Report: Backing Scotland's Currency - Foreign Exchange Reserves for an independent Scotland

The interest paid on Scottish foreign reserves would likely be significantly less than Scotland’s current contribution to the interest on UK foreign reserves

A NEW report by Common Weal has detailed how the stability of a Scottish currency can be achieved through the holding of foreign currency reserves.

The report is the third by Common Weal on the case for a Scottish currency as part of its White Paper Project, which is building a new case for an independent Scottish state. The report is written by Peter Ryan, an IT expert in the financial sector with over 25 years’ experience.

It can be read in full here

What are foreign currency reserves?

Foreign currency reserves are used by all countries to stabilise a currencies exchange rate, protect against speculative attacks and service debt obligations. It is essential for all countries to base their own currency on a build-up of adequate reserves of commonly used international currencies.

How much foreign currency reserves are needed?

The size of a country’s foreign reserves are very much dependent on the policy and history of a country and there is a substantial spread of holdings across countries ranging within the European Union from 5.69% of GDP in the UK, through 11.96% in Sweden, up to more than 40% of GDP for countries like Bulgaria or the Czech Republic For the purposes of this paper, a more typical sum of 20% of GDP shall be demonstrated, which for Scotland is approximately $40 billion (approximately the same value of foreign exchange reserves as Denmark).

How would an independent Scotland get those reserves?

In total, $40.23 billion can be feasibly raised to support an independent Scottish currency, broken down in the following ways:

  • $16.2 billion may be secured through a reasonable division of the UK’s foreign exchange reserves under a debt and asset negotiation.
  • £4.462 billion worth of hard Sterling currency is in circulation within Scotland. If half of this is converted into the new Scottish currency and the Sterling held by the Scottish Central Bank, $2.9 billion may be raised for the foreign reserve. An equivalence between the new Scottish Currency and Sterling over the transition period will ensure prices initially stay the same.
  • $13 billion would be raised via a foreign exchange swap with the Bank of England to aid the mutual stability of both the economies of Scotland and the rest of the UK.
  • €8 billion Euros ($8.8 billion) will be raised via the issue of a Euro bond. Funds raised will be partially converted into other reserve currencies such as Yen and Renmimbi.

How much debt would be accrued on these foreign reserves?

The costs of servicing the debt accrued by Scotland for these reserves (approximately £70.2 million per year) will be substantially less than the current annual contribution by Scotland to the UK’s foreign reserves (£500 million per year) which are being built up by the UK government to bail out the City of London in the event of another crash.

What about bailing out are own banks?

Several scenarios are outlined regarding the ownership of currently nationalised banks such as RBS. Assuming sufficiently regulatory oversight in no case could it be expected that Scotland would bear the full burden of banking losses incurred outside of Scotland.


Robin McAlpine, Common Weal director, stated: “Building up a foreign currency reserve has been one of the issues which opponents of independence have put forward as an impossible or prohibitively difficult barrier to establishing a Scottish currency. This carefully argued, well informed paper makes clear how straightforward it would be to achieve and how it might even save Scotland money. We are working on a paper on how to establish a central bank and a regulatory framework for a new currency, when complete we will have set out a comprehensive plan for the establishment of a strong, secure, reputable and trusted Scottish currency. The more we build the case for a new independent Scottish nation state, the more achievable and desirable it becomes.”

Craig Dalzell, head of research at Common Weal, said:

“This report is the third by Common Weal to address questions around a Scottish Currency for an independent Scotland. In our previous reports, we established that the best choice for Scotland was to launch our own currency and in our second we explained the details of how we would launch such a currency. In this new report, we deal with the last great "uncertainty" within the topic which is how we create the foreign reserves required to stabilise and defend our currency. The proposals laid out here show that there are various mechanisms available to Scotland by which these reserves can be created and demonstrate that the creation of an independent Scottish currency is entirely reasonable and would be a viable underpinning of a successful economy.”


Derek Henry

Fri, 06/23/2017 - 14:32

It looks like Peter Ryan is somewhat confused. He suggests that Scotland should float its own currency but then describes how you defend a fixed exchange rate system. It also looks like he believes in bond vigilantes.

You only need to go to wikipedia to see the flaws in his arguements. Even wikipedia states in a free floating system you don't need to protect your foreign currency reserves. It's why most countries moved from fixed exchange rates to free floating ones.

If a government chooses a fixed exchange rate policy, and simultaneously attempts to achieve full employment, it could very well lose its foreign exchange reserves. Interest rates would be rising, as expressed by the forward price of the currency falling while the spot price is being supported by a diminishing pool of fx reserves. This could happen with either a bse program, or a more traditional spending increase.

In any case the higher interest rates may accelerate the loss of fx reserves in two ways. First, higher rates could reduce business profits and consumer spending, slowing the economy and reducing tax liabilities. Second, the higher rate of interest the government must pay to borrow itself puts more of that currency into private sector hands in the form of interest income.

Furthermore, if the government attempts to tighten fiscal policy it may slow down the economy and thereby reