A Simple Modern Money Tale – Buckwell Island Establishes a Currency

At one time or another many of us have probably pondered questions such as: Where does a national currency come from? How does a currency system basically work? Why might people agree to accept a national currency in the first place? How can we be confident that a national currency won’t collapse and that people will continue to accept it in economic transactions? Can a government ever go broke and leave citizens footing the bill? Can financial affordability even be an issue for government?

The answers to these questions depend, above all, on whether the government in question is a currency issuer or a mere currency user. The simple tale traced below illustrates some basic aspects of a society in which government issues its own currency. It is important to understand that the illustration does not apply to governments that use a currency issued by some other entity. For example, it does not apply to a state or local government that is required to transact in a currency issued by its national government. Such governments are mere currency users, much like households and private businesses. They do not issue their own currencies. Equally, the illustration does not apply to a national government that has given up its prerogative to issue a currency and has instead agreed to use what is essentially a foreign currency. This is currently the predicament of those European governments who have committed to using the euro. At least for now, such governments have reduced themselves to the status of mere currency users. If, at some point in the future, these European governments decide to go off the euro and reintroduce their own currencies, the following illustration will then become applicable to them, but not until then.

Most national governments, however, do issue their own currencies. This is true of the national governments of countries such as China, the US, Russia, the UK, Japan, Brazil, India and too many others to mention.

To illustrate in very simple terms the position of such governments and the nature of their currencies, consider Buckwell Island. It is an imaginary island. Its people have just voted to form a nation. Elected representatives from each region of the island have gathered to discuss some basic needs of the new nation.

After much discussion and consultation it is agreed that there need to be some common rules governing access to natural resources, ownership or stewardship of property, and the conduct of business activities. It is decided that the newly formed government will need to see to the effective defense of the island and develop key public services in education, child and aged care, health care and civil administration as well as build or oversee the building of roads, a public transport system and a modern communications network. All this will take time and much effort.

The island government realizes that it will need to hire some people to perform roles in the public sector. It also needs a way for private sector activity to be integrated into the economy. To this end, it decides to introduce a national currency called the ‘buck’.

The currency is established in two basic steps:

First, the government officials return to their local electorates and announce that all citizens of at least working age will be required to pay taxes. A tax authority will be established to monitor and enforce payment. Significantly, it is specified that all taxes and other government charges will have to be paid in bucks. No other currency or item will be accepted. In addition, all income and wealth generated on the island will be evaluated in bucks, with taxes imposed accordingly. Court settlements will also be specified in bucks.

Since people require an income, and since income and wealth will be evaluated in bucks and subject to tax, this first step in establishing a national currency creates a need within the community for its members to earn or otherwise obtain bucks.

The effect of this first step is to ensure at least some demand for the currency. Since people need bucks to pay taxes and other government charges, they will accept the currency in payment for goods and services that they are able and willing to supply either to government or to fellow Buckwellians.

With a basic demand for the currency now created, the second step in establishing the currency is for the government to open up various channels through which members of the community can actually get hold of the currency. In partial fulfillment of this objective, nominated government representatives release a list of public sector job positions. It is announced that there will be jobs for teachers, health practitioners, administrators, police officers, defense and peacekeeping forces and other important roles. Suitable applicants are free to apply for these jobs. If successful, they will be paid in bucks.

The officials also announce a list of goods and services that the government would like to purchase from private businesses. This opens up opportunities for prospective businesses to sell output to a large customer (the government). To obtain finance, competing businesses will be able to approach a newly established public bank for loans. These loans will be issued in bucks. In time, private banks may also be permitted to operate. For now it is left as a future question for the voters to decide.

The effect of these measures is to ensure that citizens can get hold of the currency. Some people will accept a job offer from the government to work in the public sector. Business operators, financed at least initially by public loans, will be able to start production and sell their products or services to customers, generating revenues in bucks. The rest of the working-age population will be able to seek employment in the private sector in exchange for bucks.

The government also announces a Job Guarantee program. Anyone who cannot find a job elsewhere can accept a job-guarantee position financed by government and administered by local government or perhaps community organizations. Those who are unable to work due to age or sickness will receive a pension paid by government.

With these policies in place, everyone can get hold of bucks. They will be obtained either as newly issued currency when the government spends, pays pensions or lends, or as circulating currency when households or businesses make payments with bucks yet to be extinguished by taxation.

