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Politics

Around the ’50s a political ideology formed. I’m sure its ideas date back further but it was at this time that it crystalised into a coherent group. More than a political ideology, it was, and is, a worldview. This worldview has no explicit pop-culture presence. No-one preaches it overtly. So most people are unaware of it directly. However it was, and still is, insidiously influential on the thoughts of some important people.

One of the most basic assertions/assumptions of this worldview is what is technically called strong reductionism. This is the idea that any system is just the sum of the elements in the system. Put plainly: to understand a society you have to only understand individuals. So, for example, if crime increases by 10% then the explanation is that individuals like crime by 10% more than before. It is this idea that lead Thatcher to believe and proclaim that “there is no such thing as society.” What she meant is that society is a kind of academic myth. A mirage created by a bad understanding of the world.

I don’t know how but this worldview has filtered out into popular culture. The world is confusing right now, and confusion both inspires and demands analysis. Reading the never-ending stream of analyses of how we got here, on racism, on sexism, on equality, on social justice, I have noticed that the worldview I mention is encoded right into all of them, and it makes these analysis irrelevant because they’re blind to the biggest factors.

These analyses seem mostly to try to reduce behaviours of societies down to how individuals think and act. Attributing things to individuals is difficult, as there are billions of them, so this approach necessarily requires demographic segmentation i.e. stereotypical thinking (which is ironically often what the analysis is out to criticise.) You have to find the demographic group whose behaviour, or thoughts, or opinions can reasonably be said to contain the behaviour you are trying to explain. I say reasonably because these analyses are usually only opinions; what the writer thinks is a reasonable explanation is accepted, usually without any actual evidence, instead relaying on the reader liking the sound of the conclusion. How many “why Trump got elected” videos and articles have you seen? Few provide any causal evidence, most only provide demographics as data masquerading as evidence. These are plentiful and have, undoubtedly, already coloured peoples ideas of how the world works.

This approach to understanding the world is limited to specific types of conclusions. If the phenomena we are most concerned about are recent this type of analysis can only conclude that the difference in our society is obviously the fault of whichever group represents the biggest recent demographic change; millennials. Things like institutional racism or sexism are incomprehensible because those phrases don’t mean anything. How can an institution be racist if none of the individuals in the institution are guilty of overt racism? How can we even approach fixing a sexist education system if none of the parts of that system are being sexist? How can inhuman labour practices be an issue if everyone working in the factories chose to work there?

Strong reductionism is bullshit. It was shown, with actual maths, to be bullshit over 100 years ago. The hard sciences, you know, the people who put robots on comets millions of miles away, predict weather with miraculous precision, run optical cables across the ocean floor, create self-driving vehicles, use general relativity to account for transmission distortion in communication between machines in geo-stationary orbits, put the magic machine you are looking at in front of you, those people, dropped strong reductionism at that time and never looked back.

If you want to understand radical changes in the behaviour of our society in the last decade there is an elephant in the room: social media. Social media itself mediates the new social interaction. The important word there being interaction. Interaction is not a feature of individuals so strong reductionist worldviews are blind to it. For them interaction is effectively inert. It just transmits benignly, having no overall effect on behaviour. It can express behavioural traits, that’s it.

When the world, apparently in unison, listens to Gangnam Style then a month later ritualistically pours buckets of water over their heads, what does that tell you? That everyone woke up one morning and decided they like songs about Korean horse farming, then changed their mind and really wanted to pour whatever over their heads and social media was just there to record it? Or is it a more feasible explanation that those things went viral largely because of the nature of social media itself? So many variables in that process are obviously part of how social media and the internet themselves work and cannot be reduced to individuals at all. If social media didn’t exist, but every music shop in the world sold copies of Gangnam Style one day, would people have bought it? There is clearly another factor at play here that isn’t just peoples’ traits.

There is a motion that fake news, transmitted by social media, was a large factor in recent political events. You might think that this is an example of a break from the worldview above because it is laying blame at Zuckerberg’s feet. Maybe it is, but this analysis, again, seems to be about the content traveling around social media rather than the system itself. The system is at fault in that it contains this type of content. It is recognised that social media creates filter bubbles in which our view of the world is coloured to match our outlook, biasing our opinions. Again, this looks at the situation in terms of individuals. Social media biases the individual, or more accurately the individual biases themselves using social media, which manifests itself as a societal bias. Social media is just providing a way for individuals to do what they as individuals want to do, but if that is true there is no bias… ta da!

