the other tournaments.