As part of a project into the history and development of Australian currency I have written a little more of the events that took place over WWII that led to Australia’s post war reconstruction. The events start at the end of the thirties and go through to just before the Commonwealth Bank was created and a Central Bank in 1945.
The Commonwealth Bank Act 1945 repealed the previous Commonwealth Bank Act 1911-1943 and recreated it as a central bank. A well known public servant H.C Coombs was largely responsible for the rationing system over the war and the creation of Australia’s post war reconstruction. He trained as a secondary teacher but over the 1930’s received his PhD in economics and went on to work in various capacities for the Commonwealth Government.
If you can obtain a copy of his book Trial Balance (now out of print) he details these extraordinary events and the shift in thinking not only of a defunct economic paradigm that was used over the 1930’s but also in society more broadly.
The finished paper will be a more coherent narrative some of which feature in the following posts and more!
Various financial statements and budget speeches in 1939 and 1940 were stating that with a given workforce and existing pattern of technology and industrial organisation there was a maximum real Gross National Product (GNP) which would for practical purposes be reached when available labour was fully employed.
(Insert EXAMPLES OF THESE SPEECHES)
The National Security Act 1939 had given powers to The Governor General to make regulations for securing the public safety and the defence of the Commonwealth and the Territories of the Commonwealth, and in particular— (h) for preventing money or goods being sent out of the Commonwealth except under conditions approved by any Minister of State; as well as other mechanisms to make provision for the Safety and Defence of the Commonwealth and its Territories during the present state of War.
This act in conjunction with the changes to the Commonwealth Bank amendments 1929, in effect abandoning a gold standard allowed for the Commonwealth to implement a system of rationing. There was contention within the Fadden Government.
By 1941 preparations were being made for a wartime economy. Chairman of the Financial and Economic Committee Lyndhurst Giblin had been in contact with Keynes regarding propositions that if the war effort was to be accomplished an additional transfer of resources amounting to 10 per cent of the total available would from civil to war purposes had to be achieved.
In a response to Giblin, Keynes had replied
…to deprive the economic system of the freedom represented by uncontrolled prices through rigorous price control supplemented necessary by rationing and by strong propaganda in favour of increased saving out of the margins of income preserved in favour of individuals by price fixing policy. (Coombs, 1981 p.11)
In a statement submitted to cabinet Fadden regarding his budget proposal submitted
There is a physical limit to our resources of manpower, equipment and materials and…the new programme will impose a severe strain on those resources. Last year (40/41) 15% of National Income was devoted to the war effort; this year (41/42) it would be 23%. The transfer of resources to achieve this must mean a substantial fall in civil production. The financial measures chosen must be designed to effect the necessary transfer. (Coombs, 1981 p.12)
In terms of an economic strategy the Finance and Economic Committee was preparing for a system of rationing as per the correspondence between Giblin and Keynes. There was awareness that rationing as a result of trade restrictions and production would need to occur. As a result of this Keynes had pointed out to Giblin ‘fairness of distribution social security would necessitate rationing’ In February of 1941 the Committee advised ‘Direct rationing or restriction of supplies of specific goods or services, chosen because the resources they use are most adaptable to war purposes.’ (Coombs, 1981 p.12)
‘There was a view within the Committee that direct rationing to consumers appeared inevitable and that plans to introduce and organise it should be prepared in secret by the Department of Customs’ (Combs, 1981 p.13)
‘Australia began in 1938 to prepare for food control in the event of war, not only to safeguard her economy, in which exports have always occupied an important place, and to protect primary producers against market collapse, but also to ensure that essential supplies moved quickly to the United Kingdom. Plans were laid then for mass marketing to replace individual enterprise, and understandings were reached that as far as shipping was available, the United Kingdom would take the export surpluses of most of our principal foods.’
The Year Book Australia 1944-45 notes the reasoning for rationing.
‘War conditions necessitated civilian rationing of clothing and certain foodstuffs in Australia. The main reasons for clothing rationing were the serious falling off in imports, increased Service demands, and reduced labour for local production of textiles and making up of garments. The supply to the United Kingdom and the Australian and Allied Services of maximum quantities of foodstuffs necessitated the rationing of sugar. butter and meat, while reduction in imports, consequent upon enemy occupation of Java, necessitated the rationing of tea. In addition to the controls exercised by the Rationing Commission, rationing of certain other commodities is directed by other departments, e.g., petrol, tobacco, liquor, etc.’ (ABS 1301.0 Year Book Australia,Clothing and Food Rationing, 1944-45)
As the concern built within the Committee around the Fadden Government’s failure to implement rationing measures onto the civilian population and the political constraints within the Parliament, the Fadden Government’s 1941/42 budget failed to pass the House of Representatives. Two independent members of the House, Alexander Wilson and Arthur Coles crossed the floor. Fadden resigned from office and the support of the two independent members of the house gave support to John Curtin and Ben Chifley delivering the ALP under Curtin and Chifley Government.
By 8 May 1942 Prime Minister Curtin had announced Australia would enter a system of rationing and by 17 May 1942 a Rationing Committee was formed. It was decided that a coupon system be introduced with interim arrangements being proposed before clothing supplies were depleted. (Coombs, 1981 p.20-21)
A coupon system was devised in respect of Clothing, Food and Petrol.
‘Coupon Rationing. After examination of the systems of rationing operating in other countries, it was considered that coupon rationing was preferable to a system of consumer registration, since it allows consumers to purchase from any retailer and also provides a comparatively simple control of traders’ replenishment of stocks by means of the passage of coupons to their suppliers. Food coupons are provided in the general Food Ration Book issued each year.’ (ABS 1301.0 Year Book Australia,Clothing and Food Rationing, 1944-45)
This coupon system would last throughout the war and was the means by which Australian citizens would obtain essential goods and services. The Food Ration Book provided each year per household negated the need to spend currency that was earned.
Australia’s Post-War Reconstruction
Following the end of the war the Government was seeking a means to continue it’s control over the economy with similar wartime powers. A failed 1944 referendum sought an insertion of a Chapter 1A in the constitution
“CHAPTER IA.—TEMPORARY PROVISIONS. POWER TO MAKE LAWS, FOB A LIMITED PERIOD, WITH RESPECT TO CERTAIN MATTERS. 6oA.—(i.) The Parliament shall, subject to this Constitution, have power to make laws for the peace, order and good government of the Commonwealth with respect to— (i) the reinstatement and advancement of those who have been members of the fighting services of the Commonwealth during any war, and the advancement of the dependants of those members who have died or been disabled as a consequence of any war ; (ii) employment and unemployment; (iii) organized marketing of commodities ; etc… (ABS 1301.0 Year Book Australia No.35 1942-43 p.65-66)
The failed referendum required another means to continue the Full Employment achieved over the war.
There was a shift in thinking as a new economic paradigm emerged. The collective conscience within our society was driven largely by remembrance of what was experienced over The Depression, what was possible as seen over the war and a desire to maintain the same level of production during peacetime. Within academia, elected representatives and a new generation of public servants – Keynes’ General Theory gave them the authority to implement what only a decade prior was seen as ‘radical’.
These events led through to the 1945 Tax White Paper on Full Employment and The Commonwealth Bank Act 1945 which created the Commonwealth as a central bank. Coombs in his text Trial Balance writes
‘Generally the functions of a central bank are: to print and control the issue of legal tender notes; to hold the country’s international reserves of gold and foriegn currencies; to act as banker to other banks, holding deposits from them; to exercise control over banks’ lending policies; to act as banker for governments and their major agencies, and frequently to arrange their borrowing; and to influence the policies of non-bank financial intermediaries which make loans.’ (Coombs, 1981 p.142)
A position that was resisted by capital for decades was finally defeated and our elected representatives had more discretion on controlling an interest rate and fiscal policy (having been subject to various impediments prior) to achieve their socio-economic outcomes.
The below is some more writing on how Australian monetary system came to form. There is a rather dry boring post here that deals with legislative instruments and various changes.
I deal with some background on how private banks issued notes prior to 1910 and why The Australian government chose to issue notes. There are institutional arrangements that restricted The Australian governments ability to spend and this is largely why the depression happened (e.g Gold Standard)
The Australian Notes Act was designed to replace the system of private bank note issuance and used to command real resources. The previous privately issued banknotes derived authority from various legislative instruments, which in turn derived their authorities to the tax driven nature of the British monetary system.
I’ll note prior to private note issue of the banks, Australia was a penal colony that didn’t have a need for a monetary system during the early years. A system of private promissory notes/bills was established that were used to gain access to supplies from the commissariat. Australia’s monetary system evolved from those early promissory notes and the tax driven nature of the British monetary system. One example of which was Governor Macquarie declaring the dump and holey as currency declaring its value at 15s 5d and setting the price of all animal Food and Grain of every Description, and all other articles of Trade and Merchandise whatsoever, received into His Majesty’s Stores in any part of this Territory, or otherwise supplied for the use of His Majesty’s Government, will be paid for in the above described Silver Money, at the Value above mentioned e.g wheat was 8s per bushel.
