The Private Sector Doesn’t Create Money – It Just Shuffles It Around
Learn Modern Monetary Theory (MMT): Debunking the orthodox myth that public services rely on private sector 'wealth creation'
Shuffling the Deck: Why Private Business Can’t Create New Money
“Your taxes don’t actually pay for anything, at least not at the federal level. The government doesn’t need our money. ” Kelton, Stephanie. The Deficit Myth.
My aim in this short article is to debunk an idea that is at the heart of orthodox economics: that the private sector generates the financial resources required to fund public sector spending.
The truth is a little uncomfortable for our politicians and the economists who advise them: private businesses, taken together, do not create any net new financial assets for the private sector as a whole.
Yes, they create output and income. And yes, they pay wages, receive revenue and make profits. And yes, they create huge wealth for some individuals and businesses. And yes, that intuitively feels like the creation of new financial assets, but in practice, what is happening is much simpler.
They are merely shuffling existing private sector assets around - or if you prefer - they are redistributing them within the sector.
Think of it this way. If I give you £100 to paint my front room, that £100 is transferred from my bank account to yours. You are now up £100 and I’m down £100.
You spend £50 on a new kettle, and £50 on a monthly subscription to a local health club. You are now down £100 and the shop and the health club are up £50. And so on.
It is clear that what is happening in this process is that money is changing hands. However, at no point does the money grow: if you think it does, you are thinking of a pot plant, not a financial asset.
And now you are thinking I’m wrong because your stock market investments have grown (assuming you have any) – but in reality, when you cash them in, that money is just a transfer from one investor to another.
And from the point of view of physics, even the pot plant doesn’t create something new - it transforms water, sun and nutrients, into leaves, roots and flowers.
So, to put it plainly, what private sector businesses are not doing is creating new net money for the sector as a whole.
A Sectoral Balances Perspective Makes the Logic Clear
Looking at the economy through the sectoral balances lens makes the logic of my argument clear: the private sector can only increase its net financial assets if one or both of the following is true:
The government spends more than it taxes.
The private sector earns from abroad.
Apart from these two exogenous sources, when a business makes a profit, it is, for the private sector as a whole, just money moving from one private sector entity to another; it does not increase the sector’s net financial assets.
The government doesn’t need your money it needs your resources
“In aggregate, there can be no net savings of financial assets of the non-government sector without cumulative government deficit spending. The government, as the currency monopolist, is the only entity that can provide the non-government sector with net financial assets.” Professor Bill Mitchell
When the public sector needs to build a new hospital, new bridge, new energy plant, or to find the money to pay pensions, pay school teachers, or tackle climate change, the money it spends does not come from a big pile of taxes provided by the private sector.
Regular readers will intuitively know where I’m going with this: I’m reminding orthodox economists that there are two types of government, currency users and currency issuers, and governments like the UK and the US are currency issuers.
And luckily for all consumers of public services, currency issuers are not bound by the same limits as the private sector.
A government that issues its own currency can pay for these projects directly, adding new money to the private sector in the process when it deficit spends. The limiting factor is the availability of resources to be purchased in that currency.
It’s not your money the government needs - it’s your resources: the materials to build those hospitals and bridges, the energy capacity, the infrastructure, and the human labour required to make it all function.
In short, the government can always provide the financial means; it’s the physical and human capacity that sets the limits.
Note that in the UK, Scotland, Northern Ireland and Wales are all currency users, while the central government at Westminster is the currency issuer. Similarly, in the US, the individual states are currency users, while the federal government is the currency issuer.
If you have any questions or if you disagree with anything I write, I want to hear from you. Please add your comments in the discussion area. Contrary views are welcome.
In Conclusion: The Private Sector Can’t Fund Public Services – So Who Pays?
“The new perspective also debunks as a myth the notion that “the taxpayer” finances government spending. Since the government is always creating new money as it spends, tax payments do not serve to finance it. (Dirk Ehnts, Modern Money Theory: A Simple Guide to the Monetary System, p.11)
It is the currency issuer who pays, by depositing its currency into bank accounts.
And in fact - and I know this is hard to swallow for orthodox economists wedded to the primacy of the private sector; it was actually the currency issuer, via the invention of government taxes, that made modern markets - as we know them - possible.
It is the government that provides the financial framework that allows money to move through ‘the various pipes’ within the economy, i.e. the central bank, the legal frameworks, the market regulations, the primary bond markets and so on.
It is the government that provides the infrastructure that private businesses rely on: roads, railways, the public education system, public health and so on.
And it was hundreds of years of fiscal deficits that have ensured the economy has never run out of money or permanently ground to a halt.
And of course it is the government that provides the (net) currency that flows through the economy. We know that private sector individuals and businesses - other than banks which are essentially agents of the central bank - are not allowed to issue the national currency.
And yes, banks can issue loans simply by typing figures into customers’ accounts, but those are loans that need to be paid back. In ‘techy’ speak, loans create matching liabilities, they do not create net new financial assets for the private sector as a whole.
It is entirely wrong, therefore, to say that the government relies on the private sector for its money, when it is clearly the other way around.
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But what about all those wealthy individuals - surely they pay their taxes and that helps?
It’s a different topic, but it would be remiss of me not to point out that some of those agents within the private sector accumulate a lot more of the available financial assets than others, creating huge disparities in financial wealth, with all the attendant problems that creates.
But accumulating money is not the same as generating net new money. It does, however, mean there is less ‘spending money’ available for day-to-day transactions.
And that has implications: one of which is reduced aggregate demand, which can lead to reduced business activity and unemployment.
We know that the wealthy spend a lower percentage of their income than those less well off: so the inequality of financial assets can also have a negative impact on growth and the business cycle.
And again, as we know – governments have a tendency to pander to the most wealthy - on the basis that they ‘need their taxes’.
That’s wrong on two counts: firstly, they don’t need their money and secondly, they may not be having such a positive impact on the economy they think they are.
The takeaway from this article is simple: private businesses move money around, generate profits, and pay wages - they don’t create net new financial assets in the private sector.
And contrary to the orthodox economics story: they don’t pay for public services via their tax contribution - except in the sense that taxation is part of the ‘origin story’, where the government sets a tax to acquire the resources it needs.
If we need net new financial assets to enter the economy, they do not come from private sector businesses - they come from the currency-issuing government.
Or they come from UK currency earned from the foreign sector, which logic tells us was also money previously issued by the government. Why? Because only the UK Government can issue the UK pound – even pounds earned from the foreign sector were originally issued by the government.
That’s all for now. if you disagree with anything I write, I want to hear from you. Please add your comments in the discussion area. Contrary views are welcome.
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Resources
The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy - Kelton, Stephanie
When two original MMT developers get together to discuss their work - Professor Bill Mitchell
Modern Money Theory: A Simple Guide to the Monetary System - Dirk Ehnts
Links to some of my most popular newsletters
My MMT Top Ten: Modern Monetary Theory’s Best Ideas Explained
Important Figures in the Development of MMT: Abba P. Lerner ‘Functional Finance’ - Jim Byrne
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MMT Factsheet 3: If Taxes Are Not For Spending What Are They For?
Another excellent article but I have a small correction: it is the workers who create wealth, the corporations just steal it.
Another great reminder on how sovereign fiat currency systems actually work. The government issues the money and the rest of us use it. It does not need our taxed income to fund its spending since the government creates it upon authorized spending. As Richard Murphy pointed out "There is no such thing as taxpayers' money. There is only government created money. And public money is society's money".
If only this simple fact would trickle down to the politicians, orthodox economists, the media and the general public. 'Finding the money' would no longer be a mystery and austerity would disappear.