To facilitate economic activity as well as saving, citizens are granted the right to hold accounts at the public bank. Payments for goods and services can be made through the direct debiting and crediting of bank accounts or the exchange of hard currency.

To summarize, there is a basic two-step logic involved in Buckwell Island’s introduction of a currency. First, by requiring taxes and similar charges to be paid in bucks, the government ensures that people are willing to accept the currency. This step ensures at least some demand for bucks since people need them, at minimum, to pay taxes. Second, the currency is issued. The government issues bucks by hiring workers, providing pensions, extending loans to businesses and purchasing some of their output.

It may be noticed that it would be impossible for anyone to pay taxes before the currency had actually been issued. Until government spent on goods and services, or paid pensions, or the public bank lent, there would be no way for anyone to obtain bucks. An implication is that government spending and public lending are logically prior to the payment of taxes. The government’s spending and lending are not constrained by the amount of taxes paid in the past. To the contrary, the capacity of citizens to pay taxes originates from government spending and lending. A currency-issuing government, such as Buckwell Island’s government, can always afford to purchase whatever is available for sale in its own currency. In other words, if something has a sale price in bucks, the island government can always afford to purchase it, since it is the sole issuer of bucks.

A system of accounting and basic bookkeeping is put in place with the aid of spreadsheets maintained by the public bank. Whenever the government decides to spend or lend bucks, the public bank types in the appropriate new numbers in its spreadsheets. If the government pays 100 bucks for office stationary, the public bank marks up the account of the stationary supplier by that amount. The new deposit will be an asset of the stationary supplier and a liability of government.

The stationary supplier is one entity in what can be called the non-government sector. This sector includes all households and private businesses on the island as well as any foreigners making transactions in bucks.

When the government spends 100 bucks on office supplies, the financial assets of the non-government sector, taken as a whole, increase by the same amount. This increase in non-government financial assets is offset exactly by an increase in government liabilities of the same amount. In this way, bucks (which are government liabilities and non-government assets) are created out of nothing.

Conversely, when the stationary supplier pays perhaps 30 bucks in tax, this amount is subtracted from its bank account. This action destroys 30 bucks. They no longer exist. The stationary supplier’s assets go down by 30 bucks as do government liabilities. As a whole, the financial assets of the non-government sector decrease by this amount, as do outstanding government liabilities.

In short, government spending and lending create bucks, which are a financial asset of non-government and financial liability of government. Taxation eliminates bucks. Loan repayments to the public bank also function as tax payments, and so eliminate bucks. The discharge of any other government charges, such as through the payment of licensing fees or fines, also eliminates bucks.

As a matter of logic, something cannot be destroyed before it exists. Bucks must be created through government spending or lending before they can be eliminated through taxes, the repayment of public loans or the discharge of other financial obligations to government. Or, to put it another way, the government must issue its financial liabilities before they can be extinguished.

Clearly, there is no limit to how many financial liabilities the government can issue in its own currency. For Buckwell Island’s government, there is never a question of financial affordability when it comes to anything that is available for sale in bucks. To issue its liabilities, the government simply makes a decision to spend, pay pensions or lend. With the decision made, the bucks are keystroked into existence when the public bank types them into the accounts of spending recipients, pensioners or borrowers.

However, the absence of a financial limit does not mean that there are no limits to what can be achieved in real terms. It would be pointless for Buckwell Island’s government to keep increasing its spending if there were no actual goods and services that could be produced to meet the extra demand. Acting in this way would merely bid up the prices of various goods and services. And since the prices of these goods and services might also enter into the costs of producing other goods and services, there could potentially be a bout of excessive inflation in which prices, on average, rose rapidly and continued to rise for some time. Inflation causes the currency to lose some of its purchasing power. A unit of the currency – one buck for the islanders – would purchase less than before.

Fortunately, Buckwell Island’s government and citizens understand that the level of total spending – which includes the spending of government, the island’s households and businesses, and foreigners – needs to be kept in sensible proportion to the capacity of the society as a whole to produce real goods and services. This does not necessarily mean that taxes must be as high as government spending. To the extent that households, businesses and foreigners wish to spend less than their incomes, this subtracts from the overall level of demand and makes it possible for government to spend somewhat more than it taxes without causing excess demand.

