A reality check on bonds and government spending

[00:00:00] There are some people who think we don't have to take all these tough, difficult decisions to deal with our debts. They say that our focus on deficit reduction is damaging growth. And that what we need to do is to spend more and to borrow more. It's as if they think there is some magic money tree. And let me tell you a plain truth. There isn't. This is the Debunking Economics podcast with Steve Keen and Phil Dobbie.

[00:00:28] Well, that was David Cameron, one of the many former UK Prime Ministers in 2013, 13 years ago, talking about government debt which can't be paid for by a magic money tree. Well, is he right on that? Well, not according to MMT or according to Steve. So, can the government really spend what it needs to spend?

[00:00:52] Well, let's go through step by step and discover how government spending adds to the money supply. But we can also try our hardest to just destroy that money as well almost as soon as it's been created. That's this week on the Debunking Economics podcast.

[00:01:14] So, welcome. It is evening time for me. It's morning time for Steve. He's just got up. That's why he looks fresh-faced and ready to face the day as opposed to I'm just starting to look a bit haggard. I guess it's the end of the day. But here we are, another one. And today, look, we got a comment from a listener on YouTube. Most of our listeners actually just listen, but we are on YouTube as well if you didn't know this, so you can actually watch us.

[00:01:41] Doug Mitchell, I think is his name. That's his username anyway. He says, I assume Phil intends to be devil's advocate when he speaks as though taxes are necessary for money issuance by governments with sovereign currencies. However, such comments go unremarked upon often enough, and I wonder whether new listeners to this great podcast, he says, great podcast, might be confused or misled by these statements.

[00:02:07] So, I probably was playing devil's advocate, but it is also confusing. And so, let's try and clear it all up. And Steve is going to be very nice to everybody on the podcast today, rather than bad-mouthing economists, because in all fairness, through this journey, and we've been doing this podcast for how many years now? 10 years. At least it's closer to 15, I think, but yeah, certainly 10. And you have learned through that process as well.

[00:02:37] There's ideas that you've- Oh yeah, I mean, I've been developing Ravel and Wisely Minsky. That's taught me an enormous about it, Martin, and that's sort of wired into my brain, which is one reason why people are confused when I speak, because I think in a completely different fashion to most people on this topic. And then there is, and I am being devil's advocate, but also there's the difference between what happens and what people think happens, and therefore the way people behave.

[00:03:02] So, governments do think that they have to either raise taxes or cut spending because they have this- Or sell bonds, yeah. Or sell bonds, yeah. They see selling bonds as really bad for the future, so they try to cut back on bond sales, which means cutting back on the deficit.

[00:03:18] Right. So today, we're going to look at how governments do create money, how that differs from when a bank creates money, the role of bonds, which might not be as significant as everyone thinks, and also how money is destroyed. And how we seem to be heading towards that with changes about how bonds are issued and who bonds are being bought by. So there's a bit to get through there, and we're going to do it.

[00:03:42] And we had a stab at this, and with you opening up your software and your godly tables, but we're not going to do that today, because it was getting- It confuses people, and also people listening to this. It's a podcast rather than a video. I can't, I can't, I'll do it without my visual aids. You do it without your visual aids, and we're just going to have to focus on telling the story. So first of all, there's different elements to this, obviously.

[00:04:08] We have to look at the equity position for the government and for individuals. We have to look at the assets and liabilities that people have, and how all that together creates money, and the role of bonds in all of that as well. And also, there's the role of assets, which I know we haven't really talked about, but I think it's particularly important as well. Well, the reason I say that is because although you think the government spends money and has nothing at the end of it, of course they do.

[00:04:37] They've built a bridge or built a hospital. And when you borrow money and you've paid it all back, you've got a house you didn't have at the beginning as well, you know, if you've paid off your mortgage. So, that's the upshot of all of it. But let's start with the important part of all of this, in the middle of all of this, is the role of reserves. So, let's look at – so, maybe we should start with I take out a loan. Yep.

[00:05:05] Oh, actually, first of all, the role of reserves with our loans. So, just in the banking sector generally. You and I, I give you some money. It's very unlikely to happen. Just setting the scene there, just in case. Don't get your expectations up. I give you some money. It comes out of my bank account, and it goes into your bank account. My bank account goes down. Your bank account goes up.

[00:05:27] There's a set amount of reserves which sit in the banking system, which is there to basically ensure that the passage of money between banks happens with basically liquidity for the banking sector. So, the reserves go from my bank to your bank just as the money goes from my bank to your bank. But the amount of reserves in the system remains exactly the same. Yeah? Yep. That's true.

[00:05:51] So, what happens now when rather than me giving you some money, I go to my bank and say, right, I want to buy a house. I need a loan. So, the bank, in effect, creates money and creates reserves. Talk us through, first of all, how that process happens. The bank does not create reserves. Right. Okay. Okay. Okay. This is why I go for my tables approach because it's so easy for people to fall into this sloppy way of thinking. Okay.

[00:06:20] And I'm in correct mode right away. Okay? Yeah. Great. Fantastic. It's double entry bookkeeping. And I want to say, so double, you do it twice. Entry, you put it in a table. Bookkeeping. And it can't create with it because it just said there's a finite amount of reserves. I just said I argue against myself. And that's the sort of thing that happens all the time with big people who don't have the godly table type mentality that I've got. So, when you go to a bank, let's say you want to buy like a nice little two-bedroom. None of my friends have a godly table mentality. None of my friends have. You're the only one.