This is, I’m sure, a factor but it’s an incomplete story. Social media filters content based on two broad factors: the user’s interaction with it and marketing revenue. So if we like things that steers social media’s shaping of the filter bubble but what we like is a function of our social interaction, which is itself mediated by social media and distorted by our filter bubble. It might sound like I have added nothing to this analysis. The first says “A affects B”. Mine says “A affects B which affects A”. I’ve just pointed out a feedback loop made from the same elements, but that feedback loop is an important extra element. Put a feedback loop in a speaker-microphone system and you get a loud, shrill whine, right? That screechy noise isn’t a product of the singer, or the mic, or the speaker, or the cables; it’s a product of those things combined. It’s exact pitch is a product of the properties of all of those things and it’s volume is a product of their interaction. You can sing a different song but you’ll still get the same pitch. The only way to get rid of it is to get rid of the feedback loop.

We all see definite polarisation on most important issues. The standard analysis is, again, that two groups form, and the difference in opinion between the two sums to the outlook of the society. And again we are ignoring interaction. What people miss out is that both sides have a vested interest in portraying the other side as as crazy as possible. So most of the examples of either side are actually picked out by the other side. Those articles about air conditioning being sexist, a woman with 40 kids on benefits, people complaining about a movie poster, outrage about this and that, political correctness gone made, are in every case minor incidents involving a handful of people selected by the other side and made viral. Then the analysis that follows is based on data handed over by this process. Apparently the worlds leading experts on gender equality are all well-off white men who think that feminists are all men hating nut-cases; a conclusion based on a biased view of the world provided largely by a social media system designed to respond to those opinions by shaping its filters to make the world look more like that view!

In technical science systems with feedback loops have a mathematical property called non-linearity. They’re called complex systems because they have complex and often weird behaviours. The properties of these systems are well understood by people whose opinions no one cares about, and are unknown unknowns to a huge number of people whose opinions that shape our society. You probably aren’t aware of this but the idea of strong reductionism is axiomatic to all neo-classical economics, which includes all the ideas about how economies function in official practice right now. It’s embedded in the university curricula studied by many of our government ministers, although to be fair they probably didn’t pay much attention.

…in the UK that is.

I will take democracy to mean “implementation of the policies of the population at the government level”.

Some might think that democracy is a kind of ideal pinnacle that we’re systematically working towards, or at least someone is, and that I am just setting my threshold too high. I don’t see “implementation of the policies of the population” as futuristic ideal form of society beyond our practical abilities, do you? It’s an obvious starting point not an ambitious end point. In any case I will point out some factors that, to me, show that our society is not only way off that definition but shows no evidence of progress toward it, and in some cases has moved away from it in our lifetime.

1) The Electoral System is a Mathematical Joke

At school we were taught to “always leave rounding to the end!” At least, I was. Maybe it’s different at Eton. If you are doing some kind of arithmetic procedure you should never round up or down until the very end of the sum. This is because rounding introduces errors, errors that add up. Our electoral procedure ignores this basic maths lesson and rounds up or down at every constituency; creating rounding errors that add up. The resulting range of error is so big that the election result is effectively irrelevant. We may as well roll some dice.

Constituencies hold, by convention, about 70 000 people. The last election’s turn out was about 50% so to secure a clear majority in a constituency only about 16 000 votes are needed (assuming they need half the votes cast, which is an over estimate). The commons is about 650 chairs so 326 seats is a majority. That means that, in ideal conditions, a party can get a majority with 5.2 million votes. On the other hand, imagine that a party gets 5.2 million votes but they are all won in the minimum number of constituencies. With full turn out (in those constituencies alone) that gives them just 74 seats, meaning that 12% of the population’s votes can secure a party anything from 11% to 51% of the commons depending on turnout and geography.

Of course these are two extremes but that’s the point, the range of error is gigantic. Although, interestingly, it’s not quite big enough for small parties to quantum leap to the top and threaten the two main parties, but it does raise the serious question: are our two main parties are Heads and Tails?

Incidentally, there has been talk over recent years of the House of Commons being too big (under the banner of being too expensive). Making the Commons smaller would make this rounding error even worse because constituencies would be bigger.

2) The House of Lords

Every act passed by our parliament starts with the following (emphasis added):

Be it enacted by the Queen’s most Excellent Majesty, by and with the advice and consent of the Lords Spiritual and Temporal, and Commons, in this present Parliament assembled, and by the authority of the same, as follows:-

For a piece of legislature to be passed, that is, for a law to be enacted, both the Lords Temporal and Lords Spiritual must give consent [1]. The Lords Spiritual were given their position by virtue of being in particular positions in religious orders. No democratic process there. The Lords Temporal used to be people whose ancestors were made Lords by the Crown for some arbitrary reason, winning battles or whatever. Nowadays people can be made “Life Peer” without any democratic process. Once made a Lord it’s permanent. You can’t even retire. The only way to get out of the House of Lords is to assume a meaningless title that they reserve for that purpose that has no obligations.

Earlier I mentioned talk of the Commons being too big. The House of Lords is bigger than the Commons and I don’t think there is talk of it being reduced in size.

3) Manifestos Are Not Binding

No-one knows what MPs are really supposed to do. They have no job description. They are supposed to represent their constituency but they are under no contractual obligation to do that at all, and party politics messes with that commitment because they are expected to go along with the party position. There is no formal process to make sure MPs actually do whatever their job is supposed to be, or even what they say they intend to do. There is also very little actual tracking of what MPs do. The don’t publish time-sheets (a basic concept in all project management). They can have meetings with lobby groups often without any mechanism for is to find out. Similarly parties are under no legal obligation to even enact their own manifesto. Not only are they free from such obligations, they aren’t even obliged to tell anyone the truth about their activities or whether their policies are having the claimed effect.

The severity of this deviation from democracy is made greater by the fact that there are plenty of other situations in which people are legally required to tell the truth. The lying of politicians is taken as another one of those laws of nature that we have to live with.

MPs only have to get us to believe that they will enact our policies but once elected they are free to do whatever they can get away with and lie to our faces about it. They can deviate from their own promises and face no discipline except the threat of losing their seat (which doesn’t apply to more than half of parliament), and they can avoid losing their seats using the same non-democratic tactics mentioned. No one is tracking whether MPs parliamentary voting is reflective of their constituencies’ wishes or just their own ideology or career strategy or personal influences.

In a real democracy a politician would have to agree to a binding policy document and would be removed the instant they deviate from it. Unfortunately we have been trained to believe that democracy means accepting vague non-binding manifestos and that once we have elected someone removing them (for not delivering it) would be anti-democratic!

You might point out that ministers can’t enact laws on their own. Even with a majority there is no guarantee that a parliamentary vote will go the government’s way so it is unfair to expect MPs to always be able to enact their own manifesto. This is true but this only applies to legislature, and a majority government will likely get it’s own way with that. It raises the question though: why promise things you don’t ultimately control? The answer: because they can promise whatever they want. It’s not binding.

4) The Economy Is Not Democratic

If democracy involves consideration of factors that affect our lives then modern democracies have a blind spot: the economy. The general principals that govern the economy affect all of our lives but could not be further from democracy.

One of the reoccurring splits in modern politics is between left and right, using various names, which often reduces to a single question: should the economy be democratic? Liberalisation of markets, corporatisation, limited liability, property rights and shareholding are all attempts to make the economy less democratic. Labour unions, co-operatives, legislation, the modern public sector are attempts to make the economy more democratic. Socialism itself is the principal that working in a company gives you the right to control it.

The number of people that control the majority of the economy is tiny, and they answer to no one because the idea of real democracy is so alien to us that we never even consider it an option when it comes to the economy. The very use of the word “economy” has become a strategy to present it as a force of nature that just is with internal rules that just are, not something that even qualifies as being considered a democratic matter.

We can debate whether the economy should be democratic, but we honestly can’t claim that it is.

If you work you almost certainly do not control the company for which you work. You give your finite time on earth to a project, there is a good chance you give more time than the owner, and yet you probably have no say at all over anything that that company does. Sure you can influence, of course the owner(s) might chose to listen to you, but the legal reality is that you have no control over how your efforts effect with world. Anyone can be fired/hired without you being consulted. How the company’s resources are used, who they sell to and buy from, how they treat people, even whether the company actually functions, are all beyond your control.

