As I have said many times, The Politics of Care infographics are so good that they can be used to educate an 8 year old; especially if the eight year old is interested in bonds! LOL!
I like to say bonds is just money you can't use now but at some point in the future. To compensate for this inconvenience, you get a bit of actual money every year until then.
I feel like Dougal in the Father Ted sketch about the cows! 'I don't get it Ted.' I've so nearly grasped this, but not quite. I have 2 questions: 1) in that Bond markets, how and why did the Bond markets 'do for' Liz Truss? 2) what are taxes for if they're not there to raise any money for the govt?
Thank you so much for doing this one. I think I get the Bonds now, but I totally failed to grasp taxes last time! (Back to homework club.)
On Liz Truss, the crucial point is that the bond markets did not prove that the UK had “run out of money”. Her government announced large tax cuts without explaining how it would manage the potential inflationary consequences, at a time when inflation was already high. Markets expected interest rates to rise, gilt prices fell, and yields rose. That created a particular crisis for pension funds using liability-driven investment strategies, which forced the Bank of England to intervene and buy gilts.
So Truss was brought down by a financial and political crisis of her own making, not because the government was unable to make payments in pounds. The Bank of England’s intervention actually demonstrated that point: when necessary, it could create the money required to stabilise the gilt market.
On tax, this is the really important bit. Tax does not raise the money that a currency-issuing government needs before it can spend. Government creates pounds when it spends, and tax cancels some of that money afterwards to control inflation - which is its primary purpose by reducing spending power.
But that most definitely does not make tax unnecessary. Tax gives value to the currency because people need pounds to settle their tax liabilities. It redistributes income and wealth. It changes behaviour by making some activities more or less attractive. And it helps shape the distribution of resources within society.
So perhaps the simplest version for homework club is this: government spending creates money; taxation cancels it. Both are essential parts of managing the economy.
And please keep asking. If this were obvious, I would not need to keep making infographics.
So I suppose the other obvious question is, the main point of contact most of us have with all of this, is when the media announce the latest government financial shenanigans. But none of those stories or headlines make the slightest bit of sense in the system you've described : ‘government debt soars’, ‘there is no magic money tree’ etc etc. So are the financial journos crap or lying to us?
Doesn't the government issue more bonds to pay back the principal on maturing bonds like a giant Ponzi scheme? If bonds don't finance public spending, why bother issuing them? And don't bond market interest rates cause the government problems if they rise as they're already paying back over £100bn p.a.
Bonds are the safest place to "Park" your money. In many instances, the government is simply rolling-over the bond at maturity because that is what the bond holder wants. In the USA this is very true for Federal Treasury Securities but is NOT always true for state and local municipal bonds. Some municipal bonds cannot be rolled over but at maturity you may invest in a new and different municipal bond if you choose to do so.
I explain why they are issued in the View From article I link. Is this a Ponzi scheme? No. It is like having a rolling series of bank bonds - which all banks and building societies do.
Thanks. I'm loving these infographics. I wonder if you could explain 'yield' as introduced in 4. I assume it's interest rate, but isn't that the 'coupon'?
Like it Richard, I'm nearly understanding this at last! One thing I need help with. The convention is that government spending needs to be exactly balanced by tax and sale of bonds. This didn't happen during Covid, and the world didn't seem to end. What would happen if bonds weren't sold to cover "the deficit"? In other words, could the government spend without (in conventional parlance) borrowing the amount to cover the difference between tax and spend?
Is there a psychological reason why humans have come up with something so complicated?
I have a science degree and quantum physics sounds easier to understand.
Could you provide a worked example of some bonds. Lets see if I've got this.
Say if I had a finance company and I bought £1000 of bonds that mature at 5 years, with an interest rate of 4%. After 5 years I get my £1000 back + 5 years worth of interest at 4%. 1% is £10, so that is £40 in year one, £41.60 in year 2; £43.26 in year 3, £44.99 in year 4; £46.79 in year 5. So I walk away with £1216.64.
So where does the bond issuer get the extra £216.64 from? From other bonds that have been issued in the interim? Or somewhere else? If it is the former, that's a ponzi scheme?
The interest rate is paid annually, so it would be £40 a year.