[00:06:49] I'm the only one. Which is why I find myself correcting verbal mistakes that people are making that they don't realize are accounting mistakes. Okay. Yeah. Okay. That kind of makes sense. So, I've got money in my bank and I've got the same amount of reserves in the bank. But I go to the bank and say, I need some money. The money base – it took me through that then. What happens? When you go – let's say you find a nice little working man's cottage somewhere, two-bedroom place, you know, going for a million bucks somewhere. You know, maybe that's a hypothetical situation.

[00:07:19] Yeah. You go to the bank and say, I want to buy this – We talked about it just before this podcast started because I'd be looking at that. You want to buy this house and it's going to cost me a million bucks. And the bank looks at your finances. We're not subprime, so you're not a ninja. So, far as I know, you do have a job and you do have assets. Yeah. Okay. So, the bank says, okay, look at your income. Half the assets are had. Okay. Half the assets are had. But that's – Look at your income flow. Yes, we think we can service this debt.

[00:07:46] Or we're going to pretend you can because we want to make money out of the loan commission. But that's another story. Okay. So, you want one million. We're going to put a million bucks in your bank account, which you will then transfer to the vendor. Okay. But once you get the million in your account, you also owe us a million. So, we put the number one million in your deposit account and we put number one million in the loan account you have with us as well now. You've got to sign a loan contract. Yeah. Okay. Okay. So, you have two entries.

[00:08:13] One which is an asset to the bank, which is the loan they've made to you, and one which is a deposit account, which is where they've put the money for you, which you then use to buy the house. So, as far as I'm concerned, I've got the asset in there. I've got that million pounds now. They didn't have before, but I've got the line in. And you don't want to hang on to it because you don't borrow for the sheer pleasure of being in debt. You borrow to spend. Yeah. But that's yet another issue. I want to get the accounting straight, first of all.

[00:08:38] So, the initial act is that you sign a contract which says the bank will put this money in your deposit account as long as you agree to an identical sum being put as a loan you now have. So, the bank's assets and liabilities have risen. The assets, the loan for them, the liability is your deposit account. Your assets and liabilities have risen as well. Your assets, the deposit account. Your liability is the loan account. Right. And the reason why the reserves have an increase for them is because no one's given them any money.

[00:09:07] They've created that money. So, they've only got the same amount of money in their reserve account. Yeah. Now, you can make textbooks leave a whole load of garbage about that. Whoa. Hang on a second. I just – this is going to affect the podcast with my – I'll edit it. I'll edit it. Decided to rotate. Okay. Yeah. Okay. Okay. Yeah. So, let's go – just for the edit point. Yeah. So, I said – I've come on, but I said that the – okay.

[00:09:37] So, the bank – yeah. So, there's no – the bank doesn't have any reserves because it's – The reserves have no impact upon the transaction. This is an important point to make because the garbage that textbooks have taught so that they can hang on to the myth that money doesn't matter in a capitalist economy, the nonsense they've taught is that banks lend out reserves. Right? So, that's – everybody's mind's confused by the textbook argument that to make a loan, the bank has to lend out its reserves. That is completely false.

[00:10:06] It is something which actually defies the rules of accounting, but that's another issue to go into. But that's what people have in their heads. So, that's why people sort of say, oh, deposit goes up, reserves must change. No. Reserves are not affected by the loan issue. It's not even the rules of accounting. It's the rules of banks that they can't lend out reserves. I mean, those reserves are just there to facilitate the passage of money from one account to another. Only people banks can lend reserves to are other banks. Yeah. Okay?

[00:10:36] Yeah. And there's all this, you know, the repo agreements and stuff like that. But in terms of the interaction with the non-bank public, the banks, when they do that, they create a loan and they create a deposit at the same time. So, loans create deposits. And that's the argument which my side of economics has been making for about a century. And the textbooks have been ignoring. Now, the Bank of England came out in 2014 and said, my side is right and the textbooks are wrong. And what are the textbooks teaching? It's still the same nonsense.

[00:11:05] They've ignored the Bank of England just like they ignored my side of economics. So, in that situation, you're going to be nice to everyone, remember, Stu, by the way. Oh, that's difficult. It's too late now. I think I just thought it was worth a shot. I failed. But look, that million that I spent on the house, right? So, the bank has given me maybe half a million towards that. So, I've got a half a million loan.

[00:11:27] That half a million that then goes to the person who's selling the house, the bank's put the million pounds, the half a million in my bank, and then it goes out straight away and goes into this other bank. The bank hasn't got any new reserves, but it's still got to take the reserves to cover off the money that's gone to this other bank, hasn't it? No, the reserves are a consequence of the loan, not a cause of the loan. Yeah. So, if you borrow-

[00:11:54] But if they made a lot of loans, they're going to run dry on reserves, presumably. That's the theory. Not because of the loans, because people then use the loans to spend and buy somewhere else. And the neoclassicals will throw all this garbage at you about how they're going to run out of reserves, therefore they've got to borrow. Garbage. What actually normally happens with situations like that, and my father used to do this for a living, so it's sort of- I know that's- Admittedly, that's 60 years ago, but this is my background.

[00:12:21] The banks often lend the reserves back, okay? So, if you have X reserves in one bank and Y reserves in another, and now you've got X minus 0.5 in one and Y plus 0.5 in the other, the bank that did the loan will then borrow those reserves back at a minor rate of interest, lower than their charging year. Yeah, yeah. So, this is part of the- So, but they- Okay. And that's the only cost, really, isn't it, for the loan? It's if they've- Well, the cost for the loan is the loan assessors, et cetera. The banks do have costs. Yeah. Okay? Okay.