Draft Australian Currency from 1909
Australian currency has its origins in the coinage act of 1909 that mandated A tender of payment of money, if made in coins which are British coins or Australian coins of current weight, shall be a legal tender andbanned the minting of other coins; No piece of gold, silver, copper, or bronze, or of any metal or mixed metal, of any value whatever (other than a British or Australian coin), shall be made or issued as a coin or as a token for money, or as purporting that the holder thereof is entitled to demand any value denoted thereon. (Coinage Act, 1909)
Privately issued banknotes and various State Treasury note issuance were still in circulation prior to 1910. The Government of Queensland was the only colony to have Treasury issue their own notes payable on demand (Qld, Treasury Notes Act of 1893). NSW had begun to regulate note issuance in 1893 mandating the gazetted banks should have no more than one third of paid up capital of notes in circulation and mandated that these notes must be exchanged for gold at the banks respective head offices. (NSW, Bank Notes Act, 1893)
Bank notes in circulation derived their authorities from various legislative instruments. NSW had begun to legislate for note issuance via the establishment of banks. The Bank of Australia Act 1827 where upon its establishment was for ‘the purpose of discount and issuing of notes and bills and lending monies on securities and cash accounts for the receiving monies on deposit accounts for the safe custody of monies and securities for monies as also for transacting and negotiating all other matters and things connected with the usual and ordinary business of banking’ (NSW, Bank of Australia Act, 1827) Other banks established via the legislative assembly of NSW include The Commercial Banking company of Sydney, 1848 and Bank of NSW, 1850. These acts specified ‘That all such notes shall bear date at the city town or place at and from which the same respectively shall be made and issued and that the same respectively shall in all cases be made payable in specie on demand at the place of date and the total amount of the promissory notes payable on demand issued and in circulation shall not at any one time exceed the amount of the capital and stock of the said corporation actually paid up.’ (NSW, Commercial Banking Company Act, 1848)
Victoria has its origins in legislating note issuance of banks in The Banks and Currency Statute, 1864 that ‘extends and apply to every company firm or individual engaged in the ordinary business of banking by receiving deposits and issuing bills or notes payable to the bearer at sight or on demand.’ (Vic, The Banks and Currency Statue, 1864)
By 1909 the Australian Government had legislated the Bills of Exchange Act with cross checks to the relevant state legislation. These included:
NSW; The Bills of Exchange Act 1887. No. 2, The Banks and Bank Holidays Act 1898. No. 9, The Banks Half-holiday Act 1900. No. 80. Victoria; The Instruments Act 1890. No. 1103, The Banks and Currency Act 1890. No. 1164, The Public and Bank Holidays Act 1897. No. 1534, The Instruments Act 1904. No. 1925. Queensland ; The Bills of Exchange Act of 1884. No. 10, The Bank Holidays Act of 1904. No. 8, The Bills of Exchange Act Amendment Act of 1905. No. 7. South Australia; The Bank Holidays Act 1873. No. 19, The Bills of Exchange Act 1884. No. 312 The Bills of Exchange Amendment Act 1904. No. 867. Western Australia The Bank Holidays Act 1884. No. 9, The Bills of Exchange Act of 1884. No. 10, The Bills of Exchange Act 1904. No. 54 Tasmania; The Bills of Exchange Act 1884. No. 14, The Bank Holidays Act 1903. No. 4, The Bills of Exchange Act 1905. No. 7, The Bills of Exchange Amendment Act 1906. No. 29.
The above listed acts (and their principal acts) governed the promissory note issuance of the retail banks. Various banking corporations established via legislative decree (all in NSW) and various banks established via royal assent had their note issuance governed by their respective legislations.
By 1910 The Australian Labor Party made attempts to eliminate private bank note use and have Treasury issue notes. They succeeded in passing the Australian Notes Act of 1910 that barred state and private bank notes being issued after the proclamation date as well as the Bank Notes Tax Act 1910 that imposed a tax in respect of all bank notes issued or reissued by any bank in the Commonwealth after the commencement of this Act, and not redeemed. (Bank Notes Tax, 1911)
The Australian Notes Act was introduced by the Labor Fischer Government. There was opposition with the member for Wentworth, Mr Kelly objecting ‘We ought further to be informed what guarantees the public will have that this particular method is not being adopted for the purpose of raising money without paying interest thereon by a Government which refuses to borrow. (House of Representative Hansard No.#30, 1910 p.690) There appears to have been concern from private interests with Senator Weedham articulating concerns that financers in the United Kingdom would be deprived of profits.
‘Under this Bill, the persons in the Old Country to whom we have hitherto gone for the purpose of raising money with which to develop our resources will find themselves deprived of a certain amount of profit, and their agents also may have cause for annoyance.’ (Needham, Fed Senate Hansard, Tuesday 6 September 1910)
We do not deal with private credit issuance in this paper but wish to state that by 1940 it was understood all money (including credit) is a promise to payeither goods or services on demand. Whether that promise to pay is stamped on a coin, printed on a note, or simply printed on a bank’s ledger, does not alter the fact that the vital thing is the promise to pay, and not the mere material upon which it is written. In ‘The Story of a Commonwealth Bank’ states the reason the Government legislated in respect to the bank note, is that they thought they understood it, and the reason the why the Government did not legislate regarding the bank deposit (credit) is because they had no clear understanding about it at all. (Amos, p3, 1940)
The opposition to Treasury issuing their own notes and hostility by the capitalist class who had their ability of note issuance stript and in some instances interest payments on borrowing lost, a desire to rest control of note issuance remained. We will look at this in further detail later, though by 1924 there was a board in place at the Commonwealth Bank that had the discretionary power to approve note issuance with no ability for the Treasurer to issue notes, even via proclamation. There either needed to be board approval or a legislative change. Considering the opposition to the initial Treasury Note issuance during the second reading of the Bill The Prime Minister affirmed
The principle of the Bill is practically embodied in the statement that if any person or corporation desires to have Commonwealth notes, application will have to be made at the Treasury, and a deposit made in gold of their face value. (House of Representative Hansard No. #32, p.1228)
The Australian Notes Act made provision that the intent of the Notes act limited the supply of note issuance to seven million pounds. The member for Calare Mr. Thomas Brown during the second reading made the comment.
‘The proposal now before us is that the Commonwealth shall issue notes to the amount of £7,000,000,’ [House of Representatives Hansard No. 32, p1464]
A year later the act was amended on 22 December 1911 to remove the requirement to equivalent gold for note issuance above seven million pounds. Though still required ‘The Treasurer shall hold in gold coin a reserve of not less than one-fourth of the amount of Australian Notes issued.’ (Australian Notes No. 21 Amendment, 1911)
Taxation Arrangements and the Consolidated Revenue Fund
Upon federation the new Australian Government’s second act was to appropriate sums of money out of the Consolidated Revenue Fund. (CRF) The CRF draws its existence under section 81 of the Australian Constitution. Section 83 states ‘No money shall be drawn from the Treasury of the Commonwealth except under appropriation made by law.’There are two types of appropriation bills. Annual appropriation acts and acts that include special appropriations. (Guide to Appropriations, https://www.finance.gov.au/publications/resource-management-guides/guide-appropriations-rmg-100)
The Australian Government didn’t have its own coins or notes until 1909 and 1910 respectively. Though the bill appropriates some £491,882 including sums of money to the states. We can infer that taxation arrangements from federation until the note issuance act 1910 ‘funded’ the Australian Governments expenditure which derived ‘value’ from the tax driven nature of the British monetary system. The various colonies (now states) had legislated definitions of currency and mandated British or Colonial Gold Coins to be only legal tender for payments (NSW Currency Act, 1855) The colonial authorities (now states) and the Federal Government largely derived their capacity to spend by the sterling deposits within the Australian banking system.
Prior to the note issuance act of 1910 the Australian government passed a number of excises, taxes and license fees in its first year. The first decade of legislation ‘debated’ in the Australian Parliament is rather ‘uninspiring’. It consists mostly of appropriating money from the CRF for the business of running the government. The other acts within the first year of Parliament mostly consist of ‘revenue’ measures. These are a Customs Act, Beer Excise Act, Excise Act and a Distillation Act all of which place money into the CRF. These sums are denominated in pound-sterling.
It was at a similar time to the introduction of Australian note issuance that the Government of the day put forward a Land Tax Act and a Land Tax Assessment Act.
Land tax shall until payment be a first charge upon the land taxed in priority over all other encumbrances whatever, and notwithstanding any disposition of the land it shall continue to be liable in the hands of any purchaser or holder for the payment of the tax so long as it remains unpaid:
During the years after the Australian Note Act 1910 was passed, the notes were issued in the following ways;
A considerable quantity of them was given to the banks in exchange for gold (sometimes £3 in Australian notes were given for £1 in gold) for, by legal enactment, the Government was compelled to hold a reserve in gold equal to one-fourth of its note issue.
A number of short-term loans at interest were made to the States.
A number of fixed deposits, bearing interest at 3 to 5% were made in different banks. These fixed deposits amounted in 1920 to £5,426,600.
More than half of the notes were invested in Common wealth stock and State securities at various rates of interest. (Amos, p.4 1940)
These notes that were then issued could redeem the tax liabilities mentioned above.
The Establishment of the Commonwealth Bank
In 1911 the Australian Government legislated for the creation of the Commonwealthbank. The act mentions that ‘The Bank shall not issue bills or notes of the Bank for the payment of money payable to bearer on demand and intended for circulation.’ (Commonwealth Bank Act, 1911) with the Labour Fisher Government keeping note issuance under Treasury and eliminating the issuance of private bank notes. It’s role was to provide competition to the private banks in relation to credit issuance.
The Fisher government who was responsible for setting up current monetary arrangements, with note issuance placed in the hands of the Treasury and eliminating private bank note issue, had been defeated in the federal election of 1913 with Commonwealth Liberal Joseph Cook becoming Prime Minister by only one seat. A double dissolution election was called prior to the declaration of WWI being made in August of 1914 returning the ALP Fisher Government to power.
The first ‘real’ test of Australia’s monetary system came during World War I with deficits peaking at twelve percent of GDP. The War Precautions Act 1914 provided the Australian Government with the power for ‘preventing money or goods being sent out of Australia except under conditions approved by the Minister’ We note here the Australian’s government ability to spend was limited by the legislative arrangements under the Note Act 1910-1914. ‘The Treasurer shall hold in gold coin a reserve of not less than one-fourth of the amount of Australian Notes issued’ The ability for note issuance fell under section 5 of the act that says ‘The Governor-General may authorize the Treasurer from time to time to (a) issue Australian Notes; (b) re-issue Australian Notes; and (c) cancel Australian Notes.’
In 1919 the ALP had lost government and National Party leader Billy Hughes was Prime Minister. The National Party formed from the 1916 ALP split. By 1920 the responsibility for note issuance was transferred to the Commonwealth Bank and maintained in the note issuance department. Changes in 1920 placed the note issue under the responsibility of a board of directors. ‘The Note Issue Department shall be managed by a Board of Directors composed of the Governor of the Bank and three other Directors appointed by the Governor-General in accordance with this Part, of whom one shall be an officer of the Commonwealth Treasury.’ (Commonwealthbank Act 1920)Further changes were made in respect to note issuance in 1924 ‘(1) The Bank shall be managed by a Board of Directors composed of the Governor and seven other Directors. (2.) Subject to this Act, the seven other Directors shall consist of— (a) the Secretary to the Treasury ; and (b) six other persons who are or have been actively engaged in agriculture, commerce, finance or industry.’ (Commonwealth Bank Act 1924)
Attempts to Establish a Central Bank
In 1930 the Labor government with treasurer E.G Theodore tried to establish a central bank in Australia. During the second reading of the house of representatives Theodore in regards to central banking stated there were ‘three outstanding exceptions being Australia, Canada and the Argentine’ The bill’s aim was for ‘a new system for the control and organization of credit in Australia’
Part II of the Act stated:
Each bank carrying on business in the Commonwealth shall establish and maintain with the Reserve Bank reserve balances of not less than ten per centum of its demand liabilities within the Commonwealth and five per centum of its time liabilities within the Commonwealth.
