Thursday, March 24, 2016

The budget gorilla

Matthew Green had rather a good piece in his blog last week, following the Budget. As usual, I found it interesting and generally in line with my own views but with some exceptions.

His piece is about "the gorilla in the room". In my experience it's usually an elephant, but I won't quarrel on a matter of fauna-in-camera. He's talking about the big difference between public sector financial commitments over the coming years and the plans to finance them. I agree with his main thesis that there is a serious problem.

I was quite surprised that he takes the standard Coalition line where he says "That this has still meant dramatic cuts to public spending shows just how out of control the government finances had become under the previous government, as it pursued the illusory goal of Scandinavian public spending backed by US taxes."

My own take on this is that the deficits run up by Labour in the mid-noughties were not a major cause of our post-2008 problems. The real problem was that we had come to rely on the banks too much as a cash cow for the Exchequer. When the profitability of the banks collapsed in 2008, tax revenue collapsed with it and that left us with an ongoing hole in our finances. I think the more serious failing of the Blair-Brown years was in allowing the banking system to develop the way it did. However, I don't remember many commentators talking about this at the time, whereas the failure of Gordon Brown to comply with his own "golden rule" on balancing the books over the business cycle was widely noted.

The issue of banking failure is dear to my heart at the moment because at the next meeting of the Kennington Sustainability Study Group (on Wednesday, April 6th, the start of the UK fiscal year, if anybody's interested) we will be discussing "Money". Now the first thing to bear in mind is that the economy of a nation with its own currency is not like a household. The government can create out of nothing whatever money it needs to finance its spending or to keep the economy running. The notion that governments must borrow the difference between what they spend and what they raise in taxes etc is a piece of fiction that politicians use to justify either raising taxes or cutting spending. They get away with it partly because most people don't understand what money is and partly because the fiction is not all that far from the truth. Real resources commandeered through government spending - labour, capital, raw materials, foreign currency etc. - are then unavailable for use by businesses and households. Also, the stability of the currency matters a great deal and, if deflation, excessive inflation or a roller-coaster exchange rate are to be avoided, the supply of money needs to be matched to the potential of the real economy.

This is particularly important in an economy as open as the UK's, which reminds me of what I think of a second large mammal in the room - our trade deficit. This issue raises interesting questions for me. Which causes the other: the surplus on the capital account and hence an over-valued pound, as more of our industry, infrastructure, national debt, land and property gets sold to foreigners; or a deep-seated propensity to over-consume imports and/or under-produce exports? Could an underlying problem be inadequate private saving and excessive borrowing for consumer spending during boom times? I suspect there is a complex pattern of cause and effect working both ways between the capital and current accounts and others no doubt have a much better handle on this than I do.

Matthew Green alludes to the current account deficit but only in the context of the constraint he thinks this would impose on "people's QE". As it happens, I think "people's QE" or "sovereign money creation" is rather a good idea, but only as part of a balanced strategy that reduces money creation by private banks from a typical 97% of all money in circulation. In other words, I tend to favour the idea that the public sector should create more money and private sector less. This would have at least three major advantages.

Firstly it should make for greater stability in the banking sector and make us less vulnerable to the sort of things that happened in 2007-8.

Secondly, money creation is a very profitable activity.  With increased sovereign money creation, some of the profits that currently accrue to banks would go to the government instead, so helping to reduce the deficit.

Thirdly, if there were another banking crisis (as some commentators think there almost certainly will be) the effects would be more limited.

Against all this, of course, there would be no return of the banks as a cash cow for the Exchequer. But I have to confess that I have a lot more reading to do around the issues of money and banking.

While I have my differences with bits of Matthew Green's post, I think his overall message is right. The public sector deficit is a serious problem and there is no simple, painless answer to it. I think that sovereign money creation might play a substantial part in the solution and might facilitate a much-needed increase in public-sector investment in infrastructure, particularly in energy conservation and clean energy. But this will not obviate a need for reduced consumption by some so that the government's commitments to others can be honoured.