by Alan Hutchison · Published on his Matches in the dark website on 27th September 2018 · Updated 20th November 2020
I use this as supporting notes for a very short talk I give on Modern Monetary Theory. It should take no more than 10 minutes to read. If you want a longer read I also have a more comprehensive introduction. The words and phrases in bold are key concepts, some of which will become links to upcoming articles.
To properly understand how Modern Monetary Theory relates to the UK you need to understand the nature of our currency and, crucially, the relationship between government spending and taxes. A good way to get to grips with what may seem a complex topic is to look at how one university encourages its students to do voluntary work.[1]
The University of Missouri-Kansas City is one of a number of academic institutions across the world which teaches economics from an MMT perspective. For the last fifteen years or so the University administration has been running a scheme to encourage students to volunteer in the community.
The University does this by issuing a local currency, but it’s a local currency that is very different from those with which some of you will be familiar. Unlike, say, the Bristol and Brixton Pounds, the University currency has all the characteristics of a particular type of national currency: a sovereign currency.
The University created the new currency and declared that its unit of account is the ‘buckaroo’ (just like the pound is the unit of account for Sterling). The University issues the buckaroos on demand to voluntary sector organisations in the wider community and students can earn buckaroos by working at those organisations. The University sets a going rate of one buckaroo for one hour’s work.
The question you most likely want to ask at this point is: Why would any student give up their spare time in order to earn a currency issued by the University? After all, this is a paper currency — it has no intrinsic value, it’s not convertible into gold and it’s not backed by another currency.[2] Why would anyone want it?
The answer is tax. At the end of each term students are required to pay a certain amount of buckaroos to the University. It’s a tax that can only be paid in buckaroos — there is no option to pay in any other currency. Students are required to pay the tax in order pass their courses and, ultimately, to get their degrees. So there is strong incentive to acquire an apparently worthless paper currency and the only way they can do so is to do voluntary work in the community. The tax coerces the students to do the work and in doing so it gives the currency value. You could say that the tax drives the currency.
If the University taxes the students at the rate of 20 buckaroos per term then each student must undertake 20 hours of community work per term in order to get their grades. The ability to demand payment for taxes, in a currency that only it can issue, enables the University to move real resources from the private sector to the public sector. The real resources in the private sector comprise student labour and the currency system causes some of that labour to be deployed to further the public purpose. The University doesn’t need any other currency (such a dollars) to achieve this. All it needs is the power to tax.
You will, no doubt, want to ask another question: Where do the buckaroos come from? Well, the University certainly doesn’t have to tax the buckaroos out of the economy before it can spend them. It doesn’t have to make spending decisions based on the amount of tax it receives. In other words, the university is not revenue constrained; it suffers no shortage of financial resources.
The University simply creates buckaroos out of thin air and spends them into the economy. And when the University taxes the buckaroos out of the economy they cease to exist. The buckaroos come from nowhere when they are issued and they return to nowhere — to oblivion — when they are used to pay taxes. This is the opposite of what most people think; most people believe that taxation comes before spending. University spending precedes taxation and exactly the same applies to the UK government spending in pounds.[3]
The University always spends sufficient currency into this alternative economy to ensure that enough buckaroos can be earned by all students who want work. The University guarantees that all students can earn at least enough to pass their courses. In other words, the University is running a Job Guarantee programme. The University’s Job Guarantee is most certainly not workfare or some pointless job creation scheme. The jobs are meaningful and worthwhile; they are jobs which further the public purpose.
Once there is full employment, when the students have done as much voluntary work as they want, the University’s spending ceases automatically. Nobody in the University administration needs to decide how much to spend into the economy.
When we analyse what happens inside the buckaroo economy, between the time the currency enters it through University spending and the time it exits via taxation, we see some interesting developments which mirror precisely the behaviour we see in the real economy.
There are some students who enjoy community work and others who don’t. Some students would rather do work that wasn’t community related, while others are happy to do more than is necessary for them to obtain academic credits. This results in an exchange of labour facilitated by buckaroos. For instance, one student may offer to fix another’s bike in return for a buckaroo or two. The bike fixer then uses the buckaroos to pay her tax.
Of course, there will be some students who can’t be bothered with any sort of work, community or otherwise. Out of this difference in productivity between students emerges a form of foreign trade and a corresponding foreign exchange market. There will be students who don’t want to do any work and who have savings denominated in ordinary US dollars. These dollars are a foreign currency in the buckaroo economy. The dollar-rich students will offer to buy, with their dollars, surplus buckaroos from the hard-working, community-oriented students and a price — an exchange rate — will be negotiated that suits both parties. The net result is the export of services from one currency zone to another. The dollar zone is buying something that can only be produced in the buckaroo zone.
It’s worth noting at this point that a currency zone does not correspond to a geographical region — it’s an abstract concept that represents all holders of a particular currency, no matter where in the world they may be.
The exchange rate between buckaroos and dollars is not set by any authority. Unlike the Bristol and Brixton Pounds, the buckaroo is not pegged to the value of any other currency. Furthermore, the University does not make any promise to exchange buckaroos for anything other than an equivalent amount of buckaroos. The only obligation the University has is to exchange, for example, a ten buckaroo note for two fivers.
The buckaroo is a free-floating currency whose external value is determined entirely by demand and, interestingly, that value exhibits a clearly discernible cyclical behaviour. The buckaroo appreciates against the dollar towards the end of each academic period, as the idle rich scrabble to acquire sufficient currency to pay their taxes and pass their courses. The value drops again once the closing date for tax payments has passed. However, what is in effect a business cycle has absolutely no influence on the University’s ability to spend and further the public purpose.