Here the deviation from democracy goes beyond practice. The religion of the market has made it undetectable at a psychological level.

5) The Political Ladder

It’s important to make a distinction between how you play a game and what the game is. Some things can be achieved by playing the game differently, but some things cannot be achieved because of the way the game itself is designed. The game has to be changed.

A person has practically zero chance of becoming an MP, let alone a minister, unless they affiliate with an established party. Parties have practically no chance of forming a government without serious funding, either directly or help-in-kind like having a media empire not destroy you, or having a few shareholders not threaten to destroy an industry when you get in power.

The process of going from child to cabinet minister ensures that only people with specific beliefs and ideologies get anywhere near their final goal. This isn’t to say that politicians are being bought (they are) but rather that only the right personalities are allowed to climb the ladder. Who is designing this screening process? I suspect that this isn’t entirely by design, for example, high ranking MPs having psychopathic levels of manipulative skills and emotional detachment is more likely a happy side-effect than an intentional strategy, but who knows?

Whether you accept that this filtering process is as I describe is one thing but if you think that what I have said is some kind of conspiracy theory then consider that three quarters of our cabinet are millionaires. Or consider that the government’s perpetual commitment to subjects like Science, Technology, Engineering and Maths and then note how few cabinet ministers come from any of those backgrounds. The discrepancies we see occurring in a democratic process would be an astronomically unlikely coincidence.

Remember that none of this is nature, these are systems created by us either intentionally or via absent-mindedness. The fact that many of these things are not even open to discussion raises serious doubts about whether we live in a democracy. The thing we refer to as our “democracy” is really a set of systems that exist to make us believe we live in, or are progressing towards, democracy.

[1] There is an exception to this in the Parliamentary Acts but they have only been used a handful of times.

I often think that if people knew what our governors really believe, or are willing to pretend they believe, about how our country works they would be horrified. The theories that form the basis of the political class’ framework for managing our country are mostly superstitions and religious nonsense, but the topics are so convoluted and boring that they’ve managed to keep it all a secret. This smokescreen around their beliefs has created a kind messy, self-contradicting, cartoon reality that can be twisted and shaped to fit any story, which is exactly the way politicians, all politicians, like things to be. Politicians would never risk reality coming into their discussions if they can help it.

I just overheard a man from the Guardian newspaper on TV, on a discussion show, say to the audience members “the deficit on all of your pensions will be £75 000!” I have no idea what he could possibly think that means.

Luckily, I have a high threshold for convoluted, boring subjects. In these religious ideas there is a particularly crazy idea. One that they will never let slip. They think that unemployment is necessary.

This idea is interesting because it really shows everything that has gone wrong with how we run our country, but first thing’s first, why do they think unemployment is necessary? The reasoning is this: if there were more jobs than people the companies would have to compete for workers, this would force them to offer higher wages to get staff. Higher wages mean higher costs, which means higher prices. Higher prices is called inflation and inflation is like the devil incarnate to economists. So if you eliminate unemployment you unleash the inflation monster and you destroy the economy.

Now this misses the obvious point that prices might be higher but wages would be too. If everything costs twice as much but wages are twice as much then any inflation just cancels itself out. So what’s the problem?

The problem is that there is a group of people who earn money, not by being paid wages, but by capital investment (which is a technical term for “owning stuff”, another one of those smoke screens). For those people wages are a cost they pay to maintain those capital investments. For example, if you own a stretch of land that you rent out you might have to pay people to look after it. Those people have a vested interest in wages being as low as possible. Those people also have vast amounts of money from centuries of capital investments, they could pay people wages with that money or they could spend a fraction of it to buy politicians and theorists to write and spread nonsense scare stories about what will happen if they don’t get what they want.

The result of this is everything we see. Wages have been held down for decades while returns for capital investors have increased. Wealth, and therefor control, is being concentrated into a smaller and smaller fraction of the population. At the top of the pile we have a financial sector that engages in no actual production, their capital is imaginary, hires very few people, and yet commands extraordinary profits for the people who own that capital. The government is implementing policies designed to cause unemployment.  When the government increases interest rates they do it because they believe it will slow down economic expansion, that is, stop people doing new productive activities, because they are afraid, or say they are, of runaway inflation. The most extreme measure is austerity. New jobs require new pounds. New pounds come from the treasury deficit. Austerity is designed to stop the creation of new pounds and thereby limit how many new jobs the economy can finance. They want to maintain what they call a “buffer stock” of workers to ensure employers can always find someone cheaper.