[00:12:51] So, there are costs involved, but the reserves are fundamentally irrelevant in those costs, unless they're a relatively trivial part where the bank has to pay a certain amount, a small amount of interest to borrow those reserves back if it's low on the first instance. This happens all the bloody time, and these guys make it into, oh my God, the sky is falling. I mean, you know, it literally is the chicken little theory of economics. That's neoclassical economics, chicken little- Okay. So, the situation we're in there then, same amount of reserves swilling around the banking system. Yeah. Nothing's changed.

[00:13:20] The bank has created money temporarily to pay, to give me, to put into my bank account. Equity-wise, where do we stand? I've got, my equity position's still the same, isn't it? Because I've got the money- Yeah. So, the assets and liabilities are risen by an identical amount, right? Yeah. Because I've got a payback. Yeah. Now, the point you made, and this is important, is that when you buy the house, you are buying a non-financial asset. Yeah. Okay?

[00:13:48] It sounds weird to call houses and shares non-financial assets, but they are. So is your coffee cup, for that matter. So, these are the things which you purchase using money, which are then your asset, nobody's liability. So, you know, as little as it's worth, this coffee cup is my asset and nobody's liability. Okay? So, when you look at it, that becomes part of your equity. Okay? But it's a notional part of your equity because I might put a value of one euro on that cup, you know? But to realize that one euro, I've got to sell it. Okay?

[00:14:18] Yeah. So, what we have in our heads and we look at the overall situation we're in, we're adding up the value of our financial assets and liabilities, and most of us are negative. This is the standard situation. If you do take out that half million dollar loan, then you only then spend the one million buying the house off the person who's the vendor. Okay?

[00:14:42] Then your situation is you've got a million dollars in debt, which is a liability. Okay? You don't have any money in your bank account because you've sent it all to the vendor. So, you're... Well, half a million in debt, but yeah. Yeah. Okay. So, what you do have is you bought a non-financial asset, which you value at 1.5 million. Yeah. You think you're going to sell it for more, that sort of thing. So, you notionally think you're better off. You're adding up your non-financial assets, which are necessarily positive, but they're

[00:15:11] also necessarily notional because the only way you can get the valuation you put on that house is to sell it. Equally, so non-financial assets, we put a notional price on, and that's where we think our overall wealth comes from. So, yes, I've got a million dollar, a half a million dollar mortgage with the bank, but I've got a house worth one and a half million, so my total worth is a million. I'm fine. That's the sort of thing we're all doing at a personal level. Yeah. That also clouds how we think about the banking sector.

[00:15:40] So, you really have to separate financial from non-financial assets, and you have to know what's an asset and what's a liability and follow the track of that through the whole system. But at the fundamental level, once you've taken out that loan, before you've purchased the house, you've got an extra liability, the half million you've borrowed, and an extra asset, the half million you've borrowed. Okay? The money turns up in your... So, the debt rises by half a million. Your deposit account rises by half a million.

[00:16:09] Your financial net position has not changed. Yeah. Cool. Which is very different to what happens when the government spends money. Yeah. Okay. So, the government spends more than it brings in taxes, so it has a government deficit. And that money is being spent. Obviously, it's not spent to satisfy the government, even if they were sort of like, you know, pocketing all the money. They're going to spend it in the real economy.

[00:16:36] So, it still finds itself in the private economy. Okay. So, any overspend by the government, which is a loss for the... is a negative. It's a deficit for the government, is a positive for the public sector or the private sector, however you want to define it. But anyway, the world in which we all live, those of us who don't work in the government. So, talk us through that situation then. So, because the... Because there, the equity position is different, isn't it? Because it's not...

[00:17:06] Yes. Because the government is going to find itself in negative equity and the rest of us find ourselves in positive equity. Because the difference is, when the bank gives me that loan, it expects the money back. When the government gives me money, in whichever way, it does that. Maybe it pays for a service that I'm providing or whatever. It spends money. It's not expecting that money back. It's pumped that money into the economy. So, that is very different. To be different to the home, though.

[00:17:33] Money turns up in your account as money with no liability for you. Yeah. Okay. So, I think it's important to separate tax and spending because people... I mean, again, textbooks have completely confused people on this front. But if you pay tax, that obviously comes out of your deposit account. Your deposit account goes down. Yeah. That means that you've got less financial assets, so your financial net worth falls. Okay. So, taxation reduces your financial net worth.

[00:18:01] And everybody understands that. But it doesn't change the money supply. Yes, it does change the money supply. Right. Because taxation is taking money out of your deposit account. Taxation reduces the money supply. Right. Okay. Okay. Okay. Okay. Now, it reduces the money supply. But at your individual level, what you see is your deposit account's gone down. Nothing else. That, therefore, means that your net worth has gone down by precisely the same amount.

[00:18:30] So, taxation reduces your net worth. That's your level of how you're looking at the financial system. Now, the banking system sees its deposits fall by that amount. Why? Because the tax revenue is taken out of reserves. Okay. So, the balancing item at the bank's level is the deposit account is – the change in the balance – the balance – the change in the deposit account caused by taxation is matched

[00:18:57] by a fall – a change in reserves, which fall by precisely the same amount. Now, the reason that happens is that at the level of the central bank, reserves, which were an asset of the banks are now a liability of the central bank. And that liability falls because that tax revenue has been transferred to the treasury's account at the central bank. Yeah. So, at the central bank, what you see is – and then this – you get the liability of reserves

[00:19:23] falling and the liability of the government's – the treasury's account rising. Then you go to the treasury level and see what happens to them. At the treasury level, the asset that they've got, which is the account they have at the central bank, that's risen. There's no offsetting change elsewhere. The taxation increases the financial net worth of the government. So, we talked about how if I gave some money to you, the reserves for my bank would go down. The reserves for your bank would go up.

