Escaping the bonds of bonds

The world has passed a tipping point and we can no longer see bond markets as facilitating democracy. They are an active threat to democracy and we need to disempower them.

Sometimes something happens in politics and everyone goes 'yeah, you see!' and I look at it and I say 'yeah, I see!' - and we're meaning completely different things. That is what happened when Andy Burnham said that democracies shouldn't be kicked around by bond markets and the bond markets increased the borrowing costs for Britain.

The Starmerites were utterly besides themselves – see! see! they shouted. And I'm thinking 'yes, yes I do'. Because surely it proves Burnham was right. Surely it proves that unaccountable foreign financial markets shouldn't be deciding what we can and can't do in a democracy?

Here is the question though; even if he is right, what can anyone do about it? If the bond markets have all the money and government needs money, doesn't that mean that it is natural for bond markets to set the terms? Well, it depends what you mean by 'money'...

There is a simple way out of this. It isn't complicated, it isn't abnormal and it isn't really radical. Yet it isn't discussed – only borrow domestically. In this piece I'll explain what that means, how it would work and how we could do it in an independent Scotland.

(First, a very quick note: I used to advocate a fairly orthodox approach to monetary policy if Scotland was independent partly because playing the game would help stabilise things in the early years. That ship has sailed; there is no stability in global finance now.)

So what does the alternative look like? To get to this, a very quick primer on how money actually works in the real economy (many of you will know this). The It's a Wonderful Life version of money is nonsense. Money isn't a finite resource where you have to find it and put it together in a big lump if you want to lend it to someone (as per Bedford Falls...).

That world ended a good while ago. Now money is just a complex system of IOUs underpinned by a central bank which is able to print money. When someone gets a bank loan, the money that appears in their account literally comes from nowhere. It is not money someone else already had which they are giving to you, it is completely new money.

But how can all the banks create new money all the time without hyper inflation? Because the money is destroyed again. As the person who took out the loan repays it, the bank doesn't keep the money, it just reduces that notional IOU which was created in the first place. The bank only keeps the interest.

And only a fraction of the money which is lent out is kept as emergency reserves in case anything goes wrong. That is what is known as fractional reserve banking – banks only keep a fraction of the reserves needed to actually bail out loans.

Money isn't a thing that circulates. It's much more accurate to think of it as something which is created and destroyed, and that it is created and destroyed in a balance which keeps the money system stable, liquidity solid but not too high (enough money to go round, but not too much) and inflation under control.

Get the idea? Great. So how do bond markets work? It is not at all dissimilar. An investor buys a bond from the government. This is basically an IOU. That is known as 'the principal'. Generally, no-one is actually going to spend the principal because you have to give that all back in one go at the end of the agreement period (or 'when the bond matures').

So what you do is stick it in your foreign currency reserves where you keep it as an asset. This is ideally left alone for the whole time it is there but can be used in all the normal ways a foreign currency reserve can be used if need be. It just sits there.

But where is the money to pay the bills the government borrowed the money to pay? If it's stuck in the foreign currency reserve, who is paying nurses' wages? The answer is the central bank. It creates money equal to the sum borrowed and as the principal sits in the currency reserve doing nothing it is the created money that actually circulates in the system.

And if money is created it must be destroyed again, and it is. Interest payments and tax are both ways to destroy money. That's what happens. The new money created disappears over time and by the time the principal is returned to the bond market it has all gone again. The loan is repaid, the cash injection it represented has disappeared.

All that happened is that future wealth was pulled forward in time by borrowing it before it was earned. The system stayed in equilibrium over the course of the agreement. That's how government can borrow money and not set inflation racing.

“The world is being turned into a billionaire-run hell-hole and we need to be able to escape them”

OK, as long as you accept that that is all greatly simplified, let me ask you a question – what is the point of the principal? It never at any point goes anywhere near the actual domestic economy and it doesn't really go anywhere else either. It literally just sits there. It's not even really insurance because you've sort of duplicated the money and that is already circulating.