Immediately after the Scottish Independence referendum Nigel Farage complained that the UK government “made a promise to maintain the Barnett Formula whereby the UK taxpayer spends £1,600 more on every Scot than on every English person”. This kind of factoid is the sort of thing that immediately pisses people off. The problem is that it’s a nonsense figure that refers to nothing meaningful and hides far more important information.

If government spending consisted entirely of paying money directly into people’s pockets then he might have a point. Some is spent that way, of course, but, as everyone is well aware, a huge chunk of government spending pays for goods and services. There would be no point in the government paying people just to pay taxes. The government wants certain things done. For example, a large part goes to the NHS. The NHS then translates that money into a health services. The taxpayer then receives those services, not the money. The NHS provides those services by spending it’s budget on provisioning the goods and services necessary to provide health services. Ultimately the money it is budgeted ends up in the revenue stream of companies that provide it goods and services, some of which will end up in people’s pay packets and some of which will end up in share holders’ and owners’ pockets. Those share holders and owners could be anyone, anywhere. They could, and statistically are likely to be, in London. They could be in the US. The fact that the initial spending is geographically, in a sense, in Scotland has almost no baring on how the money filters down to people.

Another fact is that cost structures vary. So, say for the sake of argument, that for some reason transporting things is more expensive in Scotland. Maybe because of all of the hills. That means that provisioning of services to the public via the public sector will incur higher costs, say, to pay for extra fuel. That extra payment would show up, again, in the revenue stream of a company, in the case a multinational energy company. Or more precisely some weird holding account system somewhere so that shareholder profits can be maximised. Again, where the money ends up is a matter of topology of the economy, which has almost nothing to do with geography.

It might be, arguably, more reasonable to look at spending per head at the whole-nation level, but that figure is largely meaningless as it could be anything. Working out where money really ends up would, as far as I can tell, be perfectly doable. What makes it hard is that we would need access to data on where companies spend their money and, specifically, who all the shareholders are. That data might be available, partially, through public audit records, but we have no intention of really knowing because that might be too revealing. It’s far better to use nonsense metrics like spending-per-head.

Put plainly there is a good chance everything you have been told about how our country, or other similar countries, function is pure fiction. Like a lot of my posts, I think, I’ll start by saying something that seems, at first, ridiculous and counter-intuitive but bare with me…

I am going to talk about three functions of the government: taxation, spending and borrowing (a.k.a. government / public debt). The biggest lie we are told, and largely believe, left to right, is that these three things are interrelated. In reality they are not operationally related in any way. They are related in the sense that they form parts of a strategy employed by the same governing body i.e. the government, but they are completely distinct mechanisms that exist to meet distinct objectives. Those objectives, again, form parts of an overall objective, but that is at a strategic level, not an operational one, and completely different to what we are told.

The intuition goes that government spending is funded by taxation and shortfalls met by borrowing; adding to the public debt. The debt must be financed by future taxation or more debt. The government cannot spend without raising finance from taxation or borrowing. This intuition relates to nothing in reality, and is based on straight-up lies and a few misrepresentation of facts.

Taxation and Spending

The government’s ability to spend is in no way linked to tax receipts. Have you ever gone to a cash machine and got a second hand note? No? Why? Banks buy cash from the Royal Mint. They don’t buy second hand ones, they want new ones. If you take your cash to the Treasury to pay a tax bill they just throw the money away. It doesn’t go into a pot or an account or a fund… it just ceases to exist. The treasury could keep it and they could reuse it, if they wanted to, but they don’t have to and usually don’t. Why? Pounds are of no value to the UK government. They can issue as many of them as they wish, whenever they like.

If the government wanted to build a hospital or pay housing benefits, or whatever, they just credit bank accounts and pounds appear. That’s it.