[00:19:52] If you were the government, then you'd say the same thing would happen except the government or the central bank doesn't hold their own reserves. They issue reserves to others, but they don't hold – No, let's just – please. Let's get – they have their own account. It's called the Consolidated Revenue Fund that is not reserves. And this, again, is why – economics has got extremely bad language because it's an extremely badly worked out discipline, okay? Right. It confuses people who don't have to work with it all the time. But, okay.

[00:20:19] So, the situation – because it's almost the same. Like, I'm giving money to you, but I'm not. I'm giving money to the government instead of to you. So, the reserves have come out from – money's gone down from my account. The reserves from my bank have gone down as well. But rather than going to you, they've gone to the government's account in the central bank. So, those reserves disappear in that process, you're saying? The reserves go down and the government's account goes up. Yeah. Right. Okay. Okay. And they're both liability of the central bank.

[00:20:46] So, the asset – the equity position of the central bank hasn't changed. But you go to the treasury, its account has risen and therefore its equity, financial equity, net worth has risen by the amount of the taxation. Right. So, taxation reduces the money supply, increases the equity, financial equity of the government, and reduces the financial equity of the non-government. Now, spending does exactly the opposite. Yeah. I was going to say, so everything we've described happens in reverse. Yeah, that's right.

[00:21:16] It happens – so, when the government spends, it takes money out of – it transfers money out of its account at the central bank and that reduces its net worth. Okay. So, you get a negative for the net worth of the government out of spending. At the level of the central bank, what that means is the spending reduces the treasury's account and increases reserves. Okay. Then at the level of the private banking system, reserves go up because the government is putting

[00:21:44] that spending in people's deposit accounts. Okay. Just take you back a step. But it's added to reserves because it's the opposite of what we said. So, it's put money into your bank account or my bank account. And so, that has added to the reserves in that bank. So, that's why we've got extra reserves that we didn't have before. Yeah. That's right. Yeah. I mean, it's an incredibly complicated process because like, you know, even in Australia's case, there's, you know, what, 20 million taxpayers. Yeah.

[00:22:13] So, 20 million people are getting this amount of money. So, we're talking about reserves changing. We're talking about reserve accounts for 20 million people in, you know, half a dozen banks with millions and millions of accounts each. So, we're aggregating all this stuff together. And it isn't necessarily – the government doesn't spend on the same people at taxes. Okay. That's a very important distinction. But in the aggregate, what it means is that government taxation reduces the net worth of the private sector and increases the net worth of the government.

[00:22:42] Government spending does the exact opposite. It reduces the financial net worth of the government and increases the financial net worth of the non-government sector. So, if the government spends more than it takes back in taxation, it is putting more money into private bank accounts than it's taking out. And therefore, a government deficit, which is the gap between government spending and taxation, reduces the financial net worth of the government and increases the financial net worth of the non-government. So, two things have happened. Well, three things.

[00:23:11] I mean, so, first of all, we've created more reserves through that process. Yeah. We have put money into people's bank accounts that didn't exist before. So, we've all gained by the process through the government overspending. Let's just say spending. Spending. Sorry. Okay. Well, it could be overspending. I mean, they might be spending it recklessly on stupid things, but- Oh, no. The government never does that. Well, I'm thinking- Yeah.

[00:23:39] I know people who are going to podcast my eyebrows rose when I said that. Okay. I know. Yes. Because I was thinking of, you know, in Washington, the- The reflective pool. Yes. Or maybe blowing up facilities in Iran. Yeah. That's not government- None of them are good useful money. It's spent on very useful stuff. Exactly. So, okay. So, we've gone through- Not terrible or wasteful stuff like health and education. Right. Why waste money on that when you can blow up another country?

[00:24:04] So, the government spending has helped to create money for people who are the recipients, the arms manufacturers, the swimming pool maintenance people who benefit from all of that government spending. But it's also created reserves as well. And so, this is the crucial thing here, isn't it? Because they also are going to issue bonds. And we-

[00:24:30] Because they don't need to, and we'll come back after the break to talk about that. But the reason they do is because the net worth of the government has gone down. The government has basically got a negative equity position. So, that means that they're- I mean, everything is fine. It all balances, except for the fact that nobody likes to see a negative number in the government's account at the central bank. That's the point. Yes. Okay. That's correct.

[00:24:56] Because the impact of the government running a deficit is that if it did that and didn't sell bonds at all, then it would go into an overdraft position at the central bank. And that- and people think of that- well, people don't understand the damn system. But if they did, they'd say, oh, that's just the same thing as a debt. Well, no, it's not. Because the central bank is owned by the treasury. It has no inherent capacity to reject government spending.

[00:25:26] Whereas when we try to get an overdraft, then we are dealing with a separate entity that we don't own and that can refuse us the overdraft. So, the overdraft for the government is- has nothing like the consequences of an overdraft for somebody in the private economy, but it just looks bad. You know, you've got a negative number in the account at the central bank. That looks bad. So, is there a way to fix it? And the answer is yes, there is. It's selling bonds. When we come back then, we'll look at what happens when the government sells bonds.

[00:25:57] Does it change the money supply, for example? Spoiler alert. I think the answer to that is no, isn't it? But we'll look at that when we come back on the Debunking Economics podcast. This is the Debunking Economics podcast with Steve Keen and Phil Dobby. So, we are in the situation, Steve, where the government has- we've done this, by the way, without godly tables. And I think it's- we've managed to hold the line.

[00:26:23] So, the government has spent more money than it brings in from taxes. It's got a negative bank account sitting with the central bank. And people aren't very happy about that. But most people are quite happy because they've got money from the government through this whole process. So, they're in a better position than they were before. But the government has got negative equity. We've got no liabilities from all of this. The government's given us the money. We don't owe it back to the government. So, we're in a positive situation.

