UK Government ‘spending’ is really money creation. Here's why

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FOR anyone flicking through online comments about the Scottish economy or listening to opposition MSPs in Holyrood, you will be familiar with some form of the following question: “Where does all the money come from to pay for the ‘free’ things in Scotland?”

The context is that the Scottish Government provides certain free services unavailable in the rest of the UK, for example, the baby box, prescriptions, and university tuition fees. That question really has two parts: where does the money come from in Scotland? And why are these things not free in the rest of the UK?

The best place to start to answer that question is at the top of what is known as the “hierarchy of money”. This is where you find government-created money.

The UK Government is the monopoly supplier of government money in the UK, and as a currency-issuing government, it creates money daily.

Creating brand new digital currency is how the UK Government provisions itself. This digital money enters the real economy via the reserve balance accounts of commercial banks at the Bank of England (above). The currency that enters the bank accounts of, for example, an NHS nurse or a construction firm providing a service to the government, doesn’t come from taxes or from the sale of government bonds. It is brand-new money.

Last year, researchers at UCL conducted the first-ever in-depth analysis of UK Government expenditure, revenue collection, and debt issuance operations. “Government ‘spending’ should be understood as a form of money creation,” they said.

“This conflicts with the commonly understood idea that government spending is financed through taxation or borrowing,” they added, realising they were countering the conventional wisdom.

All UK Government spending is a form of money creation

Like all forms of currency, money created by the UK Government has no use value at all. It is simply some bytes of information in a spreadsheet, and even when withdrawn as a physical currency, it has little use value.

But it has exchange value. And that exchange value is represented by a number on the note or in the cell of the spreadsheet.

That nurse gives up 40 hours of her valuable time in exchange for currency from the government. The construction firm provides steel girders in exchange for the money created, for free, by the government. In sum, the government receives real resources in exchange for its currency. It creates money and then spends it.

READ MORE: Why GDP doesn't work, and what Scotland should replace it with

This monetary system of real resources in exchange for currency is at the heart of the economy in every currency-issuing country in the world. This is, in essence, how the UK Government controls the economy. It creates money and then spends it.

Only a currency-issuing government like the UK can do this; a currency-using government like Scotland’s cannot create money. It can only spend what it takes directly from the Scottish economy in tax, or what funds are returned to Scotland via the UK Treasury.

This relationship with a currency-issuing central government only works if people need the currency units created. And, of course, they do.

They use it in exchange for goods and services. They decide to store some of it in the hope that it will create even more units. And, crucially, they need it to pay their taxes – a currency-issuing government only accepts tax payments in its own currency.

The conventional wisdom states that the government needs our money. As the UCL team outlined, that is not true. It is, in fact, the other way around: the government requires us to need its money.

If we don’t require government money, the government cannot control the economy We must trust the government to manage this complicated system for this to work. We need faith that the government will keep prices under control so we can plan our spending and saving. We must know that everyone has the same level of trust in that government money as we do so that we can always exchange it for the things we need.

READ MORE: Top US professor issues currency advice to SNP for independent Scotland

In The Finance Franchise, Cornell Law Professor Bob Hockett and his co-author Saule Omarova say all money is “the flow of public full faith and credit throughout the financial system”. This full faith is a display of trust. This is what really matters.

All forms of money are underpinned by trust in the currency-issuing government, and at the top is the most powerful money in the UK, created by the Bank of England on behalf of the UK Government.

In challenging the conventional wisdom so directly, we note that this short description of UK Government finance probably creates more questions than answers. If so, the most important question should surely be: why isn’t the UK Government paying for more universal services?

If Scotland can do this as a currency user, why can’t a more powerful government – that can create currency out of nowhere – not pay for these things as well?

The answer is that it chooses not to. That is an uncomfortable fact that few of the people asking where the money comes from are willing to accept.

Has this or any of our other articles raised more questions than answers this month? Join us for a live Q&A on Wednesday, 31st May, at 230pm BST to give us your thoughts on the economy as a subsystem of the ecosystem, what degrowth and a steady state economy look like and how UK Government spending is a form of money creation.