We live in a time where, due largely to a series of crises, most governments around the world experience severe difficulties with their finances. The question of how governments should raise money has become critical. This article is an attempt to outline the options, and the implications of each possible approach.

Before we can explore how governments can raise money in a crisis, though, we have to ask an even more fundamental question. What is money in the first place?

Money is a transferable (“negotiable” in financial jargon) claim on resources for sale anywhere that the money is accepted.

Normally, therefore, there are two major influences on the real purchasing power of such money: the size of the supply of the money itself, and the size of the stock of resources that money could be used to purchase. (NB the situation would be more complex if the money under consideration is competing with other forms of money to buy the same resources. Also, sometimes the acceptability of a given form of money will vary for social reasons, such as fad or confidence in the entity issuing the money).

There are many types of money:

• Standardised, easily transportable, storable and exchangeable commodities that intrinsically have high value (aka commodity money). The most obvious examples are coins made of precious metals.

• Intrinsically Valueless Rare Objects (that are also easily transportable, storable and exchangeable commodities) that have little or no intrinsic value but are agreed to have exchange value by convention, really by consensual delusion that something that is valueless really has value, for example cowrie shells or bitcoins. IVROs can vary significantly in value over time, for basically two reasons: it is very difficult to keep the money supply in balance with the stock of purchasable resources and the acceptability of the money as a means of exchange rests on a tenuous foundation. IVROs are therefore usually subject to huge variations in real value. (REF 1).

• Standardised Money (aka representative money): Each unit of money has a fixed value in terms of some other commodity with an intrinsic value (e.g. for the gold standard have a value equivalent to a fixed amount of the gold in gold reserves held by the issuer), but that can have a downside: it is difficult to expand the supply of such money, meaning that if the resources available for sale anywhere the money is accepted expand and the money supply does not, each unit of money is now worth a larger share of those resources, resulting in deflation and a dampening of economic activity, as people are reluctant to buy today if they can buy more with the same amount of money tomorrow. The only way out of that situation, if you can’t say increase the size of the gold reserve, is to formally devalue each unit of money, that is say it is now equivalent to a smaller amount of gold, so that you can increase the size of the money supply. Often, however, issuers of standardised money, such as money based on the gold standard, are very reluctant to devalue in this way, seeing it as a sign of weakness or defeat, or fearing economic repercussions such as imports becoming more expensive or international loans harder to repay or service.

• Fiat Money: This is money created by a government issuing its own money to pay for its own debts and purchases while simultaneously declaring that the money must be accepted as a means of payment by those under the government’s control, i.e. that it is “legal tender” . If we assume that the government is able to enforce this definition of “legal tender”, and there are no other significant forms of money in use, then the real value of such fiat money, what it can buy, would then depend purely on the relationship between the amount of such fiat money in circulation and the supply of goods and services it legally must be allowed to buy.

• Commerical Bank Created Money: I am going to call this “virtual money”. This is the money a commercial bank creates when it issues loans in excess of the amount the bank holds in reserve. In practice such money is little more than an accounting entry, usually denominated in terms of another currency, nearly always, these days, a government issued fiat currency. This is money created as a liability, as a debt, on the bank, and as soon as bank loans created in this way are repaid to the bank, that repayment to the bank cancels out the bank’s own liability, and the money ceases to exist (that is why I am calling it “virtual money”, in analogy to the fleeting subatomic “virtual particles” of modern physics). Note that, though this form of money ceases to exist once the bank loans are repaid, in the meantime, while the money exists, the bank benefits by earning interest on the loan. In practical terms such practices are sustainable provided confidence in the bank, that it can sustain any calls on its reserves on a day to day basis, is sustained. To mitigate against such a loss of confidence, and a subsequent run on the bank, the creation of virtual money is usually subject to state banking regulations, that are intended to ensure that banks hold at at least a certain fraction of the money they lend as reserves. This practice of creating virtual money is therefore often referred to as “fractional reserve banking”, though that term can itself be controversial, as there is frequent cynicism that banking regulations really force banks to retain meaningful fractional reserves, and that banks rather create as much virtual money as they feel they can get away with without damaging confidence in the bank itself.