Although our tale is very simple compared with the complexities of modern economies, it does highlight some basic points that will help address the questions posed at the outset. Introducing more real-world factors, such as a private banking sector, would greatly complicate the details of the story but not change the basic issues presently under consideration. Returning to the questions:

Question 1. Where does a national currency come from?

Answer. In a society with a currency-issuing government, the currency originates from governmental decisions to spend or lend. Whenever Buckwell Island’s government follows through with its decision to spend or lend, bucks are created. As has been discussed, the bucks so created are a financial liability of government – a form of liability that the government can issue without limit – and a financial asset of non-government.

Question 2. How does a currency system basically work?

Answer. The currency originally comes from government. When the Buckwell Islanders sell goods or services (including labor services) to government, they receive bucks in exchange as income. When businesses borrow from the public bank to invest in production or hire workers, these expenditures likewise go to somebody as income. In this way, bucks enter the economy and can be used for various purposes within the economy. Some of the bucks received as income will be used by households and businesses to pay taxes. Some will be saved in accounts at the public bank or in hard currency. Some will be used to buy goods and services from foreigners. And some will be used to buy goods and services from others in the island community, creating additional income in the process. In this way, bucks circulate from one household or business to another until at some point they are eliminated through taxation.

Question 3. Why might people agree to accept a national currency in the first place?

Answer. An important reason is that people must obtain the currency in order to pay taxes or meet other financial obligations imposed by government. This ensures that the Buckwell Islanders will accept bucks in particular, in preference to some other currency. The imposition of taxes and other government charges is not necessarily the only reason people might accept the currency. But this factor is sufficient to ensure at least a base level demand for the currency.

Question 4. How can we be confident that a national currency won’t collapse and that people will continue to accept it in economic transactions?

Answer. A complete collapse of the currency would mean that it was no longer possible to buy goods and services with the currency. It would mean that nobody was willing any longer to accept the currency in payment for anything. A complete breakdown of the currency will not happen so long as the government effectively enforces taxes and other obligations denominated in its currency. It is the successful enforcement of these obligations that guarantees the currency remains acceptable in exchange at least to some extent.

Even so, we have also recognized that the currency can lose some of its purchasing power when the tax burden becomes too light relative to the level of government spending. If taxes were kept very low but the government chose to spend a great deal in comparison, this could cause (in combination with other spending) more demand than the economy could cope with in a timely fashion and result in a bidding up of prices for many goods and services. A unit of the currency – one buck for the islanders – would then buy less than before. The purchasing power of the currency would decline.

What matters, in this respect, is the strength of spending in general, whether by government or non-government. All spending carries some risk of inflation if it causes demand to outstrip the capacity of the economy to supply additional output. The more households, businesses and foreigners wish to save bucks (rather than spend them), the more it is possible for government spending to exceed tax payments without causing undue inflation.

On Buckwell Isalnd, an outbreak of inflation would be met by a narrowing of the government’s deficit (or widening of its surplus) primarily through the operation of automatic stabilizers. In boom times, stronger private-sector activity would cause both a reduction in government spending on the job-guarantee program and an increase in tax payments. These countercyclical variations in government spending and taxing would moderate demand and help to keep inflationary pressures in check.

Question 5. Can a government ever go broke and leave citizens footing the bill?

Answer. A currency-issuing government can never go broke so long as it sticks to operating in its own currency and refrains from borrowing in foreign currencies. (To the extent that a government becomes indebted in a foreign currency, it reduces itself to the status of a currency user and can run into financial difficulties.) A government that sticks to its own currency faces no financial constraint. It can always create more currency if and when this is deemed appropriate.

Question 6. Can financial affordability even be an issue for government?

Answer. A currency-issuing government can always purchase whatever is available for sale in its own currency. By the same token – and at the risk of stating the obvious – the government cannot purchase what is unavailable for sale. Put simply, there can be a shortage of natural resources. There can be a shortage of workers. There can be a shortage of knowledge and technical know-how that prevents certain goods or services from being supplied within a particular time frame. These constraints place limits on what can be done in real terms. But, importantly, anything that can be done within these real limits is affordable for a currency-issuing government.