[00:26:53] That's created a negative situation for the government. But the government has, in that process, has created money which has gone into circulation because it's the money that's gone into our banker cats by nature of the fact that they've got negative equity. That's what's created that situation. So, the belief is that we need to put that right. We need to get rid of that negative situation. The way we do that is the government has to issue bonds. That's the belief. It doesn't change their equity position, by the way. It changes their account position at the central bank. Yeah.

[00:27:22] And that's an important point, isn't it? Because the assumption is this will get everything balanced and they won't be in a negative equity position anymore. But if they weren't in a negative – the only way they can fix that negative equity position is by saying, can we all have our money back, please? Yeah, that's right. And that would eliminate the capitalist economy, which is not a good idea, according to most people. So, yeah, what gets balanced by the bonds is the overdraft that the government would otherwise

[00:27:48] have at the central bank when it spends more than it takes back in taxation on a regular basis. And the American economy has been doing this for 150 years. So, there's only a handful of surpluses and masses of deficits. So, the average deficit in the American economy is about 2.4% of GDP. So, they're almost always running a deficit. So, what they're doing is if they didn't sell the bonds, they'd end up with an overdraft at the central bank.

[00:28:16] So, what the bond sales do – and these initially occur through primary auctions – is that the government says, how much more are we spending than we're getting back in taxation? In taxation, issue bonds equivalent to that. Actually, in the real world, it's slightly more messy. The government doesn't know what it's getting back in taxation. The spending and the taxation wings in that sense are separate. They also don't know what we're going to get from the bond sales, are they?

[00:28:46] Entirely. The bond sales – they can fiddle the bond sales. And this is what people don't realize. They can fiddle the bond sales quite easily. They can make sure there's sufficient funds available for the auctions to be fully subscribed. And they can fiddle the interest rate as well because they've got control over interest rate on reserves as well as interest rate on the bonds. So, the government plays badly, but it does play that game to make sure that it gets 100% sale of those bonds.

[00:29:15] Well, we've seen situations because, of course, they're normally the banks that are buying them. And we're possibly going off into a bit of a tangent here. But if there's not enough – so, there has to be enough money in – and the banks are buying it from the reserves that they hold. That's right. One of the few things that banks can do is spend their reserves on government bonds. They can buy them on commercial bonds as well, but they have to be sort of very high value, very safe bonds that they're buying. So, by and large, it's government bonds.

[00:29:46] And if there's not enough money sitting in reserves, then that's when central banks start to step in and go, I'll tell you what, we'll put more money in so it's easier for you to buy the bonds. We wouldn't – That's right. The reserve banks – before the great global financial crisis, that was a very important part of central bank behavior. You're going to make sure there's sufficient funds available for each auction to enable the bonds that are being sold at that auction to be fully subscribed. So, back in those days when they didn't pay interest on reserves, bank kept reserves at absolutely minimal levels.

[00:30:16] That meant that when there was a bond – let's say it's going to cost, I don't know, well, you know, $10 billion to fix up the reflective pool. You know, $1 billion to do the work and $9 billion profit, 50-50 split between the contractor and somebody called Donald, I think. That's the usual situation, isn't it? Well, not directly. Obviously, there'd be family members involved just to try and, you know, to stock. Not so obvious. Okay.

[00:30:41] So, when that decision to issue the bonds is $10 billion fixing up the reflective pool is made, there's an act passed by the Congress to spend – authorize $10 billion worth of spending. So, that $10 billion then has to be – the requirement is you've got to issue bonds equivalent to that. Now, the taxation comes back, in a sense, independently of all this stuff. You don't change the tax when you pass the bill to, you know, spend the money on the reflective pool. You're not changing the tax rate as well.

[00:31:10] So, you issue bonds equivalent to – yeah. Before that, the $10 billion though has gone into the bank accounts of Donald Trump and his family and that's added to the reserves that are in the system as well. Well, we're getting a bit complicated. Oh, the order of it. Okay. So, the initial thing is the spending is authorized, but it's not undertaken until after the bonds are sold. Right. Yeah. Okay. And that is just because – this is cosmetic. It's not causal. And this is the problem.

[00:31:37] People think the bond sales actually create money or rather give money to the government, which it then uses to spend. It's already – it creates the money that it spends by going into negative equity, which is explained in terms of taxation minus spending. But the bond issue is there to cover up or to make – to get rid of the overdraft of the central bank, would otherwise have to authorize the government to have in its account. Okay.

[00:32:05] So, when the auction occurs, the funds haven't been spent yet. Okay. So, they haven't actually turned up. But there's a historical record of all that having happened. And there's lots of bonds that banks currently own. Okay. Or, you know, other entities as well. So, the central bank used to indulge in open market operations to make sure that when the auction occurred, there was at least $10 billion available in reserves that the banks had freely,

[00:32:32] you know, could freely use to purchase the bonds that are on sale. So, that's basically made sure that the demand was there before the actual auction took place. There are hundreds of auctions. In America, now, there are about 400 per year, so more than one a day. The amount of money you're talking about isn't the scale of the total deficit. It's the total deficit divided by 400 as an average. So, it's a trivial, in that sense, amount of money at each auction.

[00:32:58] The central bank used to go through open market operations to make sure there were efficient reserves hand-in-hand. Now, there's reserves equivalent to about 10% of GDP. So, in that sense, there are hundreds of times the amount of money needed at each individual auction. So, the auction will go through. Now, whether that affects the money supply depends on who's doing the buying. Well, for the moment, let's just assume that banks do it, and then we'll come back to that point. If the banks alone do it, then what happens is- Yeah, from the money they've got in their reserves.

