After all, the Treasurer is only saying what the experts have been saying for decades in such situations: at some point we have to reign in the deficit, and right now we have to slay the inflation dragon.

Here are two alternative propositions. First, the debt burden of the so-called deficit could be paid off tomorrow, and trying to ‘balance the budget’ only slows the economy and hurts the battlers more.

Second, battlers should be helped to deal with rising costs. Squeezing the economy with rising interest rates mainly benefits the financial sector and the wealthy, at the expense of ordinary Australians.

Let’s try some rational thinking, using documented facts and evidence.

First, the federal government, through the Reserve Bank, creates money. It could just spend that money into the economy, to pay for its many programs and policies. Instead, through a complicated and arcane process it first converts that money into bonds issued by the Treasury Department. Treasury sells the bonds and uses those proceeds to spend on the government’s projects.

Those bonds pay interest to their owners, interest that must be paid by the government. In this way the government incurs debts to the private sector, and it is those debts that allegedly become a burden on ourselves and our descendants. They are not as big a burden as is usually claimed, because the interest can also be easily paid by the government, and that money flows into and ultimately benefits the economy.

But here’s the stranger thing: the money created by the Reserve Bank has no interest due on it. If the government just spent that money directly into the economy, instead of converting it into bonds, the ‘deficit’ would not involve a debt burden.

One authority for these claims is the Bank of England[1], which spelt them out in a 2014 article, and noted that many economists’ understanding of how banks work is incorrect.

Another authority is US economist Stephanie Kelton[2], who explained at length, in her book The Deficit Myth, that a currency-issuing government never has to borrow money, because it is the source of money. The common analogy of a household budget, in which you must earn money before you can spend it, is quite wrong when it comes to the federal government: money must be created and spent into the economy before anything can happen, and before taxes can be levied.

The money has to come from somewhere. If all the money was withdrawn from the economy through taxation there would be no money, and the economy would stop. So the money spent by the government must exceed the money withdrawn through taxes. It is simple accounting that the money spent by the government increases the money held by the private sector. (In fact most of the money we use comes from private banks, who have a franchise to also issue money, but that doesn’t change the principle operating here.)

We ought, more accurately, to talk about the money supplied by the the federal government, instead of a deficit in government accounts. The so-called government deficit is also the private sector’s surplus, which it can use constructively.

The Morrison Government spent a lot of money during the pandemic, much more than it withdrew in taxes. That extra money kept the economy going, and saved us from a major recession. The so-called debt-and-deficit disaster could be fixed tomorrow. All the government has to do is buy back the Treasury bonds it sold, using debt-free money from the Reserve Bank. The ‘deficit’ would then no longer carry a burden of debt.

It would not actually be smart to eliminate all the debt in one go, it would need to be spread out over some time so the financial markets had time to adjust to a new reality. We don’t need to support the unhealthy habits of the financial sector, but we do need to stop imposing unnecessary hardship on ordinary Australians.

Now to the second issue, the rising costs that are being called ‘inflation’. The problem is misdiagnosed and the remedy being applied only makes things worse.

One kind of inflation happens when more money is issued than is needed to run the economy. The extra money is then used to bid up prices. This has happened in the housing market, where private banks have issued more and more money and prices have inflated dramatically. The remedy for this kind of inflation is to slow the supply of money. This can be done by restricting the rate at which banks issued ‘loans’, as was done in Menzies’ day, or by raising interest rates, though this is a blunt instrument.

Our present problem is not of this kind. The problem is that many goods have become legitimately more expensive because of supply problems, due to the pandemic, war, floods and other natural disasters.

This has created a rise in the real cost of doing things: we must expend more effort to do the same things. It is not just a money supply problem.

If we increase interest rates and restrict government spending we only make things worse. The economy, already slowed by increasing costs, slows even more for lack of sufficient money. It is harder for ordinary people to get the money to buy what they need, and what they need costs more.

The main group that benefits from this approach is the financial sector. Their ‘assets’ are held notionally as dollars. If real prices go up, their dollars have less purchasing power, they devalue. However if prices are forced back down and money is ‘worth’ more because of higher interest rates, then financial assets hold their value. But everyone else is left to struggle even more.

The sensible approach is for the government to increase help to battlers, but this is ruled out because, it is claimed, it would only boost inflation. It would not boost real inflation, because the problem is in real supply lines, not in the supply of money.

It means the interests of the financial sector are put ahead of battlers. But generally those in the financial sector are already doing very well, and will not suffer if their fortunes decline a little, whereas the precariously employed struggle to pay for their kids’ schooling and may not even have enough for food, or a roof over their head.

Some economists do recognise the distinction between the two kinds of inflation. They speak of supply-driven and demand-driven inflation, but their jargon obscures the message and it has not cut through.

We are supposed to be a wealthy country. We do not need to tolerate poverty, and now homelessness. We can afford to ensure everyone has a dignified life. But we need to divest ourselves of some harmful myths before we can properly do that.

If you have not encountered these ideas before they may seem to contradict other things you thought you knew about the economy. You have to work through them to see  they are part of a consistent story that is quite different from what we are seeing every day in the mainstream news. Stephanie Kelton’s book is a good place to start. A more concise and approachable account is given in J.D. Alt’s book The Millennial’s Money[3].

 

1. McLeay, M., A. Radia, and R. Thomas, Money in the modern economy, in Quarterly Bulletin. 2014, Bank of England, http://www.bankofengland.co.uk/publications/Pages/quarterlybulletin/2014/qb14q1.aspx. p. 10.
2. Kelton, S., The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy. 2020, UK: John Murray. 325 pp.
3. Alt, J.D., The Millenials’ Money. 2016, Indianapolis IN: Dog Ear Publishing, http://www.dogearpublishing.net. 111 pp.