Theodore stated ‘A central bank can aid greatly in tiding a country over a period of financial stringency and credit difficulties by concentrating the reserves of all the banks operating in the country, and enabling the best use to be made of them.’
This was the principal aim of the creation of a central bank. It forced the private trading banks to hold accounts with the central bank and thus gave the government control over monetary policy (interest rates) and regulated the credit the private banks could issue.
[Fiduciary notes bill 1929-30-31 to go here] There is interesting detail about political momentum not being strong enough to get through the legislation necessary to have a more exapansionary fiscal policy. The instigator of Central Reserve Bank Bill and Fiduciary notes bill is ex-premier of Queensland, Theodore who was unable to pass the Unemployed Workers Bill 1919 in Queensland during his term. The bill would have ended involuntary unemployment within the state. During Theodore’s term as Treasurer a visit from a BoE offical Otto Niemeyer tabled a paper to parliament to ensure Balanced Budgets No Matter the Human Cost. There seems to be evidence at maintaining the high unemployment figures but I am still working through the detail of all this.
Gold Standard Changes
It may be the case that as a result of the failed bills mentioned above in efforts to end the depression by lifting the rate of spending a number of amendments to the gold standard were made to the Commonwealth Bank Act in 1929. The treasurer and the board of the bank now had the power to: (a) to require persons to furnish particulars of the gold coin and bullion held by them; and(b) to require persons to exchange for Australian notes any gold coin or bullion held by them.
The amendments went onto detail the banning of the export of gold. It gave provision for the Governor General of the bank with recommendation from the board to ‘prohibit the export of gold from the Commonwealth’ Any person wishing to export gold had to apply in writing to the Commonwealth bank board and seek approval of the treasurer. Exporting gold without permission a penalty of a minimum £100,000 was imposed or imprisonment of one year. [Commonwealth Bank Act 1929]
As the depression ensured, in 1931 amendments to increase note issuance by reducing the gold reserves passed. Gold reserves were reduced from a minimum of 25% to be held in bullion to 15% for two years between 30 June 1931-1935. The gold reserve gradually increasing to a minimum of 18% between 30 June, 1933-34; 21.5% between 30 June 1934-35; and 25% by 30 June 1935.
By 1932 further amendments were made to reserves. The amendment to the Commonwealth bank act removed the term ‘coin and bullion’ and replaced it with “The Board shall hold in gold ‘or in English sterling or partly in gold and partly in English sterling’ a reserve of an amount not less than one-fourth of the amount of Australian notes issued.” (Italics highlight the changes from the original gold reserve clause added in 1920)
The act also provided for notes that had not been redeemed to be placed on the credit of the reserve account.
(3.) For the purposes of the last preceding sub-section, notes of a denomination not exceeding One pound that have not been presented for payment within twenty years from the date of issue, and notes of a denomination exceeding One pound that have not been presented for payment within forty years from the date of issue, shall be deemed to have been redeemed and the amount of those notes shall be placed to the credit of a reserve account to which shall be debited the amount of any such notes subsequently presented and paid.
Why’ll the above is still missing bits and pieces it aims to show through the various legislative changes the Australian note issue as linked to the ‘value’ of British sterling of which The Australian government mandated be kept as reserves via British sterling or gold). It shows the constraints on spending to be of a political nature and not one of an inability to spend. e.g board approval for commonwealth note issue. I note there were political constraints in ending these institutionalised arrangements in respect to the governments spending despite efforts to the contrary e.g fiduciary notes issue. This is still a work in progress that should hopefully be completed soon!
This is a project I’ve been working on tracing the legislation that has created Australian currency. There is information a colleague and I are uncovering on a 1893 Queensland Notes bill, that was the model used on The Australian Notes act.
The early days of federation money was defined as British or Australian coins – with specified ratios of gold, silver and bronze. The introduction of Australian Note issuance banned private promissory notes and allowed the Australian Government greater spending power by only requiring the government to hold 1/4 of the notes on issue in gold reserves.
There was opposition to the Fischer governments plan to introduce Australian notes with Mr Kelly, the member for Wentworth stating
“It seems to me like breaking a butterfly on a wheel to put the forms of the House to this test in order that we may be able to argue whether we should defray the cost of setting up a printing mill for shinplasters….”
A shinplaster is a banknote or promissory note with little or no value. These are similar arguments used today to demonise public spending. These comments where in relation to the requirement to keep less gold in relation to note issuance – though the subtext is in ending the private banks ability to profit from their unchecked ability to issue bank notes.
I’ve detailed the legislative history through 1909 – just before 1920 when the Commonwealth took over note issuance.
I also hope to write on the history of Treasury Bills – These were issued at interest via the colonies and the newly formed Commonwealth Government and served different purposes throughout history depending on the make up of the legislation. But more on that another time….
This is a draft of the early stages of a larger project where I hope to show an overview of Australian currency history from a Chartalist perspective.
The aim is to demonstrate the history of Australian currency has been ‘tax driven’ looking through various legislation and detailing the history of currency issuance, its link to taxation, the history of banking and credit issuance and the establishment of central banking from an Australian perspective.
While different monetary systems have been in effect from the gold standard, the Bretton-Woods system of fixed exchange rates and now a fiat currency, these have been institutionalised arrangements. Australian currency and credit has always been subject to instruments of the state.
Keynes (p.4 1930) In his treaties on money is influenced by the earlier works of Innes (1913) and Knapp (1924)
“The State, therefore, comes in first of all as the authority of law which enforces the payment of the thing which corresponds to the name or description in the contract. But it comes in doubly when, in addition, it claims the right to determine and declare what thing corresponds to the name, and to vary its declaration from time to time—when, that is to say, it claims the right to re-edit the dictionary. This right is claimed by all modern States and has been so claimed for some four thousand years at least.”
Lerner (p.313 1947) on gold writes “Its [currency] transformability into gold and the guarantee of this possibility of gold backing are nothing but historical accounts of how acceptability came to be established in certain cases. These were possibly the only ways in which general acceptability could be established prior to the development of the well organised sovereign national states of modern times.”
Australian currency has its origins in the Coinage Act of 1909. Section 5 of the act created legal tender;
Cf. ib. s. 4.
5.—(1.) A tender of payment of money, if made in coins which are British coins or Australian coins of current weight, shall be a legal tender—
While section 6 prohibited other coinage;
Prohibition of other than official coins.
Cf. 33–4 Vic. c. 10 s. 5.
6. No piece of gold, silver, copper, or bronze, or of any metal or mixed metal, of any value whatever (other than a British or Australian coin), shall be made or issued as a coin or as a token for money, or as purporting that the holder thereof is entitled to demand any value denoted thereon.
The schedule within the act specified the dimensions and volumes of metal required in the minting of coins. These schedules were revised in 1936 and 1947 to change the ratio of gold, silver and bronze within the makeup of coins.
In 1910, with hostilities from the opposition the Labor Fischer government passed the Australian Notes Act of 1910. The member for Wentworth, Mr Kelly objected with the following statement.
We ought further to be informed what guarantees the public will have that this particular method is not being adopted for the purpose of raising money without paying interest thereon by a Government which refuses to borrow
House of Representative Hansard No.#30, 1910 p.690
It was common for states and the newly formed federal government to issue treasury bills in order to obtain gold. This of course meant interest payments.
The Australian notes act provided for note issuance to be linked with gold reserves. Under section 8, disposal of proceeds of issue notes, part 2 reads;
Part of the moneys standing to the credit of the Australian Notes Account shall be held by the Treasurer in gold coin for the purposes of the reserve provided for in section nine of this Act.
While the gold reserve is under section 9 of the act.
9.—(1.) The Treasurer shall hold in gold coin a reserve as follows:—
(a)an amount not less than one-fourth of the amount of Australian Notes issued up to Seven million pounds; and
(b)an amount equal to the amount of Australian Notes issued in excess of Seven million pounds.
(2.) In ascertaining the amount of Australian Notes issued, the amount of Notes which have been redeemed shall not be included.
Notes that had been redeemed (taxed) were no longer necessary to link to the nation’s gold supply effectively deleting the currency from existence. This meant the nation’s note issuance was tied to the quantity the Australian government held in gold. Note issuance below seven million pounds required a quarter to be held in gold reserves while anything over seven million required full gold reserves.
Furthermore the intent of the Notes act limited the supply of note issuance to seven million pounds. The member for Calare Mr. Thomas Brown during the second reading made comment.
The proposal now before us is that the Commonwealth shall issue notes to the amount of £7,000,000,
House of Representatives Hansard No. 32, p1464
The responsibility of note issuance now solely rested with the Treasury. Just after a year later the act was amended on 22 December 1911 to remove the requirement to equivalent gold for note issuance above seven million pounds.
Amendment of s. 9.
2. Section nine of the Australian Notes Act 1910 is amended by omitting sub-section (1.) therefrom and by inserting in its stead the following sub-section:—
“(1.) The Treasurer shall hold in gold coin a reserve of not less than one-fourth of the amount of Australian Notes issued.”
During the second reading to the house Mr Fischer the Prime Minister affirmed
The principle of the Bill is practically embodied in the statement that if any person or corporation desires to have Commonwealth notes, application will have to be made at the Treasury, and a deposit made in gold of their face value.
House of Representative Hansard No. #32, p.1228
The commentary continues that the act’s intent isn’t to stop private credit issuance of the banks.
It is not intended to prohibit the banks from issuing notes, but a charge is made on all such notes issued, and the money placed to the credit of the community. Heretofore the private banks practically had the unlimited right to issue notes free of charge, and the State was expected or asked to “guarantee these notes in times of crisis. The Government proposal is safeguarded.
House of Representative Hansard No. #32, p.1228
Curiously, the Australian Notes Act 1910 prohibited the circulation of State and Bank note issuance
NoState Notes to be circulated after a proclaimed date.
4.—(1.) From and after six months after the commencement of this Act—
(a)a bank shall not issue, or circulate as money, any note or instrument for the payment of money issued by a State and payable to bearer on demand; and
(b)a note or instrument for the payment of money issued by a State and payable to bearer on demand shall not be a legal tender..