Debt and Spending

So if the government can (and does) simply issue money when it spends why are we told that the government incurs debts? The government does incur debts, that’s true, and those debts do show up on the government’s balance sheets because they are financial entities that need to be tracked. The government, however, doesn’t need to incur debt to spend. It’s ability to spend is not linked, at all, to the sum of it’s debt and tax revenue. The idea that the government incurs debt to allow spending is, again, a pure lie.

Why does the government Tax, Spend and Borrow?

Borrowing

So, if the government doesn’t need to tax or incur debt to spend why does it tax and incur debt? In order to understand this and to see what the core of the misunderstanding is (and how it’s exploited) you first have to realise that the government is not part of the economy in the way private firms or people are. If the economy were a game the government would be in god mode, if the financial system were a game the government would be the score keeper. The government has it’s own rules and it’s own limitations, of course, but those rules and limitations are not commercial or market based and fall outside of what is generally referred to as ‘the economy’. Much of the confusion about all of this comes from the insistence that the government is part of the economy and is like a firm or a household.

The government does have to interact with the economy if it has any chance of doing anything effective. Once it interacts, it’s actions take on the form of economic or financial operations. This is why the government incurs debt. Or at least debt is one of the ways it chooses to interact with the economy. It lends, it borrows, it buys, it sells. It has bank accounts and asset sheets. The government debt is really just one channel for controlling the level of reserves (bank money) in the economy and controlling interest rates. It shows up as a ‘debt’ on the balance sheets. The government is constrained by the basic principals of accounting, which is why it can be said to have a balance sheet with a huge liability on it called debt.

The mechanism of government debt is familiar to you: it’s a huge collection of savings accounts. A savings account is when you give someone some money, they keep it for a while and then give you it back with interest. The treasury offers this service to banks in the form of bonds. The treasury sells bonds to banks and receives money (reserves). When the bond matures the government will buy the bond back at the sale price plus interest. The government does this to effectively bribe the banking sector into temporarily giving up some of its reserves for a short time. This, in financial terms, reduces the banks liquidity (that is their money is tied up and therefor less liquid). It also gives the government a channel to pump new reserves into the banking sector in the form of interest payments on the bonds. Banks buy government bonds simply because they can earn more interest than whatever else they were doing with the reserves. Doing so ties up their reserves. That’s why they offer savings accounts to us. We send money to the bank, the bank sends the money to the treasury (by buying a treasury bond), they take a cut of the interest earned and give us what’s left in the form of interest payments to us.

So, all in all, the  total government debt is the sum total of our savings accounts. It’s our asset and the government’s liability. That’s it. Not a big terrible monster that’ll engulf the world.

The government chooses to give the banking sector a high interest / low liquidity option and chooses the terms. It’s debatable whether it is necessary to do so and how it should be done. What isn’t a matter of debate, however, is that firstly the government can continue making interest payments of any amount forever and never become insolvent. Secondly, it can do so without ever needing to increase taxes. And thirdly, it chooses the interest level it pays, and can choose any, including zero. One of the (intentional) effects of the government doing this is that it sets the minimum interest that can be earned lending reserves out. This is because if a bank can get 5% interest by giving their reserves to the government why would they give them to someone else for less? In this case the government is intervening in the market to push the interest rate above zero. Note that the government could, I think, stop doing this. We would still have savings accounts because the banks could still offer them. It’s just that the base interest rate would be at it’s natural value: nothing.

Taxation

The primary function of taxation is to create demand for the pound. That’s it. So long as the tax burden is big enough to ensure sufficient demand for the pound then taxation is doing it’s job. The government could arguably choose, far valid reasons, to increase taxation if it needs to suck money out of the economy (for example if the economy is expanding too quickly) but of course that’s never given as a reason to increase taxes. The secondary function of taxation is to steer economic activity, for example, putting taxes on certain things to reduce demand for them. These two functions are distinct. For the first, the overall number is what’s important, for the second it’s the specifics that are important.

There is a very clear indication that this is true. No matter how broke the UK government says it is, no matter how committed to austerity they are or how desperate they are for cash, have they ever even mentioned the possibility of you paying your tax bill with gold, or dollars, or bit-coins? Why not? They could spend those things, right? Surely everyone has old gold stuff they can get rid of to pay tax bills or fines. So why don’t they? Well, if they did they would risk destroying the economy, literally. Using the tax system to raise demand for bit-coins instead of pounds would risk making pounds worthless. The government wouldn’t have to radically increase it’s spending as the value of pounds drops. In the worst case the value could drop to zero and the government would cease to function. Public services would fail and the country would be a mess*. Sovereign currency systems that fail to maintain a tax burden always collapse.

