If the reader has been following the series from the start, the idea, that a currency-issuing Government needs to borrow, is ludicrous. In this economic era of fiat currency, Governments create money as they spend and delete when they tax. There is no need for a currency-issuer to borrow its own currency, ever.
There was a time, however, when this was a legitimate tool in the nation’s economic tool box. The UK, and many other nations, set artificial restrictions on the money supply at various times, by pegging, (fixing) the value of the currency to the value of a commodity, such as gold or silver or to another currency.
Although the Government’s ability to create the currency they issue, is infinite, the commodity is not, and this sets a limit on the amount of currency that can be in circulation at any one time. The result is that the gold or silver has to be in the Government’s possession before it spends, or the currency would be in danger of depreciating in value. In the extreme case, a ‘run’ on the currency could force bankruptcy.
When a currency is pegged to a commodity, such as gold, it is theoretically possible for a member of the public to take a £20 note to the bank and demand it is exchanged for gold. This promise to pay in gold was actually printed on the note. This ‘backed’ the currency, giving it a physical value, but, of course, any Government can only hold and hoard so much of the world’s finite gold reserves.
A run on the currency is the term that refers to the process whereby the Government spends more than the gold reserves allow, resulting in investors losing faith in the currency and demanding to exchange their wealth into gold. If enough citizens and businesses demand gold, and the government has overspent currency into the economy, the gold reserves could run out and the government would be insolvent.
To alleviate this pressure and provide more fiscal space, Governments devised the bond system. The Government offered Government bonds that were not convertible to gold, but did pay an attractive level of interest, to encourage savers and institutions to exchange their cash, convertible to gold but non-interest paying, into these bonds (gilts in the UK).
The Government would take the cash from the saver, for a set period of time, draining currency from the money supply, and protecting the gold supply. In return the government would provide a 6 monthly interest payment to the investor and a lump sum repayment at the end of the term.
The UK came off the gold standard, domestically, in the 1930’s, and so, ended the ability of a member of the public demanding gold at the bank counter. However, at the international level, the gold standard continued for a long time after that, with short breaks during the wars.
After WWll, a meeting took place at The Mount Washington Resort, Bretton Woods, New Hampshire, where the allied countries resolved to peg their national currencies to the US$. The US$ would in turn, be pegged to the value of gold. This effectively pegged most of the worlds’ leading economies to the value of gold. The ‘gold standard’, as it was called, remained in place, until 1971, when President Nixon announced that the US was breaking the agreement.
Many countries, the UK included, retained the peg to the $ for a period, but eventually left the peg altogether to become a truly fiat currency. Considering the seismic change in economic potential, very little has changed in text books and political rhetoric to advise economic students or the public of the implications of the fiat economy.
With no restriction on spending limits, it is now only the amount and quality of resources available, that are the measure of the Government potential to provision itself and thus, the national wealth. This includes all labour, technology, natural resources, productive output and imports that are available to buy with the national currency.
The measure of spending is inflation. If inflation starts to rise, that is, prices start to rise continuously, then that is a sign that the Government is spending too much and must either cut back spending or increase taxation. If there is involuntary unemployment, this is a sign that government spending is too low and that Government requires to spend more into the economy or tax less.
A currency-issuing Government does not need to borrow the currency it creates. This is merely a myth to promote the scarcity narrative. It allows the ‘household analogy’ framing of the Government having to ‘tighten its belt’ or worry about ‘maxing out the credit card’, and justifies cutting essential public services and privatisation. The Government can create all the currency it needs, to buy whatever is necessary and available, for the benefit of the population.