Quite clearly, the Commonwealth Government was looking to be the sole monopolist of note issuance within the newly formed federation and to stop the issuance of notes from banks. On 10th October 1910, after the passing of the Australian Notes Act on 16th September, the Fischer Government passed the Bank Notes Tax Act 1910
Imposition of bank note tax.
4. A tax at the rate of Ten pounds per centum for each year (including the year in which this Act commences) is imposed in respect of all bank notes issued or re-issued by any bank in the Commonwealth after the commencement of this Act, and not redeemed.
The changes in the legislation from 1920 onwards detail the Commonwealth Bank takeover of note issuance in 1920 with changes to the legislation in 1929 that allowed the government with written notice return holdings of gold to the Commonwealth as well as banning the export of gold.
The changes in 1929 are juxtaposed against the attempts of some within the Labor Party to establish a central bank (that forces financial institutes to hold accounts with the central bank) and the failed Central Reserve Bank Bill in 1929-30 and the Fiduciary Notes Bill of 1930-31. (Fiduciary note isn’t linked to gold)
It appears the 1929 changes as well as changes made to the Commonwealth Bank Act in 1931 and 1932 to allow for a reduction in gold reserves and allow for English Sterling to be used as reserves were concessions to the failed bills.
This the same era when the ALP had their three way split, Lyons formed the United Australia Party, with other fiscally conservative MPs. The result of limiting spending prolonged the depression.
Jack Lang who was dismissed as Premier of NSW, advocated for abandoning the gold standard and replacing it with a ‘goods standard’ went on to form Lang Labor.
I hope to detail the above events in more detail as well as the ascent of the Commonwealth Bank Act 1945 that created it as a central bank, rescinding the Commonwealth Bank Act 1911-1943.
The 1945 Act makes no mention of needing to keep reserves in relation to note issuance and it was the same time as the world established the Breton-Woods system of fixed exchange rates. Australia was officially off a gold standard.
It wasn’t until 1965 that Australia abandoned the final vestiges of the gold standard with its introduction of the Currency Act brought in the Australian dollar and rescinding the coinage act of 1909-1947.
There have been a lot of stories in the media around the debt and the ‘cost’ future generations will bear as a result of the spending required during the covid-19 crisis.
Each and everyone of these sports the same neoliberal garbage that taxes need to rise and suggest tax changes that work in favour of capital. Some more left leaning economist state things like we will to ‘invest’, in a financial sense, as a nation and ‘value add’ to our exports or we ‘borrow against future productive capacity’. This language is tied up in the neoliberal assumption governments need to find tax dollars in order to spend or need bond markets to borrow from.
For reasons perhaps of ignorance, it appears financial commentators haven’t yet grasped there have been different types of currency systems. There has been a gold standard, a system of fixed exchange rates, and fiat currencies, the latter of which we operate under today.
There were a number of economists during the mid-twentieth century that expressed under a fiat currency we were not restricted by tax collection. The below is a quote by Chairman of the NY Federal Reserve in an article from the American Affairs Journal.
The necessity for a government to be prepared to tax in order to maintain both its independence and its solvency still holds true for state and local governments, but it is no longer true for most national governments. Two changes of the greatest consequence have occurred in the last twenty-five years which have altered the position of the national state with respect to the financing of its requirements. The first of these changes is the gaining of vast new experience in the management of central banks. The second change is the elimination, for domestic purposes, of the convertibility of the currency into gold or into any other commodity.
Under a gold standard governments promised gold in exchange for their currencies. The standard was adopted by the UK in 1844 and was the system used up until WWI. Countries would express the ‘value’ of their currencies in terms of gold. $1 may equal 30 grams of gold. The monetary authority could set it at whatever it liked. Domestically it needed to ensure sufficient gold reserves to back the currency in circulation.
It was the principle method for making international payments. Trade deficit countries would have to ship gold to trade surplus countries.
Say NZ ran a current account deficit against Australia. NZ would literally ship the equivalent gold on ships to the surplus country. This would have effects on the money supply expanding (without an increase in productive capacity) and the loss of gold reserves for the trade deficit country would force a country to withdraw currency domestically (decrease spending/increase taxes) which is deflationary and cause unemployment and falling output.
The economist Bill Mitchell described the system as such
This inflow of gold would allow the Australian government to expand the money supply (issue more notes) because they had more gold to back the currency. This expansion was in strict proportion to the set value of the AUD in terms of grains of gold. The rising money supply would push against the inflation barrier (given no increase in the real capacity of the economy) which would ultimately render exports less attractive to foreigners and the external deficit would decline.
From the New Zealand perspective, the loss of gold reserves to Australia forced their Government to withdraw paper currency which was deflationary – rising unemployment and falling output and prices. The latter improved the competitiveness of their economy which also helped resolve the trade imbalance. But it remains that the deficit nations were forced to bear rising unemployment and vice versa as the trade imbalances resolved.
During the gold standard era countries balanced their external account (trade or what call today the current account) to maintain their gold reserves. In the meantime trade deficit countries experienced domestic sessions and rising unemployment.
WWI interrupted in the gold standard and currencies were valued at whatever each country wanted to set it at. Some tried a return to the gold standard – some floated their currencies – the USA had a floating exchange rate in 1945 before deciding to go with the Bretton Woods System in 1946.
After the WWII (where countries abandoned the gold standard) Western countries formed the International Monetary Fund and created the Bretton Woods System.
This was a system of fixed exchange rates. Rather than convert directly to gold, countries converted their currencies to US dollars and the US government would convert $USD35 to an ounce of gold.
This was the nominal anchor for an exchange rate system. Countries would then build up USD reserves. If running trade deficits, they would intervene in foreign exchange markets to ensure their currency remained at the agreed parity (running down US dollar reserves) Other options would be to reduce imports (usually via tax cuts/decreased public expenditure to cut spending), increase exports (a loss of a real good or service) or alter monetary policy (interest rates) to attract foreign investment.
Monterey policy was about helping target the agreed exchange parity. It meant fiscal policy (in contrast to a fiat currency) was more restricted.
The fixed exchange rate system however rendered fiscal policy relatively restricted because monetary policy had to target the exchange parity. If the exchange rate was under attack (perhaps because of a balance of payments deficit) which would manifest as an excess supply of the currency in the foreign exchange markets, then the central bank had to intervene and buy up the local currency with its reserves of foreign currency (principally $USDs).
This meant that the domestic economy would contract (as the money supply fell) and unemployment would rise. Further, the stock of $USD reserves held by any particular bank was finite and so countries with weak trading positions were always subject to a recessionary bias in order to defend the agreed exchange parities. The system was politically difficult to maintain because of the social instability arising from unemployment.
So if fiscal policy was used too aggressively to reduce unemployment, it would invoke a monetary contraction to defend the exchange rate as imports rose in response to the rising national income levels engendered by the fiscal expansion. Ultimately, the primacy of monetary policy ruled because countries were bound by the Bretton Woods agreement to maintain the exchange rate parities. They could revalue or devalue (once off realignments) but this was frowned upon and not common.
Let’s take a step back in time and look at the history of The Bank of England. This was the world’s first central bank. Created in 1694 . The BoE website says
The Bank of England began as a private bank that would act as a banker to the Government. It was primarily founded to fund the war effort against France. The King and Queen of the time, William and Mary, were two of the original stockholders.
One could make the assumption the reason for private bankers holding shares in that original entity was to profit every time the government spent. There would be an accounting arrangement whereby the Treasury issued gilts (we call them bonds, treasuries or securities) the BoE would hand over £ and the bankers in turn would ‘own’ the government debt collecting the repayments. The bank was always governed under Government legislation and it was nationalised (removing the private stock holders) in 1946.
Pre-1844 any private bank could issue their own banknotes. Customers would deposit gold in a private bank and receive a ‘note’ that specified the amount. It was until 1725 that the BoE began to issue their own partially notes for amounts of £20 and upwards. These partially printed notes increased in denominations of £10, up to £90 and a bank cashier could increase the value of the note in writing by a maximum of £9 19s 11d
For the uninformed there were 12d to a shilling and 20s to the pound. You could further divide pence into farthings and there were 4 farthings to the pence. For the sake of staging it the (d) symbol for pence comes from the Roman ‘denarius’ a coin used in the Roman Empire.
Up until 1844 private banks had the ability to issue their own notes. The Bank of England began to open its own branches in 1826 as a result of banking crisis in the 1820’s that saw many country and provincial banks fail. The BoE website states:
One of the main reasons for establishing branch banks was to enable us to take further control of the banknote circulation, in order to prevent another crisis.
In 1844 (the formalisation of the gold standard) the UK Parliament introduced The Bank Charter Act which formalised the issuance of banknotes in the UK. It started to place restrictions on private banks issuing their own notes and stopped new banks from issuing their own notes.
In 1931 the BoE suspended the the Gold standard as confidence collapsed as a result of the depression, the Bank lost much of its reserves. The simplest way to spend when you don’t have gold in a currency system backed by gold is to remove the gold standard.
Governments that issue their own currency have always been able to finance themselves, even under a gold standard. Over the period of WWI the BoE issued war bonds to ‘finance’ the war. The public didn’t buy enough war bonds and the BoE used its own gold reserves to purchase treasury war bonds. I suppose this was to remain the rouse that governments are ‘borrowing’
In January 1915, the Treasury prohibited the issue of any new private securities without clearance, and UK investors were banned from buying most new securities (Morgan (1952)). As the war dragged on, and capital became increasingly crucial to the Allies, the net would tighten further. And this episode was to be the first of several instances during the war where the Bank used its own reserves to provide needed capital.
Over the period 1797 – 1821 the UK entered a period known as ‘The Restriction’ As a result of the panic over the war there was a rush on withdrawals of gold and the BoE reserves depleted by £14 million. They suspended the convertibility of gold as they entered a war with France.
To try to preserve the already depleted gold reserves, the Prime Minster, William Pitt the Younger, placed a Privy Council Order on the Bank of England, ordering it to stop paying notes in gold.
The power of the state by legislation ended a system that restricted supply of currency to gold and by legislative fiat they had a free floating exchange rate giving them the capability to invest in their productive capacity. In this case to fund war efforts against Napoleon.
A fiat currency is a currency that a government issues is not convertible (to gold) and floats it on foreign exchange markets.