Related Posts

Short & Simple 2 – Establishing a National Currency

Introducing a New Currency

MMT in Simple Parables


14 thoughts on “A Simple Modern Money Tale – Buckwell Island Establishes a Currency

  1. Great! Would love to read a sequel that reflects what happens to this innocent world to create oligarchs on the island, who own everyone and everything, and design to conquer every other island in the ocean. But that brings in the elements of beliefs and desire; making up a purpose to life.

    Who was the script writer that wrote the story of the current drama? Peter, you’ll have to become a philosopher too. 🙂 !

  2. I have long had doubts as to whether taxes are really needed in order to create a demand for a currency. Reason is that currency is useful even in the absence of taxes: it disposes of the inefficiencies of barter. If taxes declined to a negligibly low level, would everyone revert to barter? I doubt it. People in the US, for example, would continue to find dollars useful.

    I appreciate that currencies throughout history have mainly arisen because some ruler or king wants a more efficient way of collecting taxes, on the other hand there are examples of currencies arising without any ruler imposing taxes: e.g. the cigarettes used as currency in German prisoner of war camps in WWII.

  3. The idea that taxes support the value of the currency is based upon the idea that there is underlying demand for the currency. In the case of cigarettes, the demand was not taxes to the prison government, but rather the fact that many prisoners were desperate to get cigarettes. So the point is not that taxes are the only way to support a currency, but rather that taxes are the most common way. The alternatives, such as the cigarette example, generally lack legal backing which is necessary for large scale acceptance.

  4. Excellent!
    Question 5
    I will still want to make the argument though, that the currency issuer can and must, still create the domestic currency even if it runs into trouble with foreign borrowing, assuming there are still domestic resources available for purchase and development. Foreign debt woes though a horror story, still won`t change the central point. Will they?

  5. Prior to the creation of the nation there should have been some unit of trade. What happened to those? Isn’t part of the initial savings in domestic Buckland have to be exchanged. And would that be at a specified rate as there is no trade in this example.

  6. Good questions.

    Prior to the creation of the nation there should have been some unit of trade.

    Maybe there was, maybe there wasn’t.

    What happened to those?

    If they exist, people can still use them if they want. But they won’t be accepted in payment of taxes. So, at minimum, the islanders will need to obtain bucks sufficient to meet their tax obligations. This creates markets for goods and services specifically in bucks as the islanders endeavor to acquire the national currency by selling goods and services (including labor services) on these markets.

    Isn’t part of the initial savings in domestic Buckland have to be exchanged.

    There are no savings in bucks until the currency issuer spends or lends them into existence. Once this occurs, the non-government sector can save some bucks by spending less than they receive in income. They can spend bucks on domestically produced goods and services or, if there are foreigners willing to sell goods and services in exchange for bucks, the islanders could spend them on foreign produced goods. If foreigners require to be paid in their own currencies and the islanders wish to purchase some foreign goods or services, the islanders will need to obtain the relevant foreign currencies by offering bucks in exchange for the foreign currencies in the foreign exchange market.

    At minimum, the islanders will be able to purchase foreign output to the sum of what they have generated in export revenue by selling domestically produced goods to foreigners. In exporting, the islanders can either demand payment in bucks, which will require foreigners to purchase bucks with their foreign currencies and thereby supply the foreign currencies to the islanders. Or the exporters can demand to be paid in foreign currencies, acquiring the foreign currencies in that way.

    So, at the very least, the island will be able to import to the value of its exports. If, in addition, foreigners wish to net save in bucks (spend less bucks than they receive), the islanders will also be able to run a current account deficit.

    And would that be at a specified rate as there is no trade in this example.

    Preferably not. Preferably the government will allow the buck to float on the foreign exchange market. Although the island government could attempt to maintain a fixed or pegged exchange rate if the electorate desired this, allowing bucks to float on the foreign exchange market will maximize the island government’s policy space.

    The government will also allow the buck’s exchange rate to float relative to any private monies in existence that are not denominated in the national unit of account. (If and when the government permits a private banking sector to operate, it will require bank deposits to be denominated in the island’s unit of account and to exchange at par with bucks.)