• IOUs. This includes any form of money that derives its value ultimately from a claim on the resources of the issuer of the money. “Promissory notes”, that in part gave rise to the modern bank notes, are on examples of such IOUs, as potentially are even ordinary store “gift cards”.

In practice, in a modern economy most of the money supply is comprised of virtual money, supplemented with some fiat money (plus some IVROs, such as bitcoins, and a few IOUs). The dominance of virtual money is itself a subject of heated debate, especially as it means that most money is based on debt, provoking demands for banking reform and sometimes nationalisation of the banks. That is a large, complex and sometimes rather specialised topic in its own right and we will not go into that further now, but here is one leading proposal: https://positivemoney.org/.

In reality actual money may effectively be a blend of the above types. For example, issuers of commodity money, such as the silver denarius in the late Roman Empire, have often debased their coinage, so that the face value of the coin is less than the value of its precious metal content, making the late Roman denarius effectively a blend of commodity and fiat currency. Another example: IOUs effectively blend into virtual money once a bank issues more of such money in loans that it holds in reserve. Also, standardised money blends with IOUs where anyone possessing such money has a genuinely exercisable right to making a claim on whatever intrinsically valuable resource, such as a gold reserve, backs such money. Note, though, that if bearers of standardised money have the ability to convert that currency into gold or whatever it is that “backs” its value, then it becomes very difficult indeed to ever formally devalue, as the merest hints of a looming devaluation would cause a “run” on the currency.

Some, notably Modern Money Theorists, claim that it is taxes that give fiat currency its value, so that, in effect, fiat currency is a government issued IOU you can use to pay for Government services through taxes. This, however, is unlikely to be entirely true, and not only because, historically, sometimes governments are reluctant to accept their own fiat currency in payment for taxes (see pg 169, Modern Money Theory, L Randall Wray, 2^nd Edition). It seems more plausible that it is the entire stock of what a form of money can buy, and not just paying for “government services” via taxes, that would influence the real value of a money.

A government can spend its own fiat currency into being, providing what is called direct monetary financing, such as “helicopter money” or Quantitative Easing (REF 2). As fiat money amounts to a government using its authority to just issue additional claims on resources to itself, then “printing money” in this way will devalue existing money, which will cause inflation that in turn may be offset if the pressures on the economy are already deflationary, so may never be obvious. The “cost” of the devaluation of money will be spread across all holders of money, where-as the spending power from the creation of the new fiat money will apply, in the first instance, to the government alone. For example, say a government suddenly doubles the money supply by issuing to itself money equivalent to the current money supply: then (assuming resources available to purchase with that money supply remain constant, and that there aren’t already deflationary dynamics in action that are tending to reduce the money supply by taking money out of circulation, i.e. holding everything else constant) all money halves in value, but the Government still gains extra spending power equivalent to half the previous money supply, as well as halving the real value of all of its debts.

This is not “getting something for nothing”. All such direct monetary financing is doing, in effect, is to give the government the ability to directly control a larger share of purchasable resources, at the expense of others directly controlling a lesser share of resources. In an emergency, where significant coordinated spending is needed to address a crisis, that can be an efficient way to manage the resolution of a crisis in a way that fairly and sustainably spreads the costs of confronting the crisis.

Significant direct monetary financing allows increased public spending but with the costs being borne by savers in that money and creditors who have loaned in that money. Holders of assets with intrinsic value such as shares or property do not lose out. Therefore, a wealth tax should be considered alongside “helicopter money” to even out some of these differences and spread the costs more fairly.

A government can also spend more by borrowing, or by raising more tax.

Borrowing does not allow you to use the future’s resources today: obviously you cannot use today resources that do not yet exist. Borrowing basically redistributes the ability to use today’s resources from lenders to borrowers. Borrowing transfers the ability to make a claim on already existent resources from the lender to the borrower, so does allow the borrower to make use of resources today that they wouldn’t otherwise have available. Indeed, if the borrowing is used to preserve or expand the borrower’s ability to create or acquire resources, i.e. is used to wisely invest, then the borrowing today will also increase the borrower’s future resources, provided, of course, the return on investment exceeds any interest on the loan.

