As lockdown measures ease, people return to work, and retailers open their doors once again, a big question is looming large in the background.
How are we going to pay for all this?
I am of course talking about expensive government policies such as the furlough scheme, small business rates relief grants, bounce back loans, self-employed income sustain payments, and the many other measures which were introduced to try and nurse the UK economy by the devastation caused by the Covid-19 pandemic, and associated lockdown.
The traditional knowledge is that public spending will have to be drastically decreased (which would harm public sets), or taxes significantly increased (which would likely harm growth), in order to make a dent in the debt mountain which has piled up over the past few months.
For example, on July 11th 2020, The Observer published an article by former UK Treasury minister David Gauke, which was entitled ‘Tax Rises and Cuts Only Way to Pay for Covid-19’.
In it, Gauke stated that, ‘Once we are by the economic shock, the government will have to fill this gap with tax increases or spending cuts.’
Similarly, in an article published on the BBC website on July 9th 2020, which was called ‘Coronavirus: How much will it cost the UK?’ a conclusion of the article was that, ‘The deficit leaves the government with a choice: increase borrowing, raise taxes, or cut spending.’
However, the traditional wisdom is sometimes incomplete at best, and thoroughly wrong at worst. For example, it was once traditional wisdom that Earth, and not the Sun, was at the centre of the solar system.
In terms of the post Covid-19 recovery, inaccurate traditional wisdom has reared its head once again.
How To Make Money… Quite Literally
At this point, it’s worth remembering that money is a man-made construct.
Pounds, Euros, Dollars, or anything else, these currencies have all been produced from scratch by human societies, in order to assist with the exchange of goods and sets of value.
Also, if you were to ask people how money is produced, most would probably suggest it was printed by the Royal Mint in the form of notes and coins.
This is true, but only to an incredibly small degree.
In actual fact, over 97% of the money in the British economy (and the figure is similar in almost all industrialised countries) is produced when commercial edges (e.g. HSBC, NatWest, Santander) issue loans to their customers.
A 2014 bulletin by the Bank of England entitled ‘Money Creation in the Modern Economy’ stated this very clearly. The exact words they used were:
Where does money come from? In the modern economy, most money takes the form of bank deposits. The principal way in which they are produced is by commercial edges making loans: whenever a bank makes a loan, it creates a place in the borrower’s bank account, thereby creating new money. This description of how money is produced differs from the story found in some economics textbooks.
This course of action of ‘creating a place in the borrower’s bank account’ is as uncomplicated as it sounds. Perhaps already more so.
It simply method that the bank approves a loan, then types the numbers of the loan amount into the customer’s bank account. the time of action is thoroughly digital; no physical money has been produced or exchanged at any point.
This has several implications.
Firstly, it method that individuals and businesses receiving loans from commercial edges is the source of nearly all the money in our economy. To put it more starkly – without people taking on bank debts, there can be no money.
This puts a different spin on the concept of ‘the irresponsibility of debt’.
I’m sure we all know of people who have taken out a bank loan, and then wasted it on unimportant things. Often, we estimate these people, calling them irresponsible or indulgent, and perhaps they are, but whenever anyone takes on bank debt, we too owe that person a kind of debt, as their taking out a loan has increased the amount of money in the economy which can be earned, spent, and taxed. This in turn method that a country’s Gross Domestic Product (GDP) will likely rise as the money supply increases.
‘But Why Has No-one Told Me This Before?’
If the truth about money creation was news to you, you’re not alone. The overwhelming majority of the general public don’t know how money is produced, and a 2017 poll by the campaign group Positive Money found that already 85% of MPs were unaware.
However, once you understand that money can be produced out of thin air, with the push of a button, the argue on how to pay off the debts accumulated during the response to Covid-19, seems rather different.
This is already more true once you understand how central edges work.
Central edges are the national edges of specific countries. For example, in the UK, the Bank of England is our central bank, while in the USA, it is the Federal save, and in the EU, it’s the European Central Bank.
Nearly every country in the world has a central bank, and much like commercial edges, they have the strength to create money out of nothing – although central edges have the additional responsibility of trying to ensure the economy as a whole stays healthy.
But while commercial edges lend money to businesses and individuals, central edges mostly lend money to governments, commercial edges, and other financial institutions.
The ability of central edges to create money and lend it to their national government, is of particular interest.
‘There’s No Magic Money Tree That We Can Shake, That Suddenly Provides For What People Want’
Those words were spoken by Theresa May on June 2nd 2017 when appearing on the television show Question Time, in response to a nurse asking why she hadn’t had a pay rise in 8 years.
And she was right; we don’t have a magic money tree that we can shake to raise money.
The truth is, it’s much easier than that.
All over the world, central edges have the strength to create new money, which can then be used to pay for at all event is needed. And they certainly do use this strength, although not in a way which benefits the general population as much as it could.
For example, in the UK, the Bank of England produced £456 billion of new money between 2009 and 2017 by the use of quantitative easing, and this money went straight to commercial edges and other financial institutions, instead of into the hands of individuals or SMEs. Furthermore, none of this money has ever been repaid.
More examples of money being produced to serve privileged interests, have come as a consequence of the Covid-19 pandemic.
A case in point, is the Bank of England’s Covid Corporate Financing Facility (CCFF), which has provided £58 billion worth of newly produced money to some of the UK’s largest companies, including Easyjet, Greggs, and First Group.