  7. @wdpcpa on 11 August 2018 at 1:30 AM: It’s interesting that we really don’t know. If any of the many, many anthropological studies paid attantion to what the most primitive stone age societies they have studied used I would like to know. As far as I know they used something. The oldest records we have from Sumeria suggest they used measures of barley and something they gave the name of “cattle,” although that may have been a unit of account rather that actual cows. Mostly they seem to have been relying on “gifts,” rather than any single commodity. What we do know, though, is that after the convenience of currency was discovered societies started using it. The issue of “scrip” was widespread during the earliest years of the Great Depression, and issuance of “notes” or “scrip” by banks and towns and even small companies was known since the earliest colonies. It seems they must have used something, but it was so long ago we don’t know what it was.

  8. Thanks for the clear rendition.

    Two questions that are important for me to understand how the fable matches up with the real world situation in most countries.

    1. Suppose Buckwell is not self-sufficient, and needs to trade with other cities to survive. Other nations use their own currency and do not recognize bucks. There is a currency market to facilitate. How does the existence of international trade and finance constrain, if at all, the Buckwell government’s practical ability to spend bucks into existence?

    2. Suppose Buckwell’s citizens have access to private banks that issue notes they will exchange at par with the buck. How does the existence of private note creation constrain, if at all, the Buckwell government’s practical ability to spend bucks into existence?

  9. Good questions again. Thanks.

    Short answers:

    1. A government’s currency-issuing capacity does not eliminate real resource constraints but does enable full utilization of available resources.

    2. A currency-issuing government’s fiscal capacity is not hampered by a private banking sector.

    Longer answers:

    1. The government can always purchase what is available for sale in bucks but not what is unavailable.

    To purchase imports that are only available in a foreign currency, the relevant currency will need to be obtained.

    Sale of exports is one way of doing this. In purchasing the exports, foreign customers will either supply foreign currency in exchange for bucks (if the exports are priced in bucks) or pay the exporters in foreign currency (if the exports are priced in foreign currency). Either way, the island will acquire foreign currency.

    Assuming no borrowing in foreign currency, the island at minimum will be able to import to the value of its exports and run a current account balance of zero. That is, whatever foreign currency is earned through exports can be used to purchase imports.

    If export revenue happens to exceed the island’s demand for imports, the difference will be saved by the islanders. The island, in that case, will be running a current account surplus.

    If, instead, foreigners wish to net save in bucks (spending less bucks than they receive), the islanders will be able to import in excess of their exports (resulting in a current account deficit for the island).

    Since Buckwell Island’s government is a mere user of foreign currencies, it should not borrow in them. If private firms are permitted to borrow in foreign currency, the government should not guarantee their loans.

    A currency-issuing government that abstains from borrowing in foreign currency is constrained by real resources but does not face a revenue constraint.

    The country’s productive potential is constrained by the size, talent and know-how of its labor force, its command over natural resources and the present state of its infrastructure, plant and equipment. Government policy can only achieve what is possible within these real limits.

    To the extent the island is not self-sufficient, it should take steps to reduce its reliance on foreigners over time. Doing so will minimize the likelihood of the nation’s imports falling short of requirements for necessities. In some circumstances, there may be a need for import controls to restrict access to luxury items so as to ensure necessities can be secured in sufficient quantities.

    There can also be a case for capital controls, including restrictions on foreign ownership.

    To summarize, a government’s prerogative to issue its own currency does not make a country that is poor in resources and technology suddenly rich. It simply means that the country can always operate at full employment and make the most of what it has rather than fall short of its productive potential.

    The following billy blog posts go into much more depth on the topic.

    Trade and external finance mysteries – Part 1

    Trade and external finance mysteries – Part 2

    2. Private banking has no impact on a currency-issuing government’s capacity to issue its own currency. A private bank liability, when denominated in bucks, is the bank’s promise to supply bucks to one of its customers either on demand or at some future point in time. Since government is the monopoly issuer of bucks, the private bank is ultimately reliant on government to fulfill its promises to customers.

    For example, if a customer with an account at a private bank demands bucks in the form of hard currency either immediately or after some period of time, the hard currency the bank supplies will have come originally from government. If the customer instead draws on a bank account to purchase goods from a store, the bank is obligated to ensure that there are sufficient reserves in its account at the central bank to facilitate final settlement of the transaction. The reserves used for final settlement are also issued by government.

    Private bank issued notes also create no difficulty for the currency issuer. If a private bank issues a note that is denominated in bucks, this is the bank’s promise to have or be able to obtain bucks to the value of the note. If a private bank issues a note that is not denominated in bucks but exchanges with the national currency at par, the bank is undertaking to maintain a fixed exchange rate between its own private money and the government’s currency. This would be a constraint on the private bank but not on the currency-issuing government.