Where does that money come from? A company pays it out of income. The government creates the money via the Bank of England, as it does for all its spending.
"The government creates the money via the Bank of England"
As someone trained in physics, well, materials science, this is a fundamental mental stumbling block. You cannot create something out of nothing, that is one of the essential laws of the universe. If something is being created out of nothing, then that literally is magic, or a sleight of hand, or a faith or belief at work.
I mean, I know physical coins and notes exist, but it is stated that these only represent 3% of actual money in circulation at any one time. The rest being electrons in many sets of computers.
It might be worth doing a graphic on how a government creates money out of nothing.
Does an economic minister literally ring up their national bank and just order a few millions? Perhaps several times a day? Or is there some kind of quasi-legal basis where forms are filled in and experts agree that it can go ahead?
"If something is being created out of nothing, then that literally is magic, or a sleight of hand, or a faith or belief at work." Belief & faith are both right - remember, it's called 'fiat' currency as opposed, to say, commodity-backed currency. Also there's the fact Government demands taxes be paid in the national currency which serves to give it value as people know they'll need some come tax time.
See Richard's note above, I assumed incorrectly that it would be compound interest accumulated. Instead it's just a £40 per annum flat payment in this particular example.
But yes, the question still is, where would the £40 come from? From Richard's comment, the government creates it.
Then I'm guessing now I've got my bonds I can go to another financial company and say, look, I've got this guaranteed income in 5 years, lend me £1200 and I'll pay you back in 5 years with your interest. I get my £1200 loan/overdraft and buy more bonds, or invest in some other shares that might provide greater than the interest rate of the loan. Then with those loans and bonds I blag even more loans from other financial institutions.
Magnify all that by millions of such transactions per hour and you have the world financial market described in one go?
Wow, for the first time I think I've grasped this! Thank you - and love the graphics
As I have said many times, The Politics of Care infographics are so good that they can be used to educate an 8 year old; especially if the eight year old is interested in bonds! LOL!
I like to say bonds is just money you can't use now but at some point in the future. To compensate for this inconvenience, you get a bit of actual money every year until then.
They are savings instruments, not a source of government funding. Nothing in MMT denies the need for savings instruments.
I feel like Dougal in the Father Ted sketch about the cows! 'I don't get it Ted.' I've so nearly grasped this, but not quite. I have 2 questions: 1) in that Bond markets, how and why did the Bond markets 'do for' Liz Truss? 2) what are taxes for if they're not there to raise any money for the govt?
Thank you so much for doing this one. I think I get the Bonds now, but I totally failed to grasp taxes last time! (Back to homework club.)
On Liz Truss, the crucial point is that the bond markets did not prove that the UK had “run out of money”. Her government announced large tax cuts without explaining how it would manage the potential inflationary consequences, at a time when inflation was already high. Markets expected interest rates to rise, gilt prices fell, and yields rose. That created a particular crisis for pension funds using liability-driven investment strategies, which forced the Bank of England to intervene and buy gilts.
So Truss was brought down by a financial and political crisis of her own making, not because the government was unable to make payments in pounds. The Bank of England’s intervention actually demonstrated that point: when necessary, it could create the money required to stabilise the gilt market.
On tax, this is the really important bit. Tax does not raise the money that a currency-issuing government needs before it can spend. Government creates pounds when it spends, and tax cancels some of that money afterwards to control inflation - which is its primary purpose by reducing spending power.
But that most definitely does not make tax unnecessary. Tax gives value to the currency because people need pounds to settle their tax liabilities. It redistributes income and wealth. It changes behaviour by making some activities more or less attractive. And it helps shape the distribution of resources within society.
So perhaps the simplest version for homework club is this: government spending creates money; taxation cancels it. Both are essential parts of managing the economy.
And please keep asking. If this were obvious, I would not need to keep making infographics.
So I suppose the other obvious question is, the main point of contact most of us have with all of this, is when the media announce the latest government financial shenanigans. But none of those stories or headlines make the slightest bit of sense in the system you've described : ‘government debt soars’, ‘there is no magic money tree’ etc etc. So are the financial journos crap or lying to us?
They are crap and not presenting anything like the whole story.