The float allows a government to target domestic policies such as full employment without the need to worry about ensuring the exchange rate remains at an agreed parity. It means rather than needing to find foreign currency to purchase back its own currency to defend the exchange rate, it is the exchange rate that takes the hit. It means it doesn’t need to ensure gold reserves to the currency in circulation.
The modern fiat currencies began when Nixon ended the Bretton Woods System in 1971 and no longer promised gold in exchange for US dollars. Australia floated its dollar in 1983.
You can appreciate that under previous regimes like the gold standard, taxation ensured the spending the government did was offset to ensure the currency in circulation was in line with the supply of gold. Under a fiat currency the obligation to watch a gold supply is no longer there. The government can purchase whatever is for sale in the currency it issues. There is no need to find gold.
These types of monetary regimes are different. There is no point applying ‘gold-standard/fixed exchange rate’ thinking to a modern day fiat currency. Under a fiat currency a governments limit to spending is limited by the available real resources. There is no need to defend an exchange rate or maintain a gold supply.
Over the 19th century The British Government (through its agent the BoE) started to crack down on private note issuance (under a gold standard) to stop prevent financial crisis. Similar things where done in the USA and Australia to ensure ‘integrity’ of the financial system. It was the nation state that held power (and still does) not the financial sector and private bankers.
Australia used its wartime powers to establish a central bank and forced financial institues to hold exchange settlement accounts with the Commonwealth Bank (and in 1959 handed the role over the newly created Reserve Bank of Australia) This allowed the Commonwealth Government to have control of monetary policy (the overnight interest rate).
Broadly speaking we can divide monetary systems into two types
Gold standard/fixed exchange rates – where governments promise a commodity (such as gold) for a fixed value or they agree to maintain a particular exchange rate. These systems place institutional restrictions on governments spending because they have agreed or promised gold or a foreign currency in exchange for their currency of issue.
Fiat currencies – these allow governments to spend up to the productive capacity of the economy.
Today treasury departments have accounts with their central bank. There is usually an institutionalised accounting arrangement where by when the government taxes the equivalent tax collection is marked up in the ‘offical account’ if the account is short a department within treasury will auction bonds to make up the difference between what it has taxed and what it has spent. However, bonds can only be purchased with reserves which are the result of previous deficits.
The flow (deficit) is then represented as a stock (debt). Under current institutionalised arrangements you can view the debt as every dollar that has been spent and not taxed back. It is the savings of the non-government sector.
The British government through this crisis has done away with the bond market and have used Ways and Means facility (W&M)
The Ways and Means (W&M) facility functions as the government’s overdraft account with the Bank of England (the Bank), i.e. the facility which enables sterling cash advances from the Bank to the government.
Sovereign currency issuing governments would all have overdraft facilities with their central banks. But why go through the rouse of pretending a currency issuer needs to find funds. Combine the operations of the central bank and treasury and credit the relevant bank account and do away with the bond market all together. All reserves within the financial system are a result of government deficit spending as it is. Why hand out corporate welfare?
Hopefully this little bit of history can help you understand how different currency systems operate and see that the a currency issuing Government can do away with the bond market all together.
This is a follow up from yesterday’s post and aims to dispel the myth of the term ‘printing money’ and the orthodox understanding of inflation. The end looks at what happened in Venezuela and Zimbabwe and identifies the cause of hyperinflation as minimal productive capacity and minimal capacity to purchase imported products. They are supply side constraints and you can’t purchase things you can’t make or have access to!
All spending by the currency issuer can be considered new currency. This can be a difficult concept to wrap your ahead around at first. You need to break the myth that a government is like a household. It is not. It is an issuer of the currency and can be considered more like a scorekeeper.
When you are watching the football the umpire gives an instruction to mark the scores up when a try is scored. Theses ‘points’ don’t come from anywhere, they are keystroked into existence. The deduction of the points scored don’t give the umpire an ability to award more points.
The purposes of bond issuance (Government Debt) isn’t too ‘fund’ expenditure but is used as a tool for liquidity management. The RBA needs to ensure there is sufficient liquidity in the Exchange Settlement Accounts so Authorised Deposit Taking Institutes can pay each other at the end of each day. As banks create loans, they need to be able to pay each other. This is what they use their ESAs for. The image below shows how bond issuance (called Australian Government Securities) move reserves in the system from ESA to securities accounts.
Governments spend by marking up the appropriate account
Bonds are issued voluntarily to match deficit spending changing the portfolio mixture.
The RBA uses its Domestic Market Operations to ensure there is liquidity in the system so ADIs can pay each other. (see image above)
The RBA from 20 March has embarked on Quantitative Easing (QE) – sometimes this is called ‘printing’ money. In the image above we can see when treasury issues AGS it takes reserves from ESAs and places them in AGS accounts. There is what is called a primary bond market. There is a list of approved ADIs that can participate in this first round of issuance to purchase AGS and they can then trade them in what is called the secondary bond market. It’s important to note that QE is the RBA specifying a yield on a AGS maturity. You purchase AGS for a specified amount if time. For example a three year maturity. As the demand for AGS increases it raises the price and lowers the yield.
QE undermines the target rate when it chooses a particular maturity, in this case three years and purchases as many AGS as necessary to meet its target, which is currently 0.25%, its purchases increase reserves in ESAs and the target rate falls until it hits zero. If you’ve understood the corridor system, the current floor rate of reserves is 0.1% so the QE program undermines the target cash rate. *
To date since the 20 March the RBA has bought $25,000,000,000 (that is billion) of AGS it holds on its book. Upon maturity of those AGS, the RBA deletes funds from the OPA. *
There is often a mistaken belief that banks loan out reserves. Previously during the GFC we had all sorts of predictions of inflation taking off, banks increasing their lending, predictions of additional Government spending causing inflation and none of that came to fruition. This is because orthodox economics prescribes to the loanable funds theory that states banks loan from a limited pool of savings and as governments increase their expenditure it raises rates and increases the price which leads to inflation. This is not what happens, Government spending adds to reserves, decreasing the interest rate and banks create deposits when they loan to credit worthy customers.
You can see Alan Kohler on ABC News come to that realisation. The intro to the segment starts with ‘Is it something we can afford [stimulus]? and where does all the money come from?’ and in his concluding remarks Kohler says ‘What Dr. Lowe won’t be keen to do is give politicians the idea there’s a magic pudding – of printed money. There sort of is, just don’t tell politicians’
There you have it, there are no printing presses in any of that.
Treasury deficit spends adding to reserve levels
AGS are issued (voluntarily) to match the deficit
RBA uses its domestic market operations to ensure there is liquidity
RBA is currently purchasing AGS at three year maturites to lower the yield. The debt is now owned by the Government.
It is simpler to simply deficit spend and ignore all the accounting practices that are there in issuing AGS. They serve as a mechanism to deliver unearned income to already wealthy investors. These are the very same people that object to increases in welfare payments and public expenditure in general.
Disappointedly, I heard this radio interview on Radio National fear mongering around debt and deficit with language like ‘we’ve gone from balanced budgets to a blowout in debt and deficits’ and ‘will see the budget deficits balloon…’ This is language the invokes an unnecessary fear and that government spending at some point needs to rein its spending in or we all suffer. This crisis shows we always need government spending.
The interview continues with a nonsense analogy that previous generations had to pay for WWII spending. No they didn’t. There was no scarcity of jobs after the war. Governments used their fiscal positions to maintain full employment and seldom did it rise above 2%. Menzies almost lost an election in the 60’s and was forced to raise the deficit and bring unemployment below 2 per cent.
At the end of the interview Fran Kelly and senior business correspondent Sheryle Bagwell discuss the Governments QE program and how the RBA is purchasing Government bonds. They very clearly make the distinction that they are purchasing bonds on the secondary market and not directly from the Government [treasury]
‘If The RBA brought them directly that would be known as helicopter money, it would basically be firing up the printing presses to fund government deficits…lazy governments could really get used to that’
Governments don’t fund deficits they are a result of spending more than taxation.
Dollar for dollar Government Deficits have to match the non-government surplus.
Whether the RBA purchases bonds on the primary or secondary market, the end result is the same. The bonds sit on the RBA balance sheet and at maturity treasury instructs the RBA to pay itself the face value and interest.
The reason the RBA purchases bonds on the secondary market is that it allows investors to purchase bonds on the primary market and then make a capital gain when that bond is then brought by the RBA.
Stop it with the nonsense printing money analogy! There are no printing presses, there are no helicopters, the government is continuing to spend in the same way it always has, it instructs the central bank to mark up the relevant bank account after an appropriation bill has passed.
Inflation is excess spending (from any source) in excess of the productive capacity of the economy and the economy’s ability to absorb the additional spending. Currency issuing governments have an no financial constraint (they never need to find an income) but they are restricted by what is available for sale.
Yesterday I was involved in this Twitter exchange with Professor of economics Richard Holden from the UNSW.
The orthodoxy usually talks about deficit spending but budget balancing over the cycle. Holden in his tweet states ‘We can borrow at almost zero interest’
The Government never borrows, it spends adding to reserve levels of ESAs and bond issuance shifts those reserves from that account to securities account. The difference between that and a term deposit is that you can buy and sell access to those securities accounts.
If Holden understood that he wouldn’t feel the need to then respond back with the typical fear mongering around inflation ‘tell that to Venezuela or Zimbabwe‘ invoking hyperinflation fear!
Japan, The USA, The European Central Bank and now Australia has been purchasing bonds off the secondary market (QE) and holding treasury bonds on their books, paying the interest to themselves and there has been no outbreak of inflation.
Amongst the orthodoxy they’ll make the case prescribing to the Quantity Theory of Money. ‘the quantity theory of money (QTM) states that the general price level of goods and services is directly proportional to the amount of money in circulation, or money supply.’
The federal reserve (USAs central bank) says
‘The money supply is the total amount of money—cash, coins, and balances in bank accounts—in circulation.‘
On the liabilities side of the Federal Reserve’s Balance sheer, the amount of currency outstanding has continued to rise gradually, but reserve balances (deposits of depository institutions) have increased dramatically relative to the prior financial crisis’
The orange line is the increase in deposits of financial institutions in the US equivalent of exchange settlement accounts. Clearly, there has been no great inflationary outbreak, at least never in my life time. Since the GFC the Federal Reserve has embarked on several QE programs the latest of which has seen their purchases of bonds increase from $US700bn to an unlimited number of bonds. This swaps an asset of a bank (the bond) into currency in its exchange account and the bond is held with the central bank.
So we can put increases in the money supply, ‘printing money’ and an inflation outbreak to rest. It’s not a thing.