    Although the government (central bank), acting as lender of last resort, will ensure that a private bank can always obtain bucks sufficient to fulfill its promises to customers, the bucks will not necessarily be advanced on terms that are favorable to the private bank. This can be a problem for the private bank but not for the currency-issuing government, since there is no limit to the bucks that can be created by the currency issuer.

    There is also no difficulty when (as now in many countries) a currency-issuing government voluntarily requires itself to auction off debt to official dealers (mostly private banks). The interest rate paid on the debt, even when determined at auction, will not rise far above what government intends because the central bank can signal an intention to purchase previously issued debt in the secondary market at a certain price. Since in a country with its own currency the central bank can do this without limit, there is never any danger of the interest rate on public debt rising much beyond what government intends to pay.

    Even here, the reason government will take steps to limit the interest rate on public debt is not because of a financial constraint (the government can issue the currency without limit) but to keep in check potential inflationary pressures that might emerge if interest payments to bondholders became so large as to cause excess demand for goods and services. There might also be concern over the distributive effects of making high interest payments on public debt that primarily go to the wealthy.

  10. Peter,

    A question about something loosely related. It’s about the feasibility of a “capitalist strike”.

    In a nutshell, the idea is something like this: if a government decided to move seriously against the interests of the capitalist class, capitalists could just leave the country. The ensuing unemployment and depression would do the rest.

    An example you might remember from a few years back: when Kevin Rudd tried to pass the mining super-profits tax the big miners threatened to close shop and move.

    Now, there’s some intuitive appeal to that hypothesis in abstract. But so far, that I know of, it’s only a hypothesis. Moreover, even if capitalists didn’t pack their things and move out, they could still reduce investment.

    Having said all that, I still think in concrete situations things are much more complicated. A complication, for instance, is that to leave the country altogether capitalists would need to liquidate their physical assets. That costs money: the more in a hurry, the more it costs. Going back to the super-profits tax, it’s not like they can wrap their mines in a package, to unwrap it some place else.

    Perhaps more importantly, a capitalist strike would involve a kind of collective action problem . Many capitalists could be tempted to free-ride. Say, if Aussie gazillionaire X were fire-selling his/her mine, perhaps someone else could decide the bargain is worth the higher taxes.

    (That, of course, does not preclude other kinds of capitalist reaction against the government.)


    My question then: regardless of those considerations, is there anything in MMT making a capitalist strike technically impossible?

  11. Interesting question, Magpie. I’ll take a stab at an answer. To be clear, what follows is in no necessary relation to the views of MMTers.

    I’d distinguish firstly between capitalism and socialism. In my view, the tale of Buckwell Island applies to either system. That is, the distinction between government as currency issuer and non-government as currency user is more general than the distinction between capitalism and socialism.

    In principle, an investment strike is a non-issue under socialism since all major investment (and perhaps all investment) will be public investment.

    However, we know from the history of the Soviet Union, and we may relearn depending on what unfolds in China, that there can exist, under socialism, a section of the population that is intent on undermining the system and that might eventually succeed in bringing about a regression to capitalism.

    So, perhaps it could be said that an investment strike, if a credible threat at all, is a very distant threat under socialism and a somewhat less distant threat under capitalism.

    Is it a threat under capitalism?

    We can probably distinguish between a potential threat and a credible threat. I would say that there is a theoretical potential for an investment strike but that it is unlikely to be a credible threat.

    The potential for an investment strike (or at least the threat of an investment strike proving effective in influencing policy) will be greater, the more partial a society is to investment being determined by private interests. If a society is strongly opposed to public investment and production and prioritizes private, for-profit investment even to the point of enduring anaemic growth, then the society may be extremely reticent to do what needs to be done in the event of an investment strike.

    What needs to be done in the event of an investment strike is for government to use its currency-issuing capacity to undertake public investment, nationalize industry as necessary and, when short of this, carve up industry to the benefit of whichever private interests are willing to operate under society’s rules. The conditions for profitability are primarily determined by currency-issuing government. Any corporation, no matter how large (for now), relies upon currency-issuing government for its opportunity to make a profit. Recalcitrant capitalists can go elsewhere if they want. It will be no loss to anybody else so long as the government uses its currency-issuing capacity to the necessary extent.