[00:33:28] Okay. The banks have now 10 billion in reserves, whether that existed before open market operations or after, they then use that 10 billion to buy the bonds, which means that their reserve accounts fall by 10 billion and the account of the treasury rises by 10 billion. Okay. But when you look at that in terms of the double-entry bookkeeping for the banks themselves,

[00:33:53] their assets of reserves fall by 10 billion, their assets of bonds rise by 10 billion. Now, that's an operation that occurs solely on the asset side of the private banking system, which means it doesn't affect the liability side. So, all it does is it swaps. It's an asset swap for the banks with no effect on the liabilities of the banks, and the liabilities of the banks are the money supply. And so, if you looked at reserves and cash as being exactly the same thing, the situation with the bank hasn't changed at all, in effect.

[00:34:23] If they sold those bonds, they'd have more cash. If they buy bonds, they've got less cash, but it's theoretically the same value, unless the bonds change in value. But that's the definition of an asset swap, basically. Mate, you're going to be extremely quiet. I've barely heard that. Can you say that again? I don't know why. Oh, yeah. Okay.

[00:34:47] So, if you combined cash and bonds together and just said that's the value of the reserves, whether it's cash or in bonds, then that's not going to change. I mean, if you buy the bonds, then you've got less cash. You've got more bonds. If you sell the bonds, you've got less bonds, more cash. So, it's not changing the- Cash reserves. I mean, reserve, that's basically, again, you're going to be careful because cash depends on who's got the cash, right? Yeah. Okay. So, we're looking at banks just here.

[00:35:15] So, fundamentally, they're using electronic accounts at the central bank to purchase the bonds. Because the value of their reserves falls by 10 billion. The value of the bonds they hold increases by 10 billion. So, for the banks, there's no change in their assets and there's no change in their liabilities in total. Yeah. Okay. Now, this is important because people think when the government sells bonds, it's actually getting money. It's already created the money by running the deficit, by spending more than it gets back in taxation.

[00:35:44] So, money is not involved in this purchase of bonds by the banks. But there is money involved when individuals like you and me or non-bank financial institutions like the Vampire Squids, the Morgan Stanleys and so on, when they buy, they're going to buy it by running down their deposit accounts. Yes. So, if you're going to buy a bond, you use your deposit account to do it. Let's say the bonds are $1,000 bonds. You buy 10 of them. Your account falls by $10,000.

[00:36:11] So, your deposit account at the bank falls by $10,000. The matching entry for the bank is that their bonds fall by $10,000 because they've sold the bonds to you. So, the bank reserves obviously can't be used for anything else. So, the fact that those bank reserves have gone down isn't terribly important. But also, once that money has been spent, it's gone to pay for that pool company and whoever else was getting the money.

[00:36:42] Then that money has created new reserves in those commercial banks where that money has arrived at. So, it sort of replenishes the stock of reserves as well, which might have been brought down a little bit. So, in fact, at the end of it, we've actually got a situation, if I'm thinking right, where we've got even more reserves sitting with banks now. So, even more wash with reserves. No? No. Okay.

[00:37:09] Because when the banks buy those reserves, the reserves fall, okay? And their bonds rise. Yeah. So, reserves have been, in a sense, destroyed, inverted commas, by the bond purchase. So, let's say you've got a deficit of $10 billion to build that pool. The spending has gone in. There's $10 billion additional money in somebody's deposit account. And there's $10 billion in ESCA reserves for the banking sector.

[00:37:38] And then when the banks buy those bonds, the reserves fall by $10 billion and the value of bonds rise by $10 billion. Yeah. Okay. So, it's all a question of timing, isn't it? Timing also gets – this is another thing which gets people confused because their perception is the government can't spend until after it's sold the bonds. But, in fact, the government can spend before it sells the bonds. It's just this convention that it won't do the spending until after the bonds are sold.

[00:38:06] So, let's say it's a billion pounds, right, for the pool. A billion, okay. You're getting a discount. All right. Yeah, okay. And so, you're going to issue the bonds first because that's – because this belief that we've got to have the money before we can spend it. So, you issue bonds for a billion dollars. So, the – step by step. So, the billion dollars – and it's all bought by commercial banks.

[00:38:34] So, the banks all bid for that billion between them. They buy them all out of the reserves that they're holding in their reserve system. So, the amount of cash reserves they've got goes down by a billion. The amount of reserves they've got because these reserves have been issued by the government has gone up by a billion. So, that's the – Hang on, mate. Sorry. No, no, no. You're getting the words confused again. Right. Okay. Forget reserves. Okay. And forget cash, actually. The reserves have fallen by a billion.

[00:39:03] The bonds have risen by a billion. Yeah. Yeah. But how have they paid for those bonds? Because the reserves are – the reserves already exist. Yeah. The current level of reserves in the American economy are roughly 10% of GDP. I think that's what I was saying. I think that's what I was saying. Sorry. I think that's what I was saying. So, they pay – out of their reserves, they pay for that billion dollars of newly issued bonds. Yeah. So, they've now got less cash and more bonds.

[00:39:31] Again, less reserves and more bonds, please. Sorry. Yeah, yeah. I was thinking cash reserves. But yeah, yeah. Less reserves and more bonds. Yeah. Okay. That's what threw us. Okay. So, but then after the – so, that's all right. So, in effect, everyone's happy now because they believe that, you know, the government has issued those bonds and that's debt as far as everyone is concerned. Exactly.