So in an economic crisis, in order to maintain the productive capacity of an economy by keeping levels of spending and investment going, so avoiding the deskilling of workers, the closure of businesses and the destruction of infrastructure, with the immediate and possibly long term corollaries in the form of reduced tax receipts and increased welfare spending, should the Government fund the extra spending likely to be necessary from taxes or burrowing? (Incidentally, it should be instantly obvious that, unless the economic crisis in question has actually been caused by overly high levels of government spending or debt, adopting austere and general spending cuts is therefore one of the worst possible government reactions to an economic crisis).

The usual argument is that borrowing is more attractive because taxation will reduce spending.

However, it isn’t as simple as that: if such borrowing is from banks, then that borrowing will indeed create new virtual money when the bank issues a loan, in the normal way, but, if the banks keep to their regular reserve to lending ratios, no extra money will not be spent into the economy, rather loans to the government will effectively “crowd out” loans to riskier borrowers such as businesses. (Though this may offset the natural tendency by banks during a crisis to increase their reserves and reduce lending, as government bonds are usually regarded as such safe loans that they are treated as part of a bank’s “reserves” rather than the loan book: more on this later). If the borrowing is from non-banks, i.e. from institutions that don’t have the legal right to create virtual money, such as pension funds, then it is even more obvious that no extra money is created, and what may happen instead is that pension funds will switch to government bonds rather than what would, in the midst of a crisis, be seen as riskier investments. Therefore again government borrowing will not necessarily result in extra money being spent to help sustain the economy.

Taxes therefore start to seem not so dissimilar from borrowing. In the case of taxes it is more obvious than with borrowing that in the immediate term spending power is merely reallocated, but the same is true for borrowing. Neither approach can create resources out of nothing: both merely redistribute the ability to make claims on resources, taxes permanently and borrowing, provided the loans are repaid, temporarily.

What both taxes and borrowing do, or rather CAN do, is to redirect spending power from non-government hands into government hands. In an economic crisis that may be important as otherwise a crisis of confidence can mean that those with spending power seek ways to store that spending power for the duration of the crisis, e.g. buying gold or land banking, rather than risk wasting money on ventures that may fail owing to the harsh economic conditions.

Taxes can do this by simply taking the money that would otherwise have been stored and redirecting it to government spending intended to mitigate the crisis.

Government borrowing, on the other hand, reduces the amount of money “put on ice” by giving individuals with spare money a place they can invest that money, i.e. relatively safe government bonds, which still ensures that money, via government spending, can remain active in the economy and be used to reduce damage to the economy and aid its recovery.

This is precisely the situation that can apply to banks: in a crisis banks will usually want to build up their reserves and reduce their lending. As government bonds are considered, or deemed by regulators, as “safe”, they can form part of a bank’s reserves, so that a government that borrows by issuing government bonds therefore provides a way for banks to build up their reserves, by buying bonds, but in way that keeps the spending power used by the banks to buy those bonds active.

A second advantage to borrowing is that, if economic growth is restored and then continues into the future, a certain amount of government spending today will not, in the future, constitute as large a proportion of the economy as it does now. Paying off those debts will therefore be less of a burden on future tax payers that it would be if borrowing was avoided and those demands made immediately on current tax payers. Of course, this is equivalent to borrowing to invest, and therefore also depends on the rate of return on the investment, in this case economic growth, exceeding the rate of interest over the period in question. As government bonds usually pay a fixed return (the “coupon”) this can be a reasonable strategy for a government to pursue, especially when interest rates at the time the bonds were issued were low.

