As lockdown measures ease, people return to work, and retailers open their doors once again, a big question is looming large in the background.
How are we going to pay for all this?
I am of course talking about expensive government policies such as the furlough scheme, small business rates relief grants, bounce back loans, self-employed income support payments, and the many other measures which were introduced to try and nurse the UK economy through the devastation caused by the Covid-19 pandemic, and associated lockdown.
The conventional knowledge is that public spending will have to be drastically decreased (which would harm public services), or taxes substantially increased (which would likely harm growth), in order to make a dent in the debt mountain which has piled up over the past few months.
For example, on July 11th 2020, The Observer published an article by former UK Treasury minister David, which was entitled ‘Tax Rises and Cuts Only Way to Pay for Covid-19’.
In it, stated that, ‘Once we are through the economic shock, the government will have to fill this gap with tax increases or spending cuts.’
Similarly, in an article published on the BBC website on July 9th 2020, which was called ‘Coronavirus: How much will it cost the UK?’ a conclusion of the article was that, ‘The deficit leaves the government with a choice: increase borrowing, raise taxes, or cut spending.’
However, the conventional wisdom is sometimes incomplete at best, and entirely wrong at worst. For example, it was once conventional wisdom that Earth, and not the Sun, was at the of the solar system.
In terms of the post Covid-19 recovery, inaccurate conventional wisdom has reared its head once again.
How To Make Money… Quite Literally
At this point, it’s worth remembering that money is a man-made construct.
Pounds, Euros, Dollars, or anything else, these currencies have all been created from scratch by human societies, in order to assist with the exchange of goods and services of value.
Also, if you were to ask people how money is created, most would probably suggest it was printed by the Royal Mint in the form of notes and coins.
This is true, but only to an incredibly small degree.
In actual fact, over 97% of the money in the British economy (and the figure is similar in almost all countries) is created when commercial banks (e.g. HSBC, NatWest, Santander) issue loans to their customers.
A 2014 bulletin by the Bank of England entitled ‘Money Creation in the Modern Economy’ stated this very clearly. The exact words they used were:
Where does money come from? In the modern economy, most money takes the form of bank deposits. The principal way in which they are created is through commercial banks making loans: whenever a bank makes a loan, it creates a deposit in the borrower’s bank account, thereby creating new money. This description of how money is created differs from the story found in some economics textbooks.
This process of ‘creating a deposit in the borrower’s bank account’ is as uncomplicated as it sounds. Perhaps even more so.
It simply means that the bank approves a loan, then types the numbers of the loan amount into the customer’s bank account. The process is entirely digital; no physical money has been created or exchanged at any point.
This has several implications.
Firstly, it means that individuals and money businesses receiving loans from commercial banks is the source of nearly all the money in our economy. To put it more starkly – without people taking on bank debts, there can be no money.
This puts a different spin on the concept of ‘the irresponsibility of debt’.
I’m sure we all know of people who have taken out a bank loan, and then wasted it on trivial things. Often, we judge these people, calling them irresponsible or indulgent, and perhaps they are, but whenever anyone takes on bank debt, we too owe that person a kind of debt, as their taking out a loan has increased the amount of money in the economy which can be earned, spent, and taxed. This in turn means that a country’s Gross Domestic Product (GDP) will likely rise as the money supply increases.
‘But Why Has No-one Told Me This Before?’
If the truth about money creation was news to you, you’re not alone. The overwhelming majority of the general public don’t know how money is created, and a 2017 poll by the campaign group Positive Money found that even 85% of MPs were unaware.
However, once you understand that money can be created out of thin air, with the push of a button, the debate on how to pay off the debts accumulated during the response to Covid-19, seems rather different.
This is even more true once you understand how central banks work.
Central banks are the national banks of specific countries. For example, in the UK, the Bank of England is our central bank, while in the USA, it is the Federal Reserve, and in the EU, it’s the European Central Bank.
Nearly every country in the world has a central bank, and much like commercial banks, they have the power to create money out of nothing – although central banks have the additional responsibility of trying to ensure the economy as a whole stays healthy.
But whereas commercial banks lend money to businesses and individuals, central banks chiefly lend money to governments, commercial banks, and other financial institutions.
The ability of central banks to create money and lend it to their national government, is of particular interest.
‘There’s No Magic Money Tree That We Can Shake, That Suddenly Provides For What People Want’
Those words were spoken by Theresa May on June 2nd 2017 when appearing on the television show Question Time, in response to a nurse asking why she hadn’t had a pay rise in 8 years.
And she was right; we don’t have a magic money tree that we can shake to raise money.
The truth is, it’s much easier than that.
All over the world, central banks have the power to create new money, which can then be used to pay for whatever is needed. And they certainly do use this power, although not in a way which benefits the general population as much as it could.
For example, in the UK, the Bank of England created £456 billion of new money between 2009 and 2017 through the use of quantitative easing, and this money went straight to commercial banks and other financial institutions, rather than into the hands of individuals or SMEs. Furthermore, none of this money has ever been repaid.
More examples of money being created to serve privileged interests, have come as a result of the Covid-19 pandemic.
A case in point, is the Bank of England’s Corporate Financing Facility (CCFF), which has provided £58 billion worth of newly created money to some of the UK’s largest companies, including Greggs, and First Group.
In fact, the CCFF is not even available to small and medium sized businesses, as the terms of the scheme mean that, in effect, only the UK’s largest corporations are eligible for it.
Another example comes from the US Federal Reserve, who, in the early months of 2020, injected over $2 trillion dollars of newly created money into the American financial markets, in order to try and prevent a recession.
This proved successful to a large extent, but sending the funds directly to investment banks and corporate financiers means it is highly unlikely much of this money will filter down to ordinary working families.