[00:39:56] So, but at the same time, that billion pounds or billion dollars has been – or next after the issuance, the billion dollars is spent and that billion dollars goes into the economy. That creates new reserves, doesn't it? Because it's new money that's gone into the economy. So – You're getting your stages confused. Right. Okay. Okay. Good. Well, that's why we're having this conversation. That's why it's godly tables because each of these elements is a separate line for me. Yeah.

[00:40:25] Now, when you do it verbally and this is – again, it's not your fault. It's the confusion that textbooks have created and people just want to model their way through. Fundamentally, what we're trying to do is say, yes, I know it looks like – it looks like the sun is orbiting the earth, but bear with me for a moment. We're actually rotating, okay? So, that's why it seems to be – hang on, that can't be the case. And then you get involved in these crazy conversations. That's where we are right now. Okay. So, maybe we just leave it there and say at that stage so that the government has issued

[00:40:54] – the government's issued the bonds, banks buy it with reserves. Yep. And that satisfies people on the balance sheet with the central bank that they are no longer in debt. They are still in a negative equity position because they have to be. Well, they still got a lower net worth than they did before because that money had to go to the – that money has gone into the public sector.

[00:41:24] But there's more cash. Yes. Okay. This is why I use godly tables. Yeah, no. We can't just keep on saying that's why we use godly tables. We don't do it with that. We easily drop words. Okay. Yeah. So, okay. Terminology. Where was I wrong in that scenario? Well, you mentioned cash again. Okay. Okay. And you said a creation after the bond issue. The point which, again, having invented godly tables, it's given me an insight into what

[00:41:53] money creation involves. And the fundamental thing that for an operation to create money, it has to occur on both the assets and the liabilities or equity side of the private banking system. So, any operation which you put on the asset side for one operation and the second operation affects either bank liabilities or bank equity. That changes the amount of money. Anything that doesn't have that effect doesn't change the amount of money. So, the only way money is created is when the government spends is what we're saying. No.

[00:42:24] Remember, bank lending also creates money. So, okay. The only way money is created was an operation occurs on both the asset and the liability stroke equity side. In this scenario, though, where we're talking about the whole situation with government spending. So, the government spends, that creates money. The whole issue of issuing bonds and the bonds being bought by the reserves from the commercial banks is really just an operation that's there to satisfy the situation that they want to

[00:42:54] see a balanced budget sitting in the bank account. Well, not a balanced budget because there's a deficit. But they want to see a balanced budget. Bank account. In this scenario, they want to see no overdraft of the treasury's account at the central bank. That's what the bonds are there to achieve. Now, when they do that, it then just, well, who are the bonds being sold to? Now, we're talking at the moment about commercial banks buying them, which was the original situation.

[00:43:21] And what that means is the assets that they have, which we call reserves, which are their bank accounts of the central bank, they fall. The asset we call government bonds, which is owned by the banking sector, they rise. So, the operation is one asset on the banking sector falls and another asset rises. There is no effect on the amount of money. Okay. Yeah. Okay. Now, when you get to, when the bonds are sold, whether directly or indirectly to the non-bank

[00:43:46] public, then the non-bank public buys them by reducing their deposit accounts and then increasing their own holdings of bonds. So, when bonds are sold either, I mean, on the secondary market, which is what happens at the moment most of the time, or the Americans now allow even households to bid in primary auctions. Then any non-bank that's bidding in an auction, whether it's primary or secondary purchase, they buy the bonds using their deposit accounts.

[00:44:16] Yes. So, the deposit accounts fall, the asset of the private sector, deposit accounts fall, but the bonds owned by the private sector rise. Okay. So, from the point of view of the private sector, there's no change in their overall liabilities. They've just got a different asset. They now have, before they had an asset of a deposit account, now they've got an asset of bonds. The deposit of bonds. Yeah, yeah.

[00:44:43] Now, when you look at that at the private bank level, what that means is the liabilities of the private banking sector fall, okay? And their assets fall as well. And that's either, if the banks are doing the selling, then the value of the bonds they've got fall. Or if the government is, the treasury is directly selling those bonds, which is now allowed, I think it's crazy, but that's the situation we have, then the reserves are going to fall and

[00:45:08] that's going to be matched by a change in the bonds owned by the central bank or the bonds owned by the treasuries. And the bank's assets and reserves fall because my money is no longer as much sitting in their bank account. And that's a bit like in the UK, they've had premium bonds for a long time. And we've had war bonds, for example, as well, which is an interesting thing because what you're describing is a situation actually, if you issue bonds that are bought by people, you're actually taking money out of the economy, in effect. Right.

[00:45:37] So when I buy premium bonds, exactly as you described, I've got less money sitting in my bank account because it's gone into government bonds, in effect. Yeah, yeah, yeah. Okay. So when you have, and this has been the situation for a hell of a long, ever since the monetaries took over fundamentally, the government has almost been totally cancelling its money creation by selling bonds to non-banks.

[00:46:04] So in the aggregate, very little money is created by the deficit at all. And this is where it comes back to what, if you believe that changing the money supply changes the level of inflation, then who's changing the money supply? And it ends up being the private banks that are doing it because the government allows its money creation to be cancelled by the secondary sales. Yeah.

[00:46:28] So, you know, people scream money for creation equals Zimbabwe, which was, you know, you'll see a tweet on that effect in my tweet stream recently. They're ignoring the role of the private banks in creating money and the role of bond sales to the private, by the government to non-government, to non-bank entities and destroying money. So... Which they could say is, well, we're destroying money because we're worried about maybe too much of it, which would be inflationary.

