After a weekend of intense study reading a plethora of material online from a variety of economists I am at the point where, similar to my University days, I must put what I have learned to paper. In reality it’s even scarier than University because, unlike handing it to a tutor for a confidential and sympathetic grading, posting it online exposes me to any amount of ridicule from anyone, anywhere. But, having come this far, I have to press on and continue what I started with my previous article, “Do Taxes Fund Spending?”

If what I write is true, and naturally I believe it is, we as a nation are being deceived in a way that, I think, is unconscionable. Essentially, this is a dummies version of the previous article and is designed to attract more people like me, who are still going through the difficult process of learning and understanding what is a relatively simple principal So, here goes….

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To a sovereign nation like ours that operates its own central bank, the notion of a government being in debt and budgeting for surpluses and deficits is a ridiculous scam.

Every sovereign nation has the right and the responsibility of creating its own money. It carries out this responsibility by creating and supplying that money through the agency of its central bank and delivers that money into the market place via the commercial banking system. This is just one source from which commercial banks obtain money, but it is the most important source because it fulfills one of the essential steps a government takes to control the supply of money. Other sources are private investment and export income.

The other essential steps a government takes to control the supply of money are through taxation and the sale of bonds. Taxation and the sale of bonds remove money from the market place. There are two other ways money is removed from the market place, namely through personal savings and import payments. This two pronged process is analogous to a giant water tank with a hose at the top pouring water in and an outlet valve at the bottom allowing water out. Now think money instead of water. The objective is to maintain as close as possible a constant level of money in our economy; enough money in circulation sufficient to avoid inflation which is what happens when there is too much money in circulation and recession when there is too little. It is a finely balanced discipline undertaken and monitored by the central bank. The amount of money in circulation at any time is called the monetary base or high-powered money. It is the national income and consists of all the money the central bank holds in reserves for the commercial banks as well as all the money in the commercial bank vaults, and all the money you and I have in our wallets and purses and what we hide under the carpet. Just how the central bank calculates all that is another story, but they do it constantly. The process never stops.

Governments rely heavily on the efficiency of the central bank to keep them advised as to the amount of money in circulation, as well as the likely movement of money both in the short term and the long term. The central bank also advises the government on the implications of government fiscal decisions and the impact of those decisions upon that finely balanced position they are required to monitor. It goes without saying that sometimes the central bank miscalculates the current position and/or governments ignore warnings given by the bank which can, and does, lead to imbalances that cause inflationary pressures or recessionary outcomes. Nobody is perfect all the time. So, when things get out of hand and too much money gets into the system, the central bank will generally address this imbalance by raising interest rates to soak up and remove that money. The government may also choose to issue bonds. When too little money is in circulation and people stop buying other than for essential needs, more money needs to be poured into the economy to stimulate demand. In this case the central bank will lower interest rates to release money into circulation thus enabling increased spending power. All this activity is made possible because the government has the ability and responsibility to create money.

This brings us to the question of government budgets and the notion of surplus, deficit and debt. When a government brings down a budget it will do so to with the intention of matching what it spends with what it collects in the form of taxation. It does this to ensure a predictable outflow of money from circulation and to maintain that constant balance; not unlike how we manage our household affairs. But it is wrong to think that it must do this. It doesn’t. Managing a sovereign nation’s economy is not the same as managing a household economy. Households cannot create their own money. We all wish we could but our resources are finite. A government’s resources are not finite despite what politicians tell us. To understand this, let’s go back to the water tank analogy. The government creates money and pours it in, taxation takes money out. Taxation doesn’t fund spending. It is part of the process that removes the money from circulation in a constant predictable way. So, when a government’s budget reveals that it is spending more than it is collecting (i.e. a deficit), that doesn’t mean it has to borrow to make up the difference. It can just create more money, i.e. print it, although these days the process is little more than altering the numbers in a computer. So long as the level in the tank remains constant that extra money is not a debt. It doesn’t have to be paid back. Likewise when a budget shows less money being spent than is being collected in tax (i.e. a surplus), that doesn’t mean the government has a bank account with that surplus saved. That money simply doesn’t exist.

If we apply this principle to our present government’s rhetoric about debt and deficit, about unsustainable spending, about the “mess” the previous government left, one can clearly see that such claims are false and misleading. This government is trying to manage the economy in the same way each of us manages our own households. The figures they present to us are a fiction. Households and businesses manage their affairs differently because they cannot print money. It would be nice if we could but there you are. We must determine our profit and loss and our tax liabilities with resources that are finite. We must live within the confines of our own budgets and meet our obligations as determined by the government. But that is not the way a government should run a country.

This principle also exposes Joe Hockey’s budget as not only cruel and vindictive but also as a ridiculous sham. It smacks of something personal as if the poor are being punished for allowing themselves to be in that situation. It exposes the neo-Liberal economic strategy that treats Australia as if it were a household. They should be challenged for this. This government is not governing for the people but for the big end of town. It is blatantly unfair and unnecessary.

I am not pretending to be an economist. But I am smart enough to see the difference between the government’s management of the economy and the way it should be managed. Either they don’t know how to do it, or they don’t want to, which is the more likely, and that means we, the 90% who feed the economy, are being played for fools by the 10% who feed off us and stay rich, because of us.

Recent articles by John Kelly:

Hockey’s Class Warfare

What a Circus!

Is Abbott a Christian or just a Catholic?

Where have all the Leaders gone?

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