There are other factors that contribute to inflation and even hyperinflation. The first step is understanding what economist call ‘cost-push’ inflation.
This differs to the demand side in that it is the price level of a good or services increases either via an imported price (something the national government can’t control) or domestically via a fall in production and productive capacity.
Fadhel Kaboub at the Global Institute for Sustainable Prosperity in the linked news article below says
MMT points to a different primary cause of inflation in developing countries: not domestic spending, but foreign debt and a resulting lack of “monetary sovereignty.”
A country that is monetarily sovereign issues its own currency and floats it on an exchange rate.
There are some countries which use a currency they don’t issue, such as the eurozone countries and there are countries that fix their exchange rates to maintain a parity to another currency.
Countries that don’t issue their own currency, like the eurozone, are reliant on taxes and bond markets to fund public expenditure.
Countries that fix their exchange rate have to ensure foreign currency reserves to maintain the peg. Countries then need to obtain foreign currency either by purchasing it on foreign exchange markets (FOREX) using their own currency or through exporting goods and services.
Provided spending doesn’t outpace an economies productive capacity you won’t have a period of accelerating inflation.
Any country that issues its own currency can purchase what is for sale in the currency it issues. This includes idle labour. A country that issues its own currency always chooses the level of unemployment.
That doesn’t mean because a country at full employment is materially prosperous. You need to consider the skills of the labour force, the raw materials it can access and what it is able to produce.
For a country that relies on imported products, they are reliant on their exchange rate or exports to be able to obtain foreign currency and purchase the goods and services they are unable to produce domestically.
Exports are a loss of a good or service, it is something a nation exchanges for a foreign currency, it means unless you are able to produce an excess of that product you are depriving your citizens of the use and instead giving it to foreigners.
For developing countries, the problem begins with trade deficits and resulting debt owed in foreign currencies.
Those deficits are the product of fundamental economic shortcomings, themselves often a legacy of colonial rule. Postcolonial countries are typically unable to produce enough food and energy to meet domestic need, and they face structural industrial and technological deficiencies. Because of this, they must import food and energy, along with essential manufacturing inputs. For example, Venezuela lacks refining capacity, so—while it exports crude oil—it must import more expensive refined oil, contributing to trade deficits.
Importing more than they export causes these countries’ currencies to depreciate relative to major currencies. With a weaker currency, new imports (like food, fuel and medicine) become relatively more expensive. This imbalance is the real driver of inflation, and often of social and political unrest.
The International Monetary Fund (IMF) historically steps in at this point with emergency loans coupled with painful austerity measures. To get out of IMF conditions, even progressive policymakers typically prioritize acquiring foreign currency reserves in order to honor external debt payments. They promote tourism (tourists bring foreign currency) and design agricultural and manufacturing policies to support export industries. Meanwhile, industries that would build self-sufficiency (and thus fix the trade imbalance), like food crops for domestic consumption, receive little government support. All of this decreases self-sufficiency and reinforces the dependence on foreign goods that caused the debt in the first place.
Venezuela had external debt denominated in US dollars and little productive capacity to satisfy the needs of its population. It has nothing to do with Government spending or ‘printing money’ but sanctions imposed upon it that reduce self-sufficiency. A more just world would cancel debt denominated in an external country, aid the country in building productive capacity to be self-sufficient and have the US purchase Venezuelan bolívar on FOREX markets to maintain the currency between a certain range so they can purchase imported products.
Professor Bill Mitchell has detailed post on hyperinflation in Zimbabwe where he identifies one of the major causes of the inflationary outbreak to a fall in the nations productive capacity. In Zimbabwe’s case their agricultural production, that also happened to be one of the nations largest employers.
The problems came after 2000 when Mugabe introduced land reforms to speed up the process of equality. It is a vexed issue really – the reaction to the stark inequality was understandable but not very sensible in terms of maintaining an economy that could continue to grow and produce at reasonably high levels of output and employment.
The revolutionary fighters that gained Zimbabwe’s freedom from the colonial masters were allowed to just take over productive, white-owned commercial farms which had hitherto fed the population and was the largest employer. So the land reforms were in my view not well implemented but correctly motivated.
The output of the nation was decimated and it saw soaring unemployment levels, to over 80%. How do you reduce the demand for food without forcing people to remain malnourished and even starve?
The central bank was using its foreign reserves to purchase food supply, limiting the capacity of other industries like manufacturing on FOREX markets to purchase foreign currency and ending up in the situation where they couldn’t operate their plants. Mitchell goes on
The situation then compounded as other other infrastructure was trashed and the constraints flowed through the supply-chain. For example, the National Railways of Zimbabwe (NRZ) has decayed to the point the capacity to transport its mining export output has fallen substantially. In 2007, there was a 57 percent decline in export mineral shipments (see Financial Gazette for various reports etc).
Manufacturing was also roped into the malaise. The Confederation of Zimbabwe Industries (CZI) publishes various statistics which report on manufacturing capacity and performance. Manufacturing output fell by 29 per cent in 2005, 18 per cent in 2006 and 28 per cent in 2007. In 2007, only 18.9 per cent of Zimbabwe’s industrial capacity was being used. This reflected a range of things including raw material shortages. But overall, the manufacturers blamed the central bank for stalling their access to foreign exchange which is needed to buy imported raw materials etc.
The Reserve Bank of Zimbabwe is using foreign reserves to import food. So you see the causality chain – trash your domestic food supply and then have to rely on imported food, which in turn, squeezes importers of raw materials who cannot get access to foreign exchange. So not only has the agricultural capacity been destroyed, what manufacturing capacity the economy had is being barely utilised.
A country like Australia has none of these issues. Fears of hyperinflation are unwarranted. Mitchell describes the situation in Zimbabwe as a result of a supply side collapse, a 45% fall in agricultural capacity, difficulty in obtaining imported materials forcing manufacturing to lay idle and compounding that with a Government interested in spending for political favours while your nations productive capacity has collapsed
“Further, the response of the government to buy political favours by increasing its net spending without adding to productive capacity was always going to generate inflation and then hyperinflation. “
Tax liabilities serve the purpose of creating a demand for an otherwise useless currency.
Government debt is issued after the fact a currency issuer has spent. It moves currency from reserves into a securities account.
Deficits are a result of spending (and aren’t funded) and have a corresponding surplus in the non-government sector. This is an accounting rule and simple 7th grade algebra.
Printing money – referred to by the orthodoxy as the central bank purchasing bonds from the treasury (QE) is not inflationary. Increases in the money supply (Quantity Theory of Money) have not resulted in any outbreak of inflation despite governments embarking on these since the Global Financial Crisis.
Government deficits pushing rates up (Loanable funds theory) and contributing to rising interest rates and therefore costs and inflation is not a thing. Governments have run deficits, larger ones since the GFC and inflation has not happened. That is because loans create deposits.
Hyper-inflationary episodes in Zimbabwe and Venezuela are supply side collapses and those nations had little domestic productive capacity, had debt in foreign currencies, depreciating exchange rates (where they couldn’t purchase imports) and no ability to obtain foreign currency without adhering into bullshit IMF rules to loan them foreign currency under conditions that impose austerity by mandating selling public assets to private corporations and aiming for budget surpluses.
Hearing economists peddle misunderstandings on the way the monetary system functions, like the many I’ve documented over these lasts two posts, continues to reinforce a neoliberal paradigm that will undermine progressive aims.
We shouldn’t have to moderate demands based on a misunderstanding that we need to find the dollars.
Currency issuing governments can always purchase what is for sale in the currency they issue and deploy those resources for a public purpose.
We have seen this during the covid-19 crisis the Australian Government double the rate of the JobSeeker payment (despite 25 years from both parties claiming it was unaffordable), they have temporarily nationalised private hospitals with a $1.3bn takeover, they have made childcare free. It is never an issue of finding the money but whether we have the resources to create the public services we desire.
Old paradigms take time to shift and you can see the economic orthodoxy feeling threatened. Richard Holden, despite pushing progressive aims and goals, is stuck under an economic paradigm that has no empirical evidence.
He felt the need to respond to an amateur that questioned where do financial institutes obtain Australian dollars to purchase Australian Government Securities? and brought up arguments of hyperinflation by referencing Venezuela and Zimbabwe.
I think that is a sign that the orthodoxy knows it is losing power. It is a choice to make that paradigm shift, admit your understanding was wrong and use MMT as a lens to advocate for your values.
*Edit: The initial publication of this made an error and said upon maturity of AGS the RBA credited the OPA. It is in fact upon maturity, the RBA deletes funds from the OPA. These are a liability of the RBA. and their deletion matches the deletion of the bonds, which are assets.
It was also picked up that there was bad phrasing and it was clarified that QE drives rates to zero (or the current floor which is 0.1% in Australia) and this has also been edited. The initial publication mistakenly said the current target rate was zero. It is not, it is 0.25%
Many thanks to Steven Hail for picking up the errors.
Since the beginning of the corona virus Governments around the world have began to spend huge sums without a call from anyone on ‘How are you going to pay for it?’ In a recent 730 interview the reporter asked the question on how a sovereign currency issuing government would ‘pay for’ its spending down the track.
LEIGH SALES: Has any thought been given yet as to how Australia will ultimately pay for this or is that to be worked out down the track?
JOSH FRYDENBERG: This will be paid back for years to come. There’s no secret in that and of course, we will enter into discussions with the credit rating agencies over due course.
When I’ve publicly stated currency issuing governments have no intrinsic financial constraint the retort back is usually something like ‘if you print money you just get inflation’
This post will look at the way in which currency issuing governments spend, how ‘printing money’ does not apply to any spending operation, look at what government debt is.
The first thing to note is that there is a difference between a currency issuer and a currency user.
The Australian Government is a currency issuer. It is a monopolist of the Australian dollar – It faces no insolvency risk
As a monopolist over the currency it always has the capacity to spend (that is not a call for unlimited spending)
Regardless of past deficits or surpluses the Australian Government spends in the same way every time. – There is an appropriation bill that passes through the legislature, Treasury instructs the Australian Office of Financial Management to give the Reserve Bank an instruction to credit the relevant bank account(s)
The very concept of saving for an issuer of a currency is ridiculous. Savings are the act of forgoing current expenditure and are used to spend at a later date. When you issue a currency you always have the ability to spend.