[00:46:57] I mean, I guess that would be the argument. All sorts of errors is why they do that. The thing is, the government issue enables a new non-financial asset to be created. So this is one point you made very often, which is very important. You're using the financial system to create non-financial assets. And so you don't... The government doesn't come out with nothing. It comes out with a non-financial asset. Exactly. So the government luckily has a, you know, reflective pool of lovely green tape over the top of it. And that is why... That's why you shouldn't worry about the fact that the government has...

[00:47:24] It comes out negative in this whole situation, have negative equity, because that's... In a finance sense, because they bought stuff with it. That's right. Okay. Okay. So the stuff they've bought still exists. We all get the benefit of reflective pool that looks a nice color of green. Yeah. You know, or maybe even get... I don't know. Maybe public health. That'd be a weird thing for Americans, wouldn't it? So you get a new non-financial asset created out of it. And that's the one that matters. So people ask, what does the government money backfire?

[00:47:52] It's backfire all the non-financial assets the government has, which are huge. So it's... So the issuing of bonds is not creating money. It's not paying off the government debt. It's just balance. It's just balancing that line in the government's bank account. That's all it's doing. Yeah. So the actual money creation is being... Happens because the government is spending the money. That's right. Okay. This is a question not to ask when we've really only got a couple of minutes to go.

[00:48:20] But QE, which is when obviously the central government, the central bank is buying bonds, has been argued as that is what is expanding the money supply because they are buying bonds with money that the central bank has created. And that depends on who they're doing the transaction with. So the government's buying... If the central bank is buying bonds off the banks, then that's another asset swap. Okay. Because what it does to buy them, it says we're going to...

[00:48:49] They got a billion... We want a trillion dollars worth of bonds. Thanks. Here's a trillion dollars in your reserve accounts. Makes no difference. In other words... So what happens is the reserve accounts go up, the bonds accounts goes down, no money creation. Okay. Yeah. Now, it's different when they buy off Morgan Stanley because when Morgan Stanley buys the bonds, then it has to run its deposit account down to do it. That reduces bank liabilities.

[00:49:17] It also reduces bank assets. Either if the banks are doing the sales and the banks holding the bonds go down, if the central bank's doing the sale, then the central bank is buying those bonds off the Morgan Stanleys. So the holdings of bonds that the Morgan Stanleys have go down, their bank accounts go up. In that case, QE with non-banks creates money in the finance sector, generally speaking,

[00:49:45] because most of those bonds are owned by non-bank financial institutions. So do you think the... In the middle of all of this, of course, there's a lot of people making a lot of money by trading bonds, which is a very complicated area. And there's this belief, isn't there, of course, that the market... And this is probably a conversation for another day, but the market arriving at a particular

[00:50:11] yield for a particular bond is helping determine what the central bank rate is, therefore what the interest rate is that we're all paying. I mean, there's the rate setters, but they're very often are following what the market's doing. And that complexity adds to all of this, even though we're saying, but it's not needed. What you're doing is arguing about the rate that's set for something that really doesn't need to happen. It's a Heath Robinson machine, or I've forgotten the American equivalent, but go Rueberg.

[00:50:43] Rueberg, I can't think of the guy's name, device. It's far more complicated than it needs to be. The best way to handle it would be simply to sell the bonds to the central bank, because that's the fastest way of making sure that the account of the treasury at the central bank doesn't go into overdraft. But that's an issue for another day, I think, in time. Yeah, it is another conversation. But people would say that means there's no control happening whatsoever. But what we're not realizing is there's not a lot of control anyway. How brilliantly we're controlling government spending right now.

[00:51:11] We've stopped them spending on useless stuff, like putting tape over green pools and bombing other countries. Yeah, they're doing a great job right now. So maybe actually that control by saying, well, okay, we need to let non-banks purchase bonds, and maybe that's part of the influence. Maybe that's saying, well, okay. Because out of all of this, you'd say, whether it's delivered or not, you'd say, well, actually, that is a form of inflation control. If you're worried that the government is creating too much money, then actually allowing people to buy- Not enough money. This is the ironic thing. Okay? When you look at the-

[00:51:39] This is what Richard Vague's done great work on with his team at the Debt Economics Project. They've found that the government money creation has been almost zero for the last 50 years. Hmm. Okay? So because of all the impact of those secondary- I've got the data from Richard now, so I can include that in some of my work on my YouTube channel and Substack and Patreon and so on. But yeah, overall, there is no government money creation in the aggregate because of the effect of secondary bond sales. And this is a mistake. Okay?

[00:52:08] We should be allowing the government to create fiat money. And because we, again, all these obsessions about avoiding a government deficit both reduce the amount of fiat money being created, and then we let it be cancelled. And even when it is created, we let it get cancelled later. So, okay. Well, this is a discussion for another day because I can't fathom how if you spend a billion and you create a billion in new money and you issue a billion in bonds, that billion in bonds

[00:52:36] gets whittled away to the point where you actually back where you started from? If you sell the bonds to the people who use their deposit accounts to buy them. Yeah. But I mean, is that- That eliminates money. But that's 100%. That was 100%, hasn't it? Right. Yeah. Okay. That is a conversation for another day, isn't it? But it's a lost opportunity, that's for sure, if that is the case of what's happening. We'll have to listen again or maybe even watch us on YouTube. You never know. All right. Very good, Steve. Catch you next time. Thank you. Bye. Okay. Bye. The Debunking Economics Podcast.

[00:53:09] If you've enjoyed listening to Debunking Economics, even if you haven't, you might also enjoy The Y Curve. Each week, Roger Hearing and I talk to a guest about a topic that is very much in the news that week. It's lively. It's fun. It's informative. What more could you want? So search The Y Curve in your favourite podcast app or go to ycurve.com to listen.