Spending

Perhaps the most surprising thing about all of this, the thing that might be hardest to swallow, is that government spending doesn’t cost you anything. Of course the government could demand tax revenue to cover the cost of spending, in which case you are being charged as a result, but there is no inescapable reason why it has to cost you anything. At all. For example, the government pays for a hospital to be built. A new hospital is built. Did that cost you anything? It is possible that the resources being used to create that hospital are in limited supply, so the government bidding for them could push their price up. If you need those resources then you will have to pay a higher price (which is a very loose conception of ‘cost’). If you are selling those resources you will earn more. If you earn more you will have more money to spend on other things. If the resources used are not in limited supply then new resources will be sourced, in which case there couldn’t be inflation because there would be an increase in both supply and demand. This rough outline is about as far as mainstream (and Austrian) economic theory gets you. There are also lots of other indirect costs and savings that are hard to quantify but very important. For example having an extra hospital could save countless worker-hours lost through illness. The point is that it depends on the situation and the complexities of who supplies what to whom and why and the spending habits and interests of those whose incomes are altered. Unfortunately economists as yet have provided no way to model this outside of ludicrously unrealistic and simple thought experiments carried out in their individual heads, so don’t have much to add to the matter.

 

 

*Incidentally, if this were to happen, many economists would point to the inflation, blame it on government spending, and say “We told you so! Government spending causes inflation!”, not realising that the order of causation is the other way around.

 

My last post argued that the thing that issues money, whatever it is, necessarily runs a deficit (given the normal definition of ‘deficit’.) Some will disagree with what I posted on the grounds that I misrepresented how money is created. The will argue that banks create money, and lend it to us and the government.

It could be argued, given a narrow view, that banks create money in the sense that if you go to a bank and ask them to lend you a grand, you get a grand to spend. It’s more accurate, however, to say that banks create spending power, or what economists call demand, not money. The create promises to provide pounds, not pounds. In order to see why you just have to look at any bank’s accounting system.

Firstly, banks can create money. Anyone can. That’s why I’m talking about Pounds, not money in general. There is a key difference. Pounds are issued by, and can only be issued by, the British Government. That’s really what a Pound Sterling is. So why do some people believe that the thing that issues pounds has to borrow them? Who knows. I suspect, mostly, propaganda. Anyway, what happens when you borrow a grand?

The bank creates a deposit account with a grand balance. To the bank this is a liability, because you can demand it at any time. The transaction also creates a debt, of a grand, issued by you. The bank now has a liability and an asset, each worth exactly the same. The bank’s balance sheet total is unchanged. You, if you are keeping standard accounting records, now have an asset in the form of a deposit account and a liability in the form of the debt you owe the bank, both worth the same, so your balance sheet total stands unchanged. 

The situation has created no money. Neither yours nor the bank’s balance sheet has changed. Further, if we add interest in then not only has the bank not created any money but it’s also absorbing money from you. This shows up on the bank’s cash-flow account in the form of interest payments over time. So balance sheets are unaffected while the bank’s cash-flow is net increased while yours is net decreased. So how can this create money? It can’t. You have to pay more money back, where do you get the money? Other bank loans? Pay from employers? Where do they get it? People like you? Other banks? There is no part of this in which banks create pounds because they simple can’t. Of course this is obvious when you realise banks are businesses. If they could issue pounds why do they bother doing anything? They could just issue themselves profits. They could open themselves huge deposit accounts, but if you look at the above that would result in net zero on both balance and cash-flow accounts. Ultimately banks are interested in making useful money, like Pounds, which they can’t create. 

What if you go to the bank and withdraw your grand? Simple, the bank gives you some of the cash it had lying around. Where did it get that cash? It bought it off the Royal Mint, paid for out of their reserve account at the Bank of England. Similarly, if you want to send your pounds to another bank (for example if you bought something of someone that has a bank account in that bank) your banks sends reserves to the other bank. In both cases the banks loses both an asset (reserves) and a liability (part of your deposit balance), worth the same amount: the amount you withdrew or transfered. Net zero to the balance sheets, but your bank retains your interest cash-flow. Banks can’t issue themselves reserves. They get reserves, ultimately, from the Treasury. Usually this is achieved by the bank buying bonds off the Treasury that pay interest.