However, the economic growth side of the equation can be more challenging. Not only is it increasingly obvious that economic growth must be sustainable, i.e. not simply build up “hidden” debts in terms of accumulated environmental damage, but historically a sizeable chunk of economic growth has really just been a result of growth in the population. Provided that at least total income keeps pace with the debt plus accumulated interest, a growth in the population alone can mean that paying off a government debt will be less of a burden to future rather than current tax payers, simply because in the future that burden will be spread across more tax payers. With populations static or even falling this growth side of this equation is not so reliable, though, if a crisis has already caused a economy to contract, the likelihood of future growth from such a low point may be high, meaning deferring burdens to future post-recovery tax payers may be fair and sensible.

A third advantage of borrowing can be that it allows resources to be drawn into the society managed by a given government from outside societies. This can be important where a crisis has unevenly affected different societies, for example during and after World War Two, when the USA, which, due to distance from the conflict had largely avoided damage to its infrastructure, was able to lend to Europe. This can, however, be double edged. External debts may be payable in the money issued by external governments, and, though a government can never go bankrupt in terms of its own money, because it can always simply issue more, it can run out of the money of other governments. A government will usually be able to much more efficiently manage loans raised domestically.

By contrast, an advantage of using tax increases to fund government spending to deal with a crisis is that the redistribution of resources that ensues is then permanent. There is no liability on the government to distribute those resources back in future. That means there is no transfer of the burden to future tax payers. That, in turn, can be a significant advantage if existing government debts mean that the burden on future tax-payers is already likely to be high.

Furthermore, if the taxes are raised in a progressive way, on a “the widest shoulders should bear the greatest burden” basis, then paying now rather than burrowing can be even more important, as such a redistribution, effectively where the wealthiest help out the poorest, where those suffering less from a crisis assist those most affected, is easiest to justify during the crisis. If, by contrast, the burden is kicked down the road to future tax payers via burrowing, to a time when the reason for the burrowing has been or is being forgotten, it is far less likely that the burden will be spread so progressively.

Progressive tax rises also better sustain active spending because it is the wealthiest institutions and individuals that will attempt to protect a larger share of their wealth through conversion into stores of value (such as gold or land) during a crisis than the poorest. During a crisis the bulk of society may struggle to make ends meet, and will therefore have no option to “save” at all. Taxes can also be carefully targetted to further discourage the creation of stores of value and encourage spending and investment.

In a situation where increases in government spending are clearly unavoidable it is therefore not unusual for the richest to argue for burrowing rather than tax rises, in the hope that a deferred tax burden can be raised less progressively, but also because an issue of government bonds gives the rich, during a crisis, another way to protect their wealth.

Finally, there is, of course, a fourth source of revenue that isn’t often discussed, possibly because, to those accepting the neoliberal bias for “small” government, governments are meant to keep any “assets” they own to a bare minimum in the first place. In reality though, governments, especially those of a more left wing bent, are likely to own considerable assets. What should a government do with these assets when subject to the funding challenges of a crisis, such as the Financial Crash or COVID?

Some governments, such as Greece, have frequently been forced to sell their assets, and a crisis can easily turned into a feeding frenzy of powerful financial interests converting public assets into private. But in 2012 even the OECD said this: “Privatisation of government assets should be based on cost-benefit analysis and, except in extreme cases, not solely on revenue-raising objectives. In this regard, the current context may not be optimal for selling assets by governments that are not forced to.” (https://www.oecd.org/economy/public-finance/49648843.pdf).

For anyone on the Left, of course, the benefit side of that “cost/benefit” analysis should also consider how government owned assets can be used to address inequality, either by providing benefits in kind to everyone regardless of means to pay, such as free healthcare, or by generating revenues that can then be redistributed. We should always remember that “predistribution”, furthering economic equality by sharing ownership of the sources of wealth, is always likely to be more effective than redistribution, where wealth is allowed to accumulate in the hands of a few and then has to be prised out via attempts at taxation. Selling off state assets during a crisis, when the need to protect the poorest is likely to be most acute, is therefore arguably the last thing a government should do.