Think for a second; what if you did all of that but without the bond sale? What would be different? If government had just borrowed the money directly from the central bank, the bank had created the money and then over the course of the loan the money was destroyed again, what would actually be any different?

Technically nothing. The argument is that the bond markets bring discipline, prevent governments from irresponsible borrowing they can't afford by assessing the trustworthiness of the nation at that particularly moment and setting borrowing rates accordingly. But that's notional. As we saw with the Andy Burnham instance, bond markets can charge you higher interest at a whim.

What they are doing is not disciplining you but looking after their own interests. That is what is meant by 'bond vigilante'. These are literally people who are using the buying and selling of bonds to punish governments for not doing what the rich person (or institution) wants.

The UK's debt didn't get bigger when Burnham spoke, and our economy didn't change. The bond markets just wanted him to shut up and not blow the whistle on this whole scam so they could keep controlling democracies around the world.

So this is my fairly simple proposal; an independent Scotland should create a constitutional bar on bond issue to overseas investors. There is no need. The rule should simply be that on an annual basis, government borrows directly from the central bank. The bank does exactly what it currently does but without the principal being involved.

The argument against this is 'market discipline' and moral hazard. This is what is going on with Trump and the Federal Reserve (the US central bank). He wants them to goose the economy by cutting interests rates and he's not really bothered that inflation is climbing in the US and this will come to harm consumers as much as help them. But he doesn't care. He is a short-term kind of guy.

So how do you stop governments from being irresponsible? The answer is central bank independence. This is a thorny subject. I've been tending towards not having central bank independence of late precisely because independent central banks are unfortunately too much like bond markets – they discipline government all right but they do it in the interests of money, not citizens.

However, you can't let politicians set their own interest rates. Well, actually, I favour returning interest rate setting to government, but most certainly not their own interest rate, the rate at which they borrow. So I'd have an independent panel at Scotland's central bank which set the rate at which government could borrow.

That would create the discipline. There is so much that tumbles out from this. For example, if market conditions are right, it is perfectly possible to destroy debt too. You can destroy money through tax and interest, but you can destroy debt by writing it off (which is a little bit like a cash injection into the economy).

It stimulates the economy by decreasing debt, not increasing it. That's better for the nation because its debts fall. And if you haven't registered, all those interest payments become public money. Rather than bond investors making all the profit, citizens do. You don't want that money going straight to government (or it's not interest...), but it can be used for other purposes.

Perhaps it could be part of a Citizens’ Income. It could be used to purchase foreign currency and build up the currency reserves. It could be given to the Scottish National Investment Bank as reserve capital. In fact, I've been thinking about this a lot and I can see no reason on earth why the Investment Bank shouldn't capitalise in the same way as government – borrow from the central bank.

The assumption is that if SNIB was a proper bank it would issue bonds and use the capital as reserves to underpin its loans. But for exactly the same reason as above, that is an optional process. If it was borrowed from the central bank the result would be more or less identical.

Those two steps – secure, domestic government borrowing at interests rates that suit the Scottish economy, not the global financiers, and a capitalised major investment bank to ensure that the business sector can always access capital – can be added to a national, mutual banking network that is pure savings and loan and has no speculative wing.

That would create a Scottish monetary system which did everything the existing monetary system does and would do it in more or less the same way, but using sovereign debt and domestic markets instead of foreign capital and privatised banks operating in global markets. It would make Scotland secure.

We need to opt out of a lot of the post-1990 architecture of global finance, capital and digital infrastructure. That is my dominant thinking at the moment. The world is being turned into a billionaire-run hell-hole and we need to be able to escape them. There is no normal any more. It's becoming a fight for survival.

It is no longer possible to beat them at their own game. We need a new game. Thankfully, when it comes to financing government, the solution isn’t really tricky at all.