We can conceptualise the process from the above figure. Like you have an account with your bank, your bank referred to as, Authorised Deposit Taking Institute (ADI) has an account with the Reserve Bank of Australia. They care called Exchange Settlement Accounts (ESA). All Federal Government spending marks up reserve levels of ADIs and those ADIs credit the relevant account holder.
Taxation has the opposite effect. Demand deposits decline and Reserve levels also decline. It means less spending power for currency users.
There are institutionalised arrangements where The Australian Government holds an Offical Public Account with the RBA, however this is merely an accounting arrangement and the numbers within the OPA are not included in the money supply. The image below is a screenshot from the notes of the RBAs data on the financial aggregates of the Australian economy.
There are two options for a Government to adjust aggregate spending levels. Fiscal Policy (Spending and Taxing) and Monetary Policy (Interest Rates)
We have seen how Government spending adds to reserve levels and taxation does the opposite. What Government spending also does is effect the RBAs target rate. This is the interest rate that you hear about on the first Tuesday of every month and it is the rate ‘targeted’ for ADIs to loan to each other using their Exchange Settlement Accounts (ESA)
One of the purposes of bond issuance is to defend an interest rate. As noted above all Federal Government spending increases reserves with ADIs.
As government spending adds to reserves and increases their level it pushes interest rates down and as taxation removes reserves it pushes rates up.
Obviously fiscal policy can not be used to defend a particular target rate as it would cause all sorts of havoc. It is the RBAs job to ensure the levels of reserves are right so banks lend to each other at the target rate.
Bonds are used to drain and add liquidity. When a bond is issued (sold) it drains reserves. It is the equivalent of an ADI moving dollars from their ESA (The account used to pay other ADIs) to a securities account, an account which earns interest.
The opposite happens when bonds are purchased by the RBA. It moves dollars from the ADIs security account to their ESA. Bond issuance doesn’t alter the supply of funds but merely the portfolio mix.
The activities of Treasury and The RBA need to be very closely co-ordinated to ensure the payment systems functions.
The RBA needs to ensure sufficient reserve levels so ADIs can pay each other. Remember loans create deposits and spending and taxing by the treasury can have huge fluctuations in the levels of reserves.
Rather than relying on bond issuance to ensure a particular target rate is achieved the RBA uses what is called the corridor system. You can watch this video of Katherine from the Domestic Market Operations department at the RBA to understand how it works. Thank you Katherine.
Once you take into consideration the corridor system, bond issuance becomes about liquidity management and ensuring there are sufficient reserves so ADIs can pay each other and our payment system functions.
The RBA will always have an option for an ADI to ensure their ESAs are positive. If they are short of reserves they can borrow from the ‘penalty window’. This is where the RBA acts as a Lender of Last Resort and loans the required reserves to the ADI.
In no way does the bond issuance ‘fund’ the ability of a currency issuer. There isn’t really a reason for treasury to match deficit spending with bonds either. It just means the RBA may have to enter into more repurchase agreements to ensure there are sufficient reserves in the system. Because bond issuance moves dollars into securities accounts, draining reserves, the RBA then enters into what is called repurchase agreements (repos) where it issues bonds and then buys them back the next day with an interest rate to add to reserve levels.
What does all this have to do with ‘printing’ money. I am never too sure what people mean when they use this term.
Governments spend by marking up the appropriate account
Bonds are issued voluntarily to match deficit spending changing the portfolio mixture.
The RBA uses its Domestic Market Operations to ensure there is liquidity in the system so ADIs can pay each other.
The RBA uses a corridor system to defend an interest rate.
The very concept of borrowing for a currency issuer or using ‘this record period of low rates’ to invest is non-sensical. There is no borrowing or debt in the same way it applies to a household. Deficit spending adds to reserves and that deficit spending is what gives ADIs the ability to purchase bonds and that is what we refer to as Government debt!
The article states that the increased costs of government spending in normal times don’t apply to these pandemic times. That’s ridiculous, there is no real cost to government spending, it marks up accounts using a computer. Costs are real resources. Environmental damage, loss of habitat, climate change, individual hardships, unemployment, mental and physical health etc…
The author outlines three reasons in the risk of this ‘pandemic’ spending.
“The first is the potential for increased government spending to “crowd out” the private sector. When governments run budget deficits they are borrowing money from investors, money which is no longer going to other worthy investments. Increased demand on the limited pool of savings, in normal times, means higher interest rates”
The above quote is straight out of the loanable funds theory that states there is a limited pool of savings that banks loan from and Government spending in excess of taxation then uses that limited pool and pushes rates up. That is simply not true. I outlined in a previous post on how loans create deposits and above have described the process of how the RBA ensures sufficient reserves to ensure ADIs have sufficient reserves to pay each other. The loanable funds theory is on of those neoliberal myths that is used to demonise public spending. I like to use this thing called observation of reality. We can very clearly see through the GFC and now this crisis, deficit spending has increased and we have record low interest rates. You can see central banks around the world set interest rates every month, there is no natural reason they will suddenly increase and governments will be powerless to stop it.
“The second potential cost of increased government spending is the future cost of paying interest on that debt.“
The ‘debt’ are securities account that ADIs hold at the RBA. If you don’t like Government debt, don’t issue it.
Furthermore, the RBA announced it will engage in Quantitate Easing – a process where it chooses a particular treasury maturity (say three year bonds) chooses a yield it desires and begins purchasing those bonds from the market. Central Banks around the world have engaged in this practice since the GFC. Many central banks now hold treasury bonds. It is the treasury choosing to issue a bond, an investor buys that bond, it is then purchased by the central bank (with a capital gain for the investor) and the interest payment is then paid from treasury to the central bank who then credits the treasury account.
“The third cost of increased government spending is that it can be unsustainable (meaning it can cause problems if that level of spending continues) or can destabilise financial markets.“
Government spending can never become unsustainable. It is a currency issuer and literally as infinite financial capacity. Why are financial markets an indicator of sustainability? Fiscal policy shouldn’t be there to appease financial markets, who desire less public expenditure and the ability to make more profits, it should be there to ensure our own well being. You judge fiscal policy based on how well the bottom of the income spectrum is doing and whether we have our desired levels of public services and are reaching our goals to mitigate against climate change.
It is pathetic that the vast majority of financial journalists/commentators get the very fundamentals of the way government spending works wrong.
Adam Triggs in The Canberra Times, Leigh Sales in her interview with the Treasurer, Jessica Irvine in the Sydney Morning Herald who said “These surplus funds can then be used to pay down any existing debt.,”
No, currency issuers can always spend regardless of past deficits or surpluses. Government Debt are bonds purchased by Financial institutions who obtain Australian dollars from Federal Government deficit spending. Surpluses are not savings. It is the government spending less than taxing and removing reserves.
Lenore Taylor of The Guardian who wrote “The country will be deeply in debt, as will many households.” The Taylor article makes an argument “Having seen the life-saving benefit of our public health system, there will surely be enormous pressure to fund it better in the future.” I agree with the overall spirit of the article. However, we won’t achieve greater levels of public services and spending, if we continue to frame economics using a neoliberal perspective.
For an accurate discussion of how our monetary system operates listen to this discussion between financial journalist, Alan Kohler and Emeritus Professor Bill Mitchell.
In term of the term ‘printing money’. It doesn’t apply to any spending operation.
All spending by a currency issuer is an authorisation bill through the relevant legislature.
There is then an instruction from somewhere within treasury to the central bank to mark up the relevant account.
‘Government debt’ or treasury bonds are then issued.
It’s been a while since my last post. Writing a blog is much more intensive than I had anticipated. I have a new appreciation for anyone that can put out content on a regular basis, while maintaining a full time job and other commitments. I am endeavouring to post more frequently.
I recently had an interview on community radio 3CR based in Melbourne. The topic was “The Story of Money” and dealt with how currency did not evolve out of barter but always was a ‘creature of the state’. We attempted to break down many myths about how a country with fiat currency operates. The radio interview went to air last Friday and a podcast is available here.
One of the interesting things I’ve learned through studying the history of currency is how it functioned. Michael Hudson discusses the origins of money and interest over the Neolithic and Bronze Age as a provision of credit and not that as a system of barter that is commonly told.
“As a means of payment, the early use of monetized grain and silver was mainly to settle such debts. This monetization was not physical; it was administrative and fiscal. The paradigmatic payments involved the palace or temples, which regulated the weights, measures and purity standards necessary for money to be accepted. Their accountants that developed money as an administrative tool for forward planning and resource allocation, and for transactions with the rest of the economy to collect land rent and assign values to trade consignments, which were paid in silver at the end of each seafaring or caravan cycle.”
Once you understand that all ‘money’ is a liability or a debt (the numbers you see in your bank account are a liability for the bank and the numbers in your bank’s account at the central bank are a liability of the currency issuer [whom can always make payment]) you can understand how money came to be.
The origins of these accounting practices can be found in the Kingdom of Sumer. Sumer was a kingdom in Mesopotamia settled by humans around 4500 to 4000 B.C. The area is where strides in agriculture, textiles, carpentry, pottery and fermentation happened. The Sumerians were in control of the area by 3000B.C and their society was compromised of city states. Hudson writes
The origins of monetary debts and means of payment are grounded in the accounting practices innovated by Sumerian temples and palaces c. 3000 BC to manage a primarily agrarian economy that required foreign trade to obtain metal, stone and other materials not domestically available.
This system of accounting was used to forward plan and ensure food, textiles, and housing for the population. It was large palatial institutions designed a system to keep track of the stocks and flows of production and trade.
…The first need was to assign standardized values to key commodities. This problem was solved by creating a grid of administered prices, set in round numbers for ease of computation and account-keeping. Grain was designated as a unit of account to calculate values and co-measure labor time and land yields for resource allocation involving the agricultural and handicraft sphere, as well as the means of payment.
The second need of these large institutions was to organize means of payment for taxes and fees to their officials, and for financing trade ventures. Silver served as the money-of-account and also as the means of payment for trade and mercantile enterprise…
In my very first blog post I described the State Theory of Money where the work of Alfred-Mitchell Innes stated “Validity by proclamation is not bound to any material” That is a currency doesn’t have to be backed by any material but it derives it’s value because of the tax liability placed onto the communities in that society.
One way to understand taxes drive demand for a currency is to look at the experiences of European colonisation of African Nations that compelled Africans to provide goods and services to their European colonisers in exchange for the currencies the colonisers issued.
Prior to colonisation the Indigenous populations were non-monetary based societies engaged in substance living, largely could produce enough to provide for their communities and engaged in some internal trade. There was no reason to desire a European currency or any currency for that matter.