Over a longer time-scale the buckaroo has shown a consistent rise in dollar value. At the start of the scheme the going rate for the buckaroo was around $10 and it’s now about $25. The increase is due in part to the buckaroo becoming acceptable to people who have no obligation to pay taxes denominated in buckaroos. Café owners, for example, will be willing to accept buckaroos in payment for cappuccinos because they know that they can always spend the currency to hire a student barista. The dollar value of the buckaroo is influenced by the average dollar wage a student can expect to command for one hour of part-time employment.
It gets even more interesting when we look at the potential for a dynamic relationship to develop between the buckaroo and dollar wages. As I said earlier, the University uses its currency issuing power to move resources from the private sector to the public sector. That means there is less labour available, expressed in student-hours, for café owners to buy. Furthermore, students may prefer community work over café work because it is more rewarding in ways other than financial and the buckaroos they earn can always be exchanged for dollars. So, in order to attract student workers the café owners will either have to increase their wage offers or improve their working conditions. The University’s Job Guarantee leads to better private sector jobs.
I could go on. I could talk about how the buckaroo economy could develop with the introduction of commercial banks and a central bank, or how the University could issue bonds to provide a safe form of saving. There’s much more I could cover, but I want to keep this short.
However, there is one aspect I want to discuss and that’s deficits. On a cursory examination it would appear that the University’s tax receipts exactly match its expenditure and, consequently, it has achieved the nirvana sought by all mainstream economists: a balanced budget. In fact, the University runs a continuous deficit.
Why so? Well, it’s obviously nothing to do with the University spending more than it should. The level of spending is driven by the demand for employment and the University always spends exactly the amount that is required. There is a deficit because some of the buckaroos spent by the University don’t find their way ‘back’, they don’t get taxed out of the economy. Remember, the taxes don’t pay for the spending; all University spending is newly created money and taxes simply remove money from the economy.
Naturally, a few buckaroos don’t find their way back because they are lost. But the real reason for the deficit is that some buckaroos are hoarded. Some people hoard buckaroos rather than spend them or use them to pay taxes. Hoarding is more commonly known as saving.
Some students will do a lot more community work than they need to in their first and second years so that they can devote more time to academic work in their final year. They save the excess buckaroos and use them to pay the tax due at the end of their studies. And some students save as souvenirs any buckaroos left over at the end of their studies, effectively removing them from the system forever.
If, for example, in one year the University finds that only ninety buckaroos are returned in tax for every one hundred buckaroos it spends into the economy then University is running a deficit of ten percent. This is roughly comparable to the UK government’s fiscal balance (which is simply a less pejorative term for the ‘deficit’).
Should this be a cause for concern? Is the University living beyond its means? Will it have to borrow buckaroos from somewhere else in order to finance the next round of spending? Will it have to cut its spending? Is austerity called for? Should the University reduce the amount of community work that it supports? Should the University create unemployment? The answer to all these questions is obvious: No!
It’s here that we arrive at one of the core tenets of Modern Monetary Theory. The thing we call the ‘UK government deficit’ is nothing other than an accounting representation of the Sterling savings that take place, both here and abroad, during any given accounting period. The thing we call the ‘UK government debt’ is nothing other than an accumulation of previous deficits and represents the total amount of savings in the Sterling economy. It is simply money issued by the state which has not yet been taxed away.
Most people think that the deficit and the debt represent money that we, the people, somehow ‘owe’. It isn’t. It’s the exact opposite. The deficit and the debt are savings.
The deficit and the debt are not things that we, or future generations, have to worry about. Anyone who says otherwise either doesn’t understand how modern money works or is hiding their understanding for ideological reasons. That includes anyone who says that we need ‘sound finance’ and claims that we must clear the deficit over the next five years, ten years or twenty years.[4]
In summary, just like the University of Missouri-Kansas City, the UK government:
- Can always further the public purpose by moving resources from the private sector to the public sector. It is able to do this because of the power to tax in its own currency.
- Always spends first. Taxation is a secondary action which follows on from the spending.
- Doesn’t need to borrow to cover the ‘deficit’. The government may have other reasons for issuing bonds, but we should never call this act ‘borrowing’.
- Is not constrained by external factors such as the business cycle or globalisation.
- Is only ever constrained by the availability of real resources — people and stuff. Money is never an issue; the government always has exactly the amount it needs.
Which brings me to my final point. There are an awful lot of unused resources in the UK, including millions of unemployed and underemployed people. It’s time we gave them all a decent job.
It’s time for a Job Guarantee.
Notes:
[1] This article is based on BerkShares, Buckaroos, and Bear Dollars: What Makes a Local Currency Tick?, Randall Wray, 13 July 2009, New Economic Perspectives.
[2] Local currencies in the UK, like the Bristol and Brixton Pounds, are backed by Sterling. They cannot stand on their own.
[3] However, it does not apply to countries which are not sovereign in their currency and that includes all nineteen members of the Eurozone. Their governments do have to get the money from somewhere else before they can spend it. You should always be wary of comparisons between the UK and any country which uses euros, be it Greece or Germany, because they are much more constrained than we are.
[4] And that includes the Labour Party: ‘Our manifesto is fully costed, with all current spending paid for out of taxation or redirected revenue streams. Our public services must rest on the foundation of sound finances. Labour will, therefore, set the target of eliminating the government’s deficit on day-to-day spending within five years.’ Balancing the Books, Labour Party Manifesto, 2017, The Labour Party.