Modern Monetary Theory in practice – is it going to cause inflation?

At a TCL network meeting back in 2017 Alan Hutchison, who has taken a keen interest in MMT for years, even though, he told us, he is just an ordinary bloke in the street, gave us his opinion that our government was able to create money out of thin air, and this was going to get us on the road to economic recovery.

Alan explained that we were being hoodwinked by a government that had been telling us that they can’t increase government spending without a corresponding increase in taxes. And if they increase taxes this will increase prices and cause inflation.

“Complete and utter baloney”, said Alan.

We are so used to being told that the government’s coffers need to be filled with taxes before they can spend money, that we believe it, he went on, yet it has not been this way for a long time. Household budgets work this way. We need to earn money before we can spend it. But government money comes into existence “by deciding to spend it!”, then taxes are the means to cancel that money out again.

You can find out more about his viewpoint by visiting Alan Hutchison’s website at this link we-pay-for-it-by-spending-the-money

Four years on and we are beginning to see the effects of what happens when the government buys into the MMT theory, because not just the UK, but the USA, Europe and many other governments around the world are seemingly creating billions of £’s, trillions of $’s and whatever else, wherever fiat currencies are being used, out of thin air, before the taxes have been raised to pay for them.

But there is something missing from this talk about money. Fiat currencies are not actually created out of thin air, they are created out of debt. Just as household budgets actually don’t work by earning money before you spend it. They used to, three generations ago, when we all lived in a world where currencies were backed by gold and silver. Back then, debt was only something you got into when your family’s wealth was not sufficient to pass down through the generations. It was frowned upon.

Now, however, increasing and vast amounts of debt is how governments, corporations, small businesses and families keep the economy ticking over. There is a difference, though. We live in an unequal debt playing field. Let’s examine this in detail so that we can develop our sense of injustice at the way our economy works.

At the top of the debt pyramid stands the Bank of England. It is they who create the pound sterling out of thin air. The USA has the Federal Reserve to do this and other fiat currencies also have their own central banks. They can never be in debt because they can create all the fiat currency that they and the rest of the world needs. They also control the base interest rate that governments use to borrow the money they have created. We need to understand, though, that the Bank of England is a separate organisation to the government, with its own non-elected officials and workers.

In order to borrow pounds, the British Government issues Treasury Bonds, which are electronic promises to pay the bearer, after certain lengths of time, the amount borrowed plus interest. It exchanges these Bonds for electronic pounds from the Bank of England and the Government can then use these pounds to issue on public projects e.g. Building new roads and railways, meeting County Council budgets, or paying Universal Credit etc. The Treasury Bonds are sold by the Bank of England to large investors, such as Trust Funds, Pension Funds, billionaires etc at a slightly larger rate of interest. Commercial Banks also act as large investors as well, but they also have the ability to create more pounds out of thin air, which is known as Fractional Reserve Lending. Commercial Banks then lend pounds to corporations at a slightly larger rate of interest and also lend pounds to small businesses and individuals for mortgages. It used to be normal for Fractional Reserve Lending rules to allow banks to loan out up to ten times as much fiat currency as they had assets to cover them e.g. Treasury Bonds, but now that figure is often exceeded.

Thus, we can see that it is banks, both central and commercial that have the ability to create fiat currency out of thin air, not governments. We can also see from this simplified summary of how our economy functions, that, how much you can borrow and at what interest rate depends on how powerful you are and how much wealth you already own. At the bottom of the hierarchy, the small business may pay between 2% and 18% for a commercial mortgage and a private individual borrowing through credit cards between 20% to 39% per year. At the top, the government may pay 0.025% and the Commercial Banks, 0.05% paid after 3 years, 5 years or even longer than 10 years.

All of the fiat currency in existence, therefore, comes into existence in our economy through debt. Without debt, no money can circulate between anyone. This is why everyone is encouraged to take out more and more loans, otherwise there is no money to pay anyone.

Right now, after the pandemic, governments are having to lead the way by borrowing vast sums. hoping that this will encourage corporations and businesses as well as families to invest in expansion, to buy bigger factories, to buy bigger homes, to buy electric cars, to max out on their credit cards, to stimulate the economy and be able to pay more taxes so that the government can, one day, pay off their debts through higher taxes.

The big problem is, if the market is flooded with fiat currency, prices start to go up as demand is increased and production can’t keep up with it. We are seeing it with house prices already. Now that people are seeing an end to the lockdown they are willing to take on more debt and move to bigger homes. Many are moving to the country now that they can work from home and don’t have to commute, so house prices in Cumbria, for example, have shot up recently by as much as 10%.

We have also been seeing it with stock market prices, cryptocurrencies, gold, silver, commodities, shipping, and it’s beginning to affect food prices. It’s not difficult to see why. As fiat currencies flood onto the market and savings are spent after a year of stockpiling there is more money around and more people competing for the same products and services means higher prices. Until governments introduce higher taxes to cancel out the debt and pull pounds out of the economy there is no way to stop higher prices. They are reluctant to do this and have plans to borrow more and more billions of pounds for government projects. It is highly likely that we are going to return to inflation rates like we did in the late 1960’s and 1970’s when it peaked at 24.2%. Joe Biden, over on the other side of the Atlantic is similarly pouring trillions of dollars into his government’s spending but at least he wants to increase tax rates immediately for the mega-wealthy. The Senate has yet to approve this.

Inflation, then, is built into the design of our economic system.

Governments want the value of their debt to go down, relatively speaking, so that the mountain becomes more managable in time. It is quite feasible for a government to devalue its currency on purpose so that the taxes they raise will increase as wages increase and the debts they took out ten years before don’t appear so large anymore.

I remember, when my parents bought a house in the early 1960’s it cost them  £1,750. It seemed a lot to them at the time but if they were still alive to sell it today they would be asking £250,000 for the same house. It seems natural to those of us who have lived long enough to see it, so inflation has become part of our expectation. Yet to those on fixed pensions, what seemed like a liveable amount at the age of sixty can seem like nothing if they live to be ninety five.

The lesson of all this is, don’t be fooled by the media into thinking that there are no consequences from having an economic system based on debt. The system has been designed to make the already wealthy even wealthier, to allow banks to thrive, whatever happens, and to keep power and decision making at the top of the hierarchy, leaving those at the bottom at the mercy of the 1% and forever in debt, up to their eyeballs.

Once we really understand this, the only way we have to go forward is to say no, enough is enough. We need a new economic system, designed to make those at the bottom the ones who have the power to create money out of thin air.

Who was it that said only banks can do it, anyway? It certainly wasn’t me. We don’t actually need them anymore and future Transition City Lancaster meetings will be focussing on how we can all choose to say no – together.