My friend, Deborah Harrington, gives her two cents on where money comes from, and criticises the nonsense behind austerity that compares a state with a sovereign currency to a household and implies that the private sector is somehow required to have money and to fund the public sector.

To the below I’d just add the idea that money (or at least fiat currency, and particularly bank-created money) is given value at least partially because it is accepted in taxes, as argued by David Graeber in his book on debt (also a BBC radio series available free at the time of writing) and in this thought experiment on a Modern Monetary Theory website.

Deborah on money:

The simplest way to follow it, I think, is to imagine money circulating, rather than building up and being taken down in piles (which is the paying down debt image).

Money comes from somewhere! Neoliberal economics would tell you that government spending is dependent on government getting money from the private sector to spend. It says government has two ways to do this – it can tax people, or it can borrow from the markets by selling bonds (also known as gilts because they are a very safe investment)

In this scenario money creation is seen as something only the private sector can do. They make money, government takes some to spend on the poor, or necessary services.

But no one asks where the private sector gets the money. The simple answer is that they make it by selling goods and services. But that simply rephrases the question, it doesn’t answer it. Where do people get the money to buy the goods and services? They go to work for the private companies……..

You see? It runs to a dead end, or at least it’s a ne’er ending circle. And it still doesn’t answer the question of where the money comes from.

And the answer is that it comes from two sources. It comes from government, in sovereign money creation and it comes from banks as debt money in the shape of overdrafts, loans, mortgages, etc.

Governments are not, in fact, borrowing money from the private sector at all. They are creating it. They create it by public spending. What happens when the government employs people? They are paid. Their income isn’t spent in government shops, it pays mortgages, rents, food…well, stuff! And that is provided by the private sector. And the government builds things, hospitals, schools, etc, so builders are paid, brick makers are paid…you get the picture. And schools need books and equipment, so does every public service. All bought from the private sector.

Finally we have a source of money, not just the goods and service creation of the private sector, flowing into the economy.

BUT we have to then look at what money can buy. In the real world it pays for all the things we need and want but they are in finite supply. So if the government keeps on creating money there will be too much money chasing too few goods. Result? Inflation! Inflation isn’t actually a bogeyman, but when it spirals out of control it is very destabilising. So, in order to make sure there isn’t too much money you tax things. This controls the money supply.

Why, then, is it important to have progressive taxation? Because you are removing a portion of people’s ability to spend and if you don’t withdraw it from the rich you increase the disproportion with which they have the power to spend and to increase their real wealth.

The housing market offers a simple explanation of how what is called demand-push inflation works. You used to only be able to borrow very tightly controlled multipliers of your income to buy a house. A deposit was mandatory and your proof of ability to pay very strictly checked out. As a result house price inflation was very low and the housing market moved pretty slowly.

Then lending was deregulated. People believe that house price inflation is because of a shortage of houses. But houses for sale have increased because of all the public housing that transferred from public to private ownership. No. House prices increased because the amount of money targeted at that particular form of expenditure increased exponentially with no counterweight from government in the form of regulation or taxation.