A five-pound note carries the words: “I promise to pay the bearer on demand the sum of five pounds”, signed by the cashier of the Bank of England. Until 1931 (though with breaks around wars), you could take a five-pound note to the Bank of England and get the equivalent value in gold.
Now, all the Bank of England will “pay the bearer on demand” is... another five-pound note. Money, in Britain as in other countries, is a system of never-paid-off IOUs from the government (or rather from the central bank linked to the government). Those IOUs function as universal equivalent because of laws saying that they can validly discharge any debt and because they represent an aliquot of future British labour time.
So why then do governments run another system of IOUs — bonds (repayable after periods of over one year, commonly after 10 years) and bills (repayable after periods shorter than one year) — on which they have to pay interest?
If they run short of cash, why don’t they just print, or get their central banks to print, more banknote-type IOUs, instead of issuing more bonds or bills? Why do they sell bond-IOUs in order only to get back their own (banknote) IOUs?
And why do they run such big debts? Often governments run debts as big or bigger than the country’s annual gross domestic product, so maybe about three times as big as the government’s annual revenue.
Households sometimes run big debts to buy houses. But they do that with a view to paying off the debt over a time, usually 25 years. And until they have paid off the debt, the bank or whoever else has lent the money remains the owner of the house, and can repossess it.
Government debts are different. Bondholders have no claim over the government’s buildings, land, or other physical assets. And the government borrows, not in order to acquire any particular new physical asset, but generally just to help cover current spending.
The system of national debt originates with wars, and decisively with the War of the Spanish Succession (1702-1713) which “encumbered each power with unprecedented amounts of accumulated debts — debts that formed the eventual basis for national debts as we know them today” .
For a long time some politicians, and then numerous cranks, talked wistfully of “paying off the national debt”. But governments never got close to that. Burgeoning capitalism found that the national debt, and the system of financial markets built on it as a baseline, suited it very well.
The system of national debt means that firms and financiers can readily convert spare cash into a “fictitious” form of capital (wealth which yields income), and just as readily convert it back again. Nothing else in the financial markets does quite the same trick of quick-change between cash and capital.
In universities these days, business management students are instructed that government bonds, in greater or lesser (or sometimes, by arcane financial manipulation, negative) quantities, are an essential element of every “portfolio” of wealth. Government bonds are an essential lubricant of financial markets.
Far from being an unnecessary addition to cash (banknote-IOUs), bonds (time-limited, interest-bearing IOUs) are central to the way that new cash gets into the economic system. When the Bank of England wants to pump more cash into the system, it goes onto the financial markets and buys up government bonds. Very occasionally, it does “quantitative easing” — buying up other sorts of interest-bearing paper, and thus replacing them in circulation by cash. When it wants to reduce the stock of cash in circulation, it sells government bonds from its stock.
National debt ties governments tightly yet unobtrusively, almost automatically, to the interests of the bondholders, which these days are mostly banks and financial firms operating in the global markets.
The Cameron government’s bluster about “paying off the debt” is nonsense. No capitalist government pays off its debt; it only pays off old IOUs and replaces them by new ones. The British government sells new bonds almost every week. All the government even claims is to reduce the deficit — the rate at which the government debt increases.
There are good and reasonable arguments, within the logic of capitalist economic management, that the Cameron government’s aimed-for deficit reduction is too fast and too soon, and in any case may backfire. If a government tries to reduce its deficit too quickly, by cutting its expenditure, then it increases unemployment and depresses households’ and firms’ spending. It cuts its own tax revenues, and so the deficit-reduction drive may well produce an increase in the deficit.
Government debt is an integral part of capitalism, and operates to serve the interests of the rich. When the rich suddenly raise an outcry about the debt being excessive, or needing to be reduced soon or fast, they have some other motive than financial prudence.
Karl Marx on government debt
“[With the] national debt... a negative quantity appears as capital — just as interest-bearing capital, in general, is the fountainhead of all manner of insane forms, so that debts, for instance, can appear to the banker as commodities...
“The system of public credit, i.e., of national debts, whose origin we discover in Genoa and Venice as early as the Middle Ages, took possession of Europe generally during the manufacturing period... National debt, i.e., the alienation of the state — whether despotic, constitutional or republican — marked with its stamp the capitalistic era. The only part of the so-called national wealth that actually enters into the collective possessions of modern peoples is their national debt...
“The public debt becomes one of the most powerful levers of primitive accumulation. As with the stroke of an enchanter’s wand, it endows barren money with the power of breeding and thus turns it into capital, without the necessity of its exposing itself to the troubles and risks inseparable from its employment in industry or even in usury. The state creditors actually give nothing away, for the sum lent is transformed into public bonds, easily negotiable, which go on functioning in their hands just as so much hard cash would.
“But further, apart from the class of lazy annuitants thus created, and from the improvised wealth of the financiers, middlemen between the government and the nation — as also apart from the tax-farmers, merchants, private manufacturers, to whom a good part of every national loan renders the service of a capital fallen from heaven — the national debt has given rise to joint-stock companies, to dealings in negotiable effects of all kinds, and to agiotage, in a word to stock-exchange gambling and the modern bankocracy...
“With the national debt arose an international credit system...
“As the national debt finds its support in the public revenue, which must cover the yearly payments for interest, etc., the modern system of taxation was the necessary complement of the system of national loans. The loans enable the government to meet extraordinary expenses, without the tax-payers feeling it immediately, but they necessitate, as a consequence, increased taxes. On the other hand, the raising of taxation caused by the accumulation of debts contracted one after another, compels the government always to have recourse to new loans for new extraordinary expenses...”
[Capital vol. 3 (first para), and vol. 1 (remainder)]
“A large, liquid market in government debt [i.e. a market so active that every buyer can find sellers, and every seller can find buyers], with a central bank at its core, is the base of modern financial systems.
“Central banks manage their domestic money supply through the purchase and sale of official paper, and historically government borrowers have usually been at the vanguard of the development of a national financial system...
“Practically speaking, interest rates on public debts act as a benchmark for the rest of the credit system; interest rates for borrowers other than a central government — state and local governments, households, corporations — are usually set in reference to government rates at the same maturity. Markets in general seem to need benchmarks like this...
“Public paper [i.e. debt, or bonds, the bits of paper which certify you hold government debt] is a nice mechanism for profit making and income redistribution. It provides rich underwriting and trading profits for investment bankers and interest income for individual and institutional rentiers, courtesy of nonrich taxpayers... Instead of taxing rich people, governments borrow from them, and pay them interest for the privilege...
“Government debt not only promotes the development of a central national capital market, it promotes the development of a world capital market as well. Short-term paper like treasury bills — places that investors can park short-term cash — is important for a currency’s admission to world markets...
“Modern versions [of financial markets] took shape first in Amsterdam in the 17th century and then in London in the 18th, with the growth of government debt and corporate shares. Free-market ideology to the contrary, the role of government debt in the development of finance can’t be exaggerated... What was being established were markets to claims to future income — fictitious capital, in Marx’s famous phrase... This enables a whole class to own an economy’s productive assets, rather than being bound to a specific property as they once were.
“The transformation of a future stream of dividend or interest payments into an easily tradeable capital asset is the founding principle of all financial markets...”
[Doug Henwood, Wall Street]