    But this presupposes a political will to support public investment and perhaps the nationalizing of various industries. If that political will is missing, then there is perhaps the potential for an investment strike, or at least the possibility of an effective threat of an investment strike that would keep the population from making capitalist-unfriendly demands on government.

    How credible is the threat?

    I would say not very credible. You refer, quite appropriately, to a kind of collective-action (specifically, free-rider) problem for capitalists. I would argue that this free-rider dynamic applies to much more than the extreme scenario of investment strikes. It applies to private investment full stop.

    Consider Kalecki’s profit equation:

    Total Profit = Capitalist Spending + Government Deficit + Net Exports – Worker Saving

    It might seem that capitalists have a reason to spend (consume or invest) because it ends up as profit. But, of course, the spending does not end up as the profit of the specific capitalist who does the spending. It ends up as the profit of the capitalist class as a whole. There is no guarantee, at all, that the specific capitalist doing the spending will end up seeing a profit.

    For this reason, I’d suggest that it is the other items in Kalecki’s profit equation that are actually essential in inducing any kind of private investment. And for global capitalism (for which net exports are zero), those items are the government deficit and worker dissaving (worker consumption financed out of either past savings or private borrowing).

    It seems to me that capitalists would do diddly squat in the absence of government spending and/or debt-financed worker consumption. The capitalist who invested, in the absence of either of these types of spending, would be adding to the realized profit of the capitalist class as a whole but not necessarily to his or her own profit. So what would be the inducement to invest? It would be safer to wait for some other capitalist to place the first order rather than going into investment blindly with no reason to expect revenue let alone profit at the other end of the process.

    This is basically Rosa Luxemburg’s reliance of capitalism on ‘external markets’, with the most critical external market (and the only one at the level of global capitalism that can last indefinitely without generating insurmountable debt problems for the spender) being currency-issuing government.

    It is capitalists who are dependent on currency-issuing government, not the other way round. Capitalists are the parasites, not the host.

    An implication is that capitalists only have clout to the extent that it is bestowed upon them by currency-issuing government.

    But even granting them this clout, are they really likely to strike?

    I think they are more likely to make the threat than actually follow through with it.

    You mention a mining tax. That is a policy that would subtract from domestic demand and perhaps, to some extent, the inducement to invest. However, since much of the market for the resource being mined is external to the national economy, there will still be an inducement to invest (via the net exports term in Kalecki’s equation). Are capitalists really going to miss out on profit because the profit on offer is likely to be less, after tax, than it was before? I seriously doubt it. If these particular capitalists don’t want the profit, some other mining capitalist somewhere else will probably step in and find for him or herself some extra customers.

    More generally, if the policies that the capitalists object to are nonetheless policies that will add to total demand, the inducement to invest will be strengthened. In my opinion, capitalists will not turn their backs on demand and profitable opportunities. Doing so would just leave the market to their competitors. They are more likely to continue investing, so long as there are profits to be made, and in the meantime work in the political sphere to overturn the policies that they dislike.

    In a sense, this is what happened in the postwar period in the west. Capitalists didn’t like the policies in place and yet the growth performance was much stronger than in the neoliberal period. Capitalists had little choice but to invest if they wanted a share of the profits. But, at the same time, they worked to overturn the policies. They eventually succeeded in this and one result has been the much slower capitalist growth of the neoliberal period.

    To summarize, I don’t think we can rule out the theoretical possibility of an investment strike, though I don’t find it a credible threat, largely because I consider private investment to be induced by autonomous demand and the income growth that it drives through its multiplier effects (I’ve outlined some of my reasoning on this point in earlier posts, for example here). But certainly nothing in MMT makes an investment strike theoretically impossible. Rather, what MMT makes clear is that an investment strike could only ever matter if we let it matter, by relenting to capitalists’ demands rather than taking democratic control of production.

  12. Thanks Pete, very clear and instructive, too.

    I too think that kind of threats are more likely than not bluff. That was particularly clear in the Australian example, when international commodity prices were high.

    I also found very insightful the explanation regarding the Kalecki price equation. Normally what one hears about that equation seem to assume that there is one Capitalist (with big C) who’s free to spend more in the certainty that he/she is going to get the money back.

Comments are closed.