Groucho Marxism

In the world of finance, a ‘bond’ is a legal contract whereby one party – the ‘issuer’ of the bond – is obliged to provide a cash flow to another party – the ‘holder’ of the bond. The holder will typically pay cash up front to the issuer in order to enter into this arrangement. A government bond is a bond issued by a government to an individual or organization in the sector. Governments issue bonds all the time. The usual explanation is that they do this in order to obtain money from the private sector: a government will agree to make interest payments to the holder of the bond in return for the holder providing cash up front to the government. However that explanation makes no sense for sovereign currency-issuing governments that can create money by fiat, such as the UK government.

There was a time when the UK government did have to borrow money, because there was an artificial constraint placed upon the amount of money in the economy. That artificial constraint was imposed through the convertibility of money into gold. At that time, if the government wanted money and could not get its hands on any gold, it had no choice but to borrow the money from the private sector. It did that by issuing ‘gilts’ – that is, government bonds. These gilts essentially acted as a savings account for the holder. Somebody could buy a government bond and sometime in the future get their money back; in the meantime, they would get a steady stream of interest payments. These days, however, there is no such constraint and the UK can simply create money at will.

In theory, the UK government could have stopped issuing bonds the moment the UK abandoned the gold standard in 1931. However, the City of London had become quite fond of having access to what were essentially risk-free savings accounts. Gilt issuance had become essential to the functioning of many financial institutions – and still is to this day. That is the real reason the UK government continues to issue bonds: to enable financial markets to function. These markets are completely dependent upon the government providing a risk-free saving mechanism. This demonstrates that power lies with the government, not with the markets. It is time that we recognise that and stop the nonsense that we are dependent upon these markets for money – because we aren’t.

Why, then, does this myth persist? It is because the erroneous idea that the government is dependent on the financial markets to provide it with money is extraordinarily convenient for the people who run those markets – namely, the ruling class. There is an obvious incentive for the ruling class to keep up this pretence, and that’s precisely what it does, in a couple of different ways. One way is by imposing a rule that whenever there is a budget deficit – that is, a discrepancy between the level of government spending and the tax revenue collected – the government must issue bonds equal in value to the size of this deficit. This makes it looks like the government is forced to borrow money from the private sector in order to ‘fund’ the deficit, whereas in reality it doesn’t need to do this at all.

If you don’t believe me, ask yourself the following question: Why would a currency-issuing government need to borrow money that it, and only it, can create at will? It doesn’t make any sense! So why don’t pundits in the media ever point this out? This brings us to the second way in which the ruling class maintains the illusion that the government is dependent on the private sector for money: through control of the narrative. The role of the media is not to dispassionately report on news and current affairs. Rather, it is a tool of propaganda for the ruling class. I am not suggesting that media pundits knowingly mislead their audiences; but any pundit who dared to question the prevailing narrative would probably find themselves out of a job pretty quickly.

Whenever a government runs a budget deficit, the media will inevitably start bleating on about increased borrowing costs. As we have seen, however, these costs are entirely self-imposed. Not only that, they are a form of corporate welfare. This explains why interest rates on gilts go up during periods of price inflation. It is usually said that the Bank of England raises interest rates during times of inflation in order to try to bring inflation down; but this is a smokescreen. Nobody has ever provided evidence that increasing interest rates decreases inflation – at least, not that I am aware of. It certainly doesn’t make any sense to increase rates during times of inflation caused by supply shocks, as interest rates have nothing whatsoever to do with these.

The real reason interest rates go up during times of inflation is that inflation erodes the real value of assets such as bonds, so rates are raised in order to compensate the owners of these assets – i.e. rich people – by providing them with higher interest payments. Although the Bank of England does not directly control the interest rate on government bonds, it does control the so-called ‘base rate’, the baseline for short-term borrowing, which heavily influences the yields demanded by the broader bond market. This arrangement is clearly very beneficial for the ruling class; but it is just an arrangement. There is no law of nature which says that governments must pay more money to rich people during times of inflation, or at any other time for that matter.