Doesn't the government issue more bonds to pay back the principal on maturing bonds like a giant Ponzi scheme? If bonds don't finance public spending, why bother issuing them? And don't bond market interest rates cause the government problems if they rise as they're already paying back over £100bn p.a.
Bonds are the safest place to "Park" your money. In many instances, the government is simply rolling-over the bond at maturity because that is what the bond holder wants. In the USA this is very true for Federal Treasury Securities but is NOT always true for state and local municipal bonds. Some municipal bonds cannot be rolled over but at maturity you may invest in a new and different municipal bond if you choose to do so.
I explain why they are issued in the View From article I link. Is this a Ponzi scheme? No. It is like having a rolling series of bank bonds - which all banks and building societies do.
Thanks. I'm loving these infographics. I wonder if you could explain 'yield' as introduced in 4. I assume it's interest rate, but isn't that the 'coupon'?
What place would bonds have in an economy based on the principles of Modern Monetary Theory?
Brilliant explanation. Thank you.
Like it Richard, I'm nearly understanding this at last! One thing I need help with. The convention is that government spending needs to be exactly balanced by tax and sale of bonds. This didn't happen during Covid, and the world didn't seem to end. What would happen if bonds weren't sold to cover "the deficit"? In other words, could the government spend without (in conventional parlance) borrowing the amount to cover the difference between tax and spend?
Yes, because the money "borrowed" (actually deposited) was created by spending in the first place. See today's infographic on tax.
Thanks for doing these graphics Richard.
Is there a psychological reason why humans have come up with something so complicated?
I have a science degree and quantum physics sounds easier to understand.
Could you provide a worked example of some bonds. Lets see if I've got this.
Say if I had a finance company and I bought £1000 of bonds that mature at 5 years, with an interest rate of 4%. After 5 years I get my £1000 back + 5 years worth of interest at 4%. 1% is £10, so that is £40 in year one, £41.60 in year 2; £43.26 in year 3, £44.99 in year 4; £46.79 in year 5. So I walk away with £1216.64.
So where does the bond issuer get the extra £216.64 from? From other bonds that have been issued in the interim? Or somewhere else? If it is the former, that's a ponzi scheme?
The interest rate is paid annually, so it would be £40 a year.
Where does that money come from? A company pays it out of income. The government creates the money via the Bank of England, as it does for all its spending.
"The government creates the money via the Bank of England"
As someone trained in physics, well, materials science, this is a fundamental mental stumbling block. You cannot create something out of nothing, that is one of the essential laws of the universe. If something is being created out of nothing, then that literally is magic, or a sleight of hand, or a faith or belief at work.
I mean, I know physical coins and notes exist, but it is stated that these only represent 3% of actual money in circulation at any one time. The rest being electrons in many sets of computers.
It might be worth doing a graphic on how a government creates money out of nothing.
Does an economic minister literally ring up their national bank and just order a few millions? Perhaps several times a day? Or is there some kind of quasi-legal basis where forms are filled in and experts agree that it can go ahead?
"If something is being created out of nothing, then that literally is magic, or a sleight of hand, or a faith or belief at work." Belief & faith are both right - remember, it's called 'fiat' currency as opposed, to say, commodity-backed currency. Also there's the fact Government demands taxes be paid in the national currency which serves to give it value as people know they'll need some come tax time.
"So where does the bond issuer get the extra £216.64 from?"
Is it from compounded interest starting with a different bond principal in year two???
See Richard's note above, I assumed incorrectly that it would be compound interest accumulated. Instead it's just a £40 per annum flat payment in this particular example.
But yes, the question still is, where would the £40 come from? From Richard's comment, the government creates it.
Then I'm guessing now I've got my bonds I can go to another financial company and say, look, I've got this guaranteed income in 5 years, lend me £1200 and I'll pay you back in 5 years with your interest. I get my £1200 loan/overdraft and buy more bonds, or invest in some other shares that might provide greater than the interest rate of the loan. Then with those loans and bonds I blag even more loans from other financial institutions.
Magnify all that by millions of such transactions per hour and you have the world financial market described in one go?
Or, in the case of quoted bonds, you could just sell the bond you own and buy something else.