Monday, October 4, 2010

National debt reduction for dummies.

The dummies in charge of Britain and several other countries can’t fathom out how to stop their national debts rising. All they plan to do is SLOW DOWN THE RATE OF GROWTH. For example the consensus amongst British politicians is that Britain should halve its deficit in about four years.

Well pay attention dummies. Here’s how to stop the national debt rising as from tomorrow. (This is actually just a move towards a monetary regime advocated by Milton Friedman which involved NO NATIONAL DEBT AT ALL.)

1. Stop all government borrowing tomorrow (apart from rolling over existing debt).

2. Leave public sector spending untouched.

3. That means a large UNFUNDED deficit. That is, the deficit accumulates as extra monetary base instead of extra national debt.

4. Still with me?

5. The effect of “3” above would be excessively stimulatory and probably inflationary. So temper that with a DEFLATIONARY method of deficit reduction, i.e. get some of the money for the deficit reduction by raising taxes and/or cutting public spending: ideally by just enough that the above inflationary and deflationary effects cancel out. That leaves a NEUTRAL EFFECT.

6. Having the above stimulatory and deflationary effects EXACTLY cancel each other is of course difficult. But getting ANYTHING exactly right when running an economy is never easy. The important point about the argument here is that it achieves something that according to conventional thinking is impossible. That is the important point about the argument here is the THEORY.

7. If you think the above tax rises and public spending cuts means “austerity”, then you are wrong. Remember I said “NEUTRAL” just above? That is, there is (ideally) no stimulatory or deflationary effect from the above wheeze. That is aggregate demand, output per head, total numbers employed, etc. etc. etc. etc. etc. etc. remain the same.

8. Still with me?

9. A moderately intelligent question at this stage would be along the lines “You’ve just said no austerity is involved, but you’re advocating tax rises and public spending cuts. Isn’t that a self contradiction?”

Answer: remember that the unfunded deficit or accumulation of monetary base in the hands of the private sector puts extra spending power into the hands of the private sector. Thus the private sector will spend more. If some of that money is then taken away from the private sector in the form of extra tax, the private sector will be approximately back where it started. Ergo . . . . . no austerity!!!!!

As to the public sector spending cuts, these can be immediately cancelled because of the above mentioned increased government income from the above extra tax which can be spent on public sector employment.

10. It would be easy to take the above argument a stage further and actually bring about a REDUCTION IN THE NATIONAL DEBT STARTING AS FROM TOMORROW. But that would be too much of a shock for economic conservatives and adherents to the conventional wisdom. One step at a time when teaching babies to walk!

11. The real bonus of the above policy is that it would enable Britain to stick two metaphorical fingers up at “the markets”. “The markets” are currently desperate to lend to just about anyone willing to take their money, apart from obvious no hopers (e.g. some PIG countries). Yields on U.S. inflation proofed government bonds are currently NEGATIVE*.

If Britain, the U.S. and other major countries all adopted the above “Churchillian salute” policy, I suspect “the markets” would have a collective nervous breakdown and would beg any reasonably responsible country to take their money at a negative real rate of interest.

12. It is worth summarising the changes in the flows of money between households and government that result from the above policy So here goes.

First, those who do not have significant holdings of national debt (roughly speaking the less well off) pay less tax because they do not need to fund so much interest on national debt. Thus extra taxes can be raised on this section of the population: ideally enough tax to put them back where they started.

Second, there are those who DO have significant holdings of national debt (roughly speaking, the well off). The purpose of having government borrow from these people (as Modern Monetary Theory correctly points out) is NOT to fund government. The purpose is to damp private sector demand by enough to make room for proposed increases in government spending.

Under the “no more borrowing” policy advocated here, these people would pay more tax. Ideally the amount of tax needs to be whatever brings the same “damping” effect as would have been occasioned by borrowing, had the deficit been left in place.

The ACTUAL AMOUNT of tax will CERTAINLY NOT be equal to the amount of borrowing that would otherwise have taken place (and any suggestion that the two are or would be equal is to fall for the most popular mistake in economics: applying micro economic ideas at the macroeconomic level).

At a rough guess, the amount of tax that would have to be raised from the wealthy would be a small proportion of the amount that would otherwise have been borrowed, perhaps about a tenth. Reason is that there is a very big difference between government PERMANENTLY CONFISCATING one’s money (tax) and government borrowing one’s money. In the latter scenario (borrowing) one is still the “owner” of the money. Moreover, one gets a receipt from government (Treasuries in the US and “Gilts” in the UK) which are almost as good as money: the “receipts” can readily be used (like money) to transact business. To illustrate if you have $10k of Treasuries, no money, and want to buy a $10k car, all you do is sell the Treasuries and use the cash to buy the car!

Stop press - (6th Oct). Looks like my above suggestion about responsible governments being able to stick two fingers up at their creditors has become slightly nearer a reality. See post by Stefan Karlsson entitled "Please, U.S. Government. Take My Money" (6th Oct).

Afterthought (12th Oct).
Re the amount the amount of extra tax than needs to be raised from the wealthy or Gilt owners, it could easily be less than a tenth of the value of the Gilts concerned. The relevant question is: “what amount of tax leaves a neutral effect?” To illustrate, if I get £X in exchange for £X of Gilts, there will be a finite stimulatory effect: I’ll have excess cash and will channel it to other assets (and presumably a small amount of extra consumption). But suppose I get £0.95X, because I am taxed to the tune of 0.05 of the value of the Gilts. In that case I may well feel poorer and will in consequence not do anything that results in stimulation. I.e. the ratio could easily be 1:20 or less.

* See Stefan Karlsson’s blog post, “Record Low Real U.S. Treasury Yields.” (28th Sept 2010).

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