The excellent book by Sticher, Migrant Laborers (African Society Today) published in 1985 describes the imposition of a hut tax in Malawi being imposed by the British colonisers.
….imposition of a Sh.3 annual hut tax over the whole colony in 1896. This was a high figure for the northern areas. And undoubtedly stimulated further labor migration [to find work paying shillings]. In the south of Malawi, however, Africans preferred to meet the tax by [selling products]. Southern [European] planters therefore were short of labor and pressed for an even higher tax. As a result the tax was raised in 1901 to Sh.6, with a Sh.3 remission for those who could prove they had worked for a European for at least one month. This ‘labor tax’ had an immediate effect. The labor market in the south became flooded… Taxation, then, if it were high enough…could force men into wage earning … Taxation as a method of forcing out laborers but it did not distinguish between the various sources of the cash. Most Africans who could simply sold produce or livestock [to Europeans at administered prices] in order to pay the tax. But where Africans were poor in items to sell, or were distant from markets, taxation could produce laborers
The evidence is rather clear that from the Bronze age the early kingdoms devised a system of credits and debits to keep track of production and all the way to modern times it is the imposition of a tax liability that derives the value and demand of a currency.
Markets are then created post the tax liability and the spending. Polyani’s book ‘The Great Transformation: The Political and Economic Origins of our Times’ explains the market not as some natural state and economic rationality and market mechanisms for providing the basis of organisation, rather a market is based on communal patterns of organisation tied to our social structures.
The performance of all acts of exchange as free gifts that are expected to be reciprocated though not necessarily by the same individuals–a procedure minutely articulated and perfectly safeguarded by elaborate methods of publicity, by magic rites, and by the establishment of ‘dualities’ in which groups are linked in mutual obligations–should in itself explain the absence of the notion of gain or even of wealth other than that consisting of objects traditionally enhancing social prestige. . . . But how, then, is order in production and distribution ensured? . . . The answer is provided in the main by two principles of behavior not primarily associated with economics: reciprocity and redistribution.
Polyani, K. The Great Transformation: The Political and Economic Origins of Our Time, Beacon Press 1957 (reprint 2nd Edition 2001)
Much of the orthodox text uses nonsense theories about human behaviour and rational expectations which attempt to ‘demonstrate’ that markets themselves find equilibrium and are self correcting. The empirical or anthropological evidence holds these theories to be nonsense. Exploring the concept that money evolved out of barter and ‘disrupted’ the market causing the system not to be able to correct itself is common amongst the orthodoxy that Government intervention should be kept to a minimum as it disturbs the ‘natural’ state of markets and the economy.
Thinking about a common problem, unemployment, the orthodox framework describes it as a problem of the individual and we have a framework of ‘full employability’ where we push the unemployed through ‘training’ because they aren’t skilled enough to have their labour demanded. The issue isn’t a lack of jobs per se but that the unemployed haven’t gained enough skill to have their labour in demand and have chosen leisure over employment.
The description above is of course complete bull. Anyone that views unemployment through a framework of an individual issue whereby the unemployed has chosen leisure over employment is clearly, in my mind, sociopathic.
Unemployment is always a result of insufficient spending. The imposition of a tax liability creates a demand for a currency, that spending sets the general price level and is used to purchase real goods and services created by the private sector into the public sector. Those that do not have the means to provision the government with a good or anyone else with the currency with a good need to sell their labour in order to obtain the currency and pay their taxes.
It is insufficient spending in aggregate that causes unemployment. Here it is important to realise taxation decreases someones income and thus the ability to spend is less causing further unemployment.
A view on what constituents aggregate demand is important. National Accounting statistics describe the sources of spending as; Government Spending, Consumption, Investment, Exports
The initial spend has to come from the currency issuer – this is Government Spending, the recipients of that income spend further and then those receiving income from that spending spend again – until such a state that a certain portion of the labour force is employed. Investment expenditure and Export expenditure is also income for someone or to some business and thus contributes to employment.
Within the cycle of spending there are what are called leakages – these are taxation, savings and imports. Taxes take away spending power, causing unemployment but allowing the Government to create the non-inflationary space to spend and acquire real goods and services. Savings and imports (which are a foreigners desire to save) is income not spent and thus can be thought of as contributing to unemployment. Keynes argued that Government Spending needs to equal full employment and the savings desires of the non-government sector.
Sectoral balances between the the Government and non-Government show that the Government deficit has to equal the Non-Government sector surplus. This is an accounting rule. If the Government spends 100 and taxes 30, we record that as a deficit of -70 but that +70 has to sit within the non government sector. It is income.
Unemployment is a result of insufficient aggregate demand (total spending) A currency issuer always chooses the unemployment rate. It is a political choice as the issuer of a currency can ALWAYS purchase whatever is for sale in the currency it issues. It uses the computer to mark up the size of a bank account and gives them a task to do!
Within an MMT framework a Job Guarantee is a superior automatic stabiliser (spending increasing/decreasing without a change in policy) that maintains ‘loose’ full employment and price stability. It is a superior inflation anchor than the current orthodox approach that uses unemployed to discipline the inflation rate. Spending at the bottom of the income spectrum can not be inflationary as inflation is excess spending beyond the productive capacity and the economies ability to absorb the additional spending. Purchasing the unemployed (those that have been rejected by the labour market, that is constructed from the Governments initial spend) can not be inflationary because there has been no competing bid for their labour. I’ll write in more detail on inflation at some future point.
The radio interview was a simplified explanation of the above. Many thanks to Anne for the edit making me sound coherent. It is an art form giving an interview.
It should be noted that the story of money is much much more complex. It involves different types of monetary regimes which you can divide into three types. A Gold Standard, Fixed Currency Exchange Rates and Fiat currency regimes. The latter is what we operate under today.
To further complicate things add a banking system to a monetary system and you have entities that are given license to issue credit and I dealt with this in my first blog post.
I’ve had a number of friends that have been encouraging me to write a blog for at least a few years now. This is my attempt at a blog.
For the last five years I’ve been informally studying Modern Monetary Theory. I became captivated by the elegance and internal consistency of the body of work. The captivation went so far that I named a fighting fish (the one pictured on the main blog page) after a well known MMT academic. I did so because the fish happened to sit under one of Randall Wray’s books on my bookshelf. Irrelevant to the topic at hand but Randy (the fish) spends his life in the Darwin Festival office.
Orthodox economist will tell a simplistic story about barter and ‘money’ evolving out of that.
A credit approach to money stems from the work of an economist Alfred-Mitchell Innes where he emphasises credit and debt are the same thing but from a different view point. David Graeber’s book, Debt:The First 5000 years is recommended if you wanted to delve into detail about credit and debt relations throughout history and I might write more about on what debt is at a latter date. Simply put think of it as ‘Someone else’s debt is someone else’s asset.’
The State Theory of Money comes from the work of Georg Friedrich Knapp where he states “Validity by proclamation is not bound to any material” That is a states currency gains its value from the liability enforced in that same unit of account.
Wray in the conclusion of his paper writes there is an integration between the creditary and state money approaches. I’ll discuss the state money approach first.
…the state chooses the unit of account in which the various money things will be denominated. In all modern economies, it does this when it chooses the unit in which taxes will be denominated and names what is accepted in tax payments. Imposition of the tax liability is what makes these money things desirable in the first place. And those things will then become the money-thing at the top of the “money pyramid” used for ultimate clearing.
L. Randall Wray, The Credit Money and State Money Approaches, Center for Full Employment and Price Stability, University of Missouri-Kansas City.
An easy way to think about that is to first distinguish between a Currency Issuer and a Currency User.
Say you want chores completed around your house and you offer your business cards in exchange for household chores. Why would your children desire your business cards?
The MMT money story states the tax liability comes first, followed up by government spending, so the people can meet the liability imposed and taxation comes after the fact the currency issuer has spent.
In the business card example sighted above, you would impose a tax of say 30 cards a month and without payment at the end of each month there would be consequences. It’s the coercive power of the state that drives the value for the currency.
Soon the kids are doing chores, earning their cards (that only you issue) and they develop a market and trade cards with each other getting their siblings to do chores when they’d rather not. You tell the kids that if they want to snack between meals and have desert there is charge, denominated in business cards.
There is a limit to the kids spending because eventually they have to earn more to pay their taxes and be able to eat desert and snack between meals.
Think of the snacks and desert as a fee imposed to gain access to things you may want to limit. Breakfast, Lunch and Dinner involve no exchange of cards and are akin to a public service – they can always be provided by you, provided you have the food to cook!
Going back to Wray’s conclusion and discussing the creditary money approach.
The private credit system leverages state money, which in turn is supported by the state’s ability to impose social obligations mostly in the form of taxes.
L. Randall Wray, The Credit Money and State Money Approaches, Center for Full Employment and Price Stability, University of Missouri-Kansas City.
You may have heard loans create deposits. The Bank of England in this paper says;
“‘Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created“
That is the bank creating itself an asset which becomes the borrowers liability.
There are several different ‘money things’ we refer to as money:
1. Physical notes and coins 2. Reserves – like you have an account with the bank, your bank has an account with the central bank. They use this account to settle payments with each other. 3. Bonds – What we refer to as Government debt. Banks exchange their reserves to purchase these and they earn interest and the face value paid upon maturity, similar to what you would do with a term deposit account 4. Demand deposits – what you see when you check your online bank account.
And I’ll write more about these in the future.
Federal Government spending adds to reserves and then is placed in a demand deposit. Banks create demand deposits and need to ensure their reserves are in surplus at the end of each day. It is the central bank’s job to ensure there are sufficient reserves for financial institutes to pay each other otherwise the payments system would grind to a halt. Banks are reliant on the consolidated government (treasury and the central bank) to add to those reserves.
What we call ‘money‘ is a social construct. Each of the numbered points above are created using different ‘mechanisms’. What matters is whether we have the real resources (labour, skills, raw materials) to provide for our society. There are only political constraints that stop a currency issuer from deploying real resources for a public purpose.
I recently attended the Sustainable Prosperity Conference in Adelaide. It was great to meet people I’ve linked in with through social media and meeting several of the keynote speakers whose work I have been reading. This lecture was put on by the university of Adelaide for the Harcourt Lecture an annual talk featuring a prominent economist. This year it was Stephanie Kelton and is an excellent introduction to modern monetary theory and understanding economics.