Many have a bizarre interpretation of banking by looking at the fact that the treasury issues bonds and conclude that the treasury is ‘borrowing’ and running a deficit to fund spending, while the money creator is really the Bank of England (funnily also a branch of the government anyway), which runs no deficit, and that the treasure simply prints cash and mints coins. The BoE runs no deficit because it is funded by the Treasuries deficit, issued via bond sales. The treasure creates the pounds that the BoE puts in commercial banks’ reserve accounts. The process of creation takes the form of bonds, that’s all. 

This is why the talk of ‘government debt’ is misleading. A large chunk of the government’s deficit takes the form of debt in accounting terms because that’s how the Treasury choses to control the reserve level in the banking sector, it’s not even funding spending, the Treasure can just spend pounds out of nothing, this is how it pays for… everything. If the government wants to pay benefits, build a hospital or a road or a train track or a tank, it just puts money directly into a bank account: no borrowing. The ‘debt’ part of the deficit is just the sum total of treasury bonds issued by the Treasury. The interest that the Treasury pays on those bonds is just the total cash flow of new money creation (minus money created through real government spending), and is entirely optional*. The government could pay zero if it wanted to, and it can pay whatever it wants because it can just create the pounds to pay for it. There is no funding / debt servicing problem. It’s just a matter of choosing the rate at which to create new money.

*in fact the Treasury only pays interest on these bonds to limit interest rates. If you take out a saving account your bank funds that with a Treasury bond. The bank wants to make a profit so it takes a chunk of the interest it earns and gives the rest to you. If the bank took no cut at all, then you would get what the Treasury is paying, so that is effectively the limit your savings account will pay (unless the bank decides to run a loss).

The key to understanding how our economic systems work is really to realise that most of what is said about it is irrelevant bullshit. The more I learn about our money systems the more I realise that it is, as a high-level system, not very complicated and easy to understand. That isn’t the same as saying it isn’t complex or that it’s easy to predict. You shouldn’t confuse complicatedness with complexity. Take, as analogy, the weather. Weather systems are complex but despite that you can still take it for granted that it’s colder when it rains. There’s no hidden property of weather systems that messes up that simple rule, and you don’t need to model precise rainfall to come to that conclusion (except, perhaps, rain falling through a volcano eruption).

Which is why, to me, the title of this post isn’t controversial. It fact it’s about as insightful as saying “circles lack corners.” It’s really just a deductive statement about what the words in it mean:

The thing that issues money, whatever it is, is running a deficit.

This throws a spanner in the cogs of those who take the position in favor of what is called either monetarism or austerity, depending on your memory span. Everyone aggress that we need money. It seems a pretty effective means of resource management. No-one has had a better idea. But, many are ideologically apposed to state spending. At the extreme end there are those who want a metal standard implemented in order to make it impossible for the government to run deficits over the long term, requiring them to fund deficits with surpluses.

Imagine: The gold standard is in effect. You go into your garden, stick a shovel in the ground, and pull a pound’s worth of gold out of the earth. Let’s say you have a magic machine that turns it into a pound coin for free. Now, it’s not in circulation until you circulate it. You have two options: spend it or give it away. Pick one. You just ran a £1 deficit.

I think the first instinct, for most, would be to point out that you bought a pound’s worth of stuff. That is true, but that would be a real asset. Real assets aren’t part of a deficit, which makes sense given that they have no price until they flow. A deficit is negative cash flow. Money in minus money out. Of course the word ‘deficit’ can be used to mean anything, but it has a technical definition, and that is the definition used when people refer to the government’s deficit. If you don’t believe me go and check your government’s treasury FAQ.

The eagle eye might be drawn to the point that, although you lost £1, you gained £1 to start with, so your cash-flow is zero. This is shady given that the pound doesn’t sit anywhere on a cash-flow account, you didn’t gain it through a transaction, you just issued yourself it. Anyone can issue themselves money whenever they want, it doesn’t usually show up on a cash-flow account. But even if that argument holds then you’ve just proved that the government isn’t running a deficit, because it creates the pounds that fund it, else how could it spend them?