In fact, the CCFF is not already obtainable to small and medium sized businesses, as the terms of the scheme average that, in effect, only the UK’s largest corporations are eligible for it.
Another example comes from the US Federal save, who, in the early months of 2020, injected over $2 trillion dollars of newly produced money into the American financial markets, in order to try and prevent a recession.
This proved successful to a large extent, but sending the funds directly to investment edges and corporate financiers method it is highly doubtful much of this money will filter down to ordinary working families.
Proof Of Concept
While much of the money which has been newly produced by central edges in response to the Covid-19 pandemic has gone to the corporate class, the creation and dispensing of these funds has at the minimum shown what can be done.
Namely, money can be produced from scratch by a central bank, and injected into the economy where it’s needed most. Indeed, the concept of a nation’s central bank creating new money to finance government spending, is not a new one.
It is a policy known as Direct Monetary Financing, and some influential supporters of Direct Monetary Financing include the economists Milton Friedman, Adair Turner, Willem Buiter, Jordi Gali, and Ben Bernanke, who was Chair of the US Federal save between 2006 and 2014.
The Bank of England has in fact always had the strength to create money for the UK government to use in whichever way it sees fit, and sometimes this strength is used. More specifically, the account which the government has with the Bank of England is called the Ways and method facility, and every so often these two institutions work together to create new money, that the government can use to pay for the additional expenses which arise during challenging circumstances.
For example, following the 2008 financial crash, the size of the government’s Ways and method facility (i.e. the amount of money the Bank of England produced from thin air to assist with the government’s spending requirements) was nearly £20 billion.
And as a consequence of the Covid-19 sudden increase, the UK government has already worked with the Bank of England to create new money, which will be used to help finance the government spending programs that have been introduced to protect the British economy by the pandemic.
Confirming this, a press release published by the Bank of England on 9th April 2020 announced that they had granted the Treasury a ‘permanent extension to the Ways and method facility’ to help the government ‘smooth its cashflows and sustain the orderly functioning of markets, by the period of disruption from Covid-19’.
However, the Bank of England also said such an extension would be, ‘permanent and short-term’.
When reporting on this announcement, the Financial Times ran with a headline of ‘Bank of England to directly finance UK government’s additional spending’.
Making It Rain
So if money can be produced by the government and the central edges at will, then why is this strength not used more often to better fund the public sets which we all rely on? Indeed, as Positive Money noted, the Bank of England creating money for the UK government to use during the Covid-19 crisis, ‘demonstrates once and for all that the government need not depend on private markets to finance its spending’.
In short, if the NHS is low on funds, if schools are lacking resources, or if the police don’t have the equipment they need, then why can’t the government order the creation of more money, so all these things (and more) can be afforded?
Generally, the answer provided is that doing this would increase inflation.
This is not incorrect, but it is by no method assured that increasing the supply of money in an economy will make the goods and sets more expensive.
The slightly hysterical examples of Zimbabwe and the Weimar Republic are sometimes used as situations where the government creating money for itself to use has led to hyperinflation, but when looking closer to home, both in terms of location and time period, it is easy to observe different outcomes.
Firstly, it is important to observe that new money is entering the economy all the time, as a consequence of edges providing loans to their customers, foreign investment capital flowing into the country, and governments borrowing money from financial markets to fund their public spending commitments, however whenever money from these supplies enters the economy, the argument is never made that the increase in money supply will cause inflation to rise. And at times when inflation is high, rarely is the finger pointed at the money supply being too high.
Furthermore, as noted earlier in this article, the Bank of England produced £456 billion of new money between 2009 and 2017 by the use of quantitative easing, however inflation only rose by 2.77% a year on average in the UK for the period between 2009 and 2020. In terms of historical inflation rates for both the UK and other developed economies, this figure is remarkably low.
In fact, as a consequence of lockdown measures having reduced the amount of money being newly produced by commercial edges granting loans (such as mortgages or startup loans etc.) over the past few months, some economists argue that we now have the opposite problem in the form of deflation, and that what we need now more than anything, is a fresh supply of money entering the economy.
For example, David McWilliams, a former economist at the Central Bank of Ireland, has said that:
We have an economic vaccine – it’s called money. We know the central bank prints it. It doesn’t already have to print it, it just has to put a zero after people’s accounts.
We have the vaccine, we know what to do. And amazingly, we’re not using it because of some morality idea that we can’t do this because it will rule to inflation, when we know we’re in a deflationary spiral.
It is absolutely nonsensical. It is as mad as a laboratory having the vaccination for COVID-19, and saying “we’re not going to use it.”
While Canadian historian Quinn Slobodian has noted of the US Federal save injecting newly produced money into the American economy, ‘Economists see no sign of inflation on the horizon. Some have become concerned about inflation in recent weeks, but others worry about the opposite – deflation.’
The Path Not Mentioned
Returning to the quotes at the beginning of this article from David Gauke, and from the BBC, about how the only options on offer to pay for the additional government spending that has arisen from the Covid-19 pandemic, are to raise taxes, increase borrowing, or cut spending, it should now be clear that this represents an incomplete set of choices.
One of the other options, which has been outlined in the article, but which (for one reason or another) is rarely mentioned by politicians, or by the media, is simply for the Bank of England and the British government to work together and create enough new money that the bulk of the Covid-19 spending commitments could be met by Direct Monetary Financing.
This is an option you may agree or disagree with, but knowing that it is already an option in the first place, will help us all to make properly informed decisions about where to go next.