Money, banking, credit, Adam Smith, finance, central banking etc, Michael Durkin channel4 film

Tony

Let’s have a critical look at the underlying ideas, shall we?

Most credit (>97%) – which is the deficit-based money we use – is created privately by banks, while the balance is notes and coin.

This credit is created not only when banks lend at interest, but also when they spend – either by crediting the accounts of suppliers; staff; management; shareholders (for dividends) or on acquiring income producing assets – in particular when they acquire the debt (gilts) which the Treasury issues to ‘fund’ its expenditure.

So most of our money comes into existence when banks create credit by lending or spending, and simultaneously creating a ‘demand deposit’ held by the recipient borrower or supplier etc.

Quite a few economists – and almost the entire population – are under the impression that deposits precede credit creation. They have the polarity reversed: a pyramid of credit is first created – based upon a relatively small amount of capital specified by the Bank of International Settlements – and this credit is then instantaneously deposited into the system.

There is no such thing as ‘fractional reserve banking’ any more – although there used to be – since credit creation now depends upon the amount of capital held, not the reserve deposits held to ensure liquidity.

Banks get the deposits they need from a shrinking (since welath has become increasingly concentrated in the last 30 years) retail deposit base, and increasingly from wholesale deposits in the interbank market. When the latter market ‘seized up’ in the ‘credit crunch’ the central bank stepped in as ‘lender of last resort’.

So much for that background.

A parallel causality/polarity applies to taxation and public spending.

You assume – and the conventional ruling ideology is – that ‘taxpayers money’ is collected and spent. By definition it cannot be ‘invested’….only shareholders ‘invest’, since this defines the ‘private sector’.

ie you wrongly assume that tax comes first and expenditure later in the same way that you also wrongly assume that deposits precede credit.

This is not the case.  The Treasury spends money by using its ‘overdraft’ account at the Bank of England to create credit, which is then instantaneously deposited in the accounts of recipients

The BoE then typically ‘funds’ that public expenditure by issuing and selling debt – ‘gilts’ – which are purchased by banks who create credit (as above) for the purpose.

Treasury payments to public servants creates a tax liability, and so of course they become ‘tax-payers’ without that money having been anywhere near the private sector.

This tax relates to work carried out by a productive civil servant carrying out a service which the population have democratically decided through their representatives are necessary. A tax demand and an invoice from a  private supplier are functionally equivalent, the difference being that public services do not require a payment to shareholders.

While I agree that the public service could be carried out more efficiently, it is certainly by any standards – other than those of shareholders – ‘productive’. It is just not productive of profit for shareholders. Orwell would have been proud of the way that apologists for shareholders have hijacked the language of ‘productivity’.

But I digress.

An increasing amount of public expenditure on services is now carried out by private enterprises, and almost all spending on productive assets is carried out by the private sector.

They are the recipients of public credit, and then in due course repay part of that to the Treasury as tax.

Part of the payment to private sector suppliers is extracted by unproductive shareholders as financial profit, while a massive amount is extracted by equally unproductive landlords as rent for the use of UK land. Both of these constituencies benefit from privileged property rights which give rise to ‘unearned’ income and gains, which go largely untaxed.

To cut public expenditure on productive assets and productive public servants under current circumstances  is like applying leeches or cutting off the limbs of a patient bleeding to death internally.

That is not to say that there are not savings to be made from cutting public and private sector managerialism, and the private sector professional consultocracy which supports it. But the greatest savings to be made are in financing costs.

The fact is that Treasury spending does not need to be funded by the issue of gilts. The proof of this is QE, where public credit is being used to buy previously issued gilts, but all this achieves is to replace one – interest-bearing asset (gilts) with another non interest-bearing asset (demand deposits of virtual cash/IOUs).

What should be happening is that hundreds of billions of Public credit should be issued over the next few years as needed for the creation of affordable housing; renewable energy and energy savings projects; a new generation of infrastructure; and above all to train domestic capacity to create these assets.

This credit creation should be managed by professional service providers with a stake in the outcome, under the accountable and transparent supervision of a Monetary Authority.

Once productive assets are created, then they may be re-financed – ie long term funded by investors such as pension funds – by credit based directly upon the use value of the assets themselves. This would then enable the Public credit which financed them to be retired and recycled.

Likewise, the newly productive public and private sector individuals responsible for the creation of these assets would be paying tax, which would again retire and recycle the public credit which financed it.

So the basis of the economy could be the creation of credit based upon the earnings of productive individuals, on the one hand, and the use value of productive assets, on the other.

Finally re Hong Kong, it is true that they do get a lot right, and a correct understanding of Adam Smith – rather than cherry picking with an ‘invisible hand’ – probably had a lot to do with it.

Firstly, HK (uniquely) has no Central Bank or central credit counterparty, but does have a central credit clearing system under the supervision of a Monetary Authority.

Secondly, they were accustomed to raise up to 35% of their income from ‘Crown Rentals’ charged on Crown leases – the reason being that GB actually leased much of Hong Kong from the Chinese and therefore there was no freehold property available.

What this means is that the HK population did not have BOTH a landlord and government monkey on their shoulders, and taxation of earned income is commensurately lower, which stimulated their entrepreneurial instincts further.

We might usefully apply a similar approach to the basis of taxation, which is entirely consistent with classical liberal thought, from Adam Smith, through J S Mill to those pinko subversives, Lloyd George and Winston Churchill 100 years ago.

Best Regards