It should also be noted that addressing a crisis is likely to involve conscious, coordinated actions of the type of which markets are generally incapable, especially when there has been a general collapse in economic confidence. Owning productive assets within the economy can help the government in carrying out its emergency economic and social strategy as it then simply has more “levers” it can pull. Also, although a crisis may reduce a government’s earnings from its assets, any sale of such assets during a crisis is likely to yield less than in ordinary times.

Assets may provide a government with useful additional “tools” to deal with a crisis, but, in the midst of a crisis itself, asset ownership is therefore unlikely to help much with funding issues.

Therefore, government spending increases to deal with a crisis can be met by a combination of issuing new fiat money, tax increases and burrowing. Issuing new fiat money simply and very directly gives a government additional spending power, but at the cost of devaluing the currency and so reducing spending power across the rest of the economy. Holders of extensive deposits in the currency, or creditors owning loans denominated in the currency, lose out, though all borrowers of the currency, including the government itself, win. Tax rises directly transfer spending power to the government from elsewhere in the economy. Any such tax rises must, however, be progressive in nature and discourage the creation of store of values while attempting to encourage, or at least not further discourage, spending and investment. Burrowing should be thought of both in terms of burrowing to invest and as deferred taxation. The extent to which a government should attempt to borrow itself out of a crisis depends on the current interest rate and the likelihood or not that future tax payers will be able to meet any burdens more easily than current tax payers (will there be more of them, and will the economy grow from what may be a current low point, and how much burden has already been transferred to those future tax-payers by existing government debt?) and the possible desirability of drawing in resources from external societies (with the caveat that this can be the riskiest type of burrowing in which a society can engage).

There is no “silver bullet” to solving the problem of how to increase government spending to deal with a crisis; no simple magic formula. Instead, there are three basic approaches, each of which comes with major advantages and disadvantages, and all of which will need to be considered pragmatically in the light of the details of the situation in which a society finds itself.

Notes

REF 1:

Douglas Adams in the “Restaurant at the End of the Universe”, had this brief description of an attempt to base a money supply on IVROs:

““If,” [“the management consultant”] said tersely, “we could for a moment move on to the subject of fiscal policy. . .”
“Fiscal policy!” whooped Ford Prefect. “Fiscal policy!”
The management consultant gave him a look that only a lungfish could have copied.
“Fiscal policy. . .” he repeated, “that is what I said.”
“How can you have money,” demanded Ford, “if none of you actually produces anything? It doesn’t grow on trees you know.”
“If you would allow me to continue.. .”
Ford nodded dejectedly.
“Thank you. Since we decided a few weeks ago to adopt the leaf as legal tender, we have, of course, all become immensely rich.”
Ford stared in disbelief at the crowd who were murmuring appreciatively at this and greedily fingering the wads of leaves with which their track suits were stuffed.
“But we have also,” continued the management consultant, “run into a small inflation problem on account of the high level of leaf availability, which means that, I gather, the current going rate has something like three deciduous forests buying one ship’s peanut.”
Murmurs of alarm came from the crowd. The management consultant waved them down.
“So in order to obviate this problem,” he continued, “and effectively revalue the leaf, we are about to embark on a massive defoliation campaign, and. . .er, burn down all the forests. I think you’ll all agree that’s a sensible move under the circumstances.”

The reader is invited to draw whatever connections they like between the above and the global warming impact of the mining of cryptocurrencies.

REF 2:

And Quantitative Easing (QE), where-by a government issues debt as government bonds but then has its central bank buy them straight back, is direct monetary financing, it is “printing money”. The financial sleight of hand where-by bonds are issued only to be re-purchased very soon there-after is intended to manage expectations in a way to mitigate inflation risk, by creating the illusion that those bonds, now held by the central bank, would eventually be sold back into the markets or “cancelled” by wiping out a corresponding amount of government receipts, so that the bonds, now held by the central bank, offset the money that has been created. In practice, the bonds are highly unlikely to be resold or cancelled anytime in the foreseeable future. The following discussion re QE in the UK and the COVID crisis is particularly revealing: https://www.youtube.com/watch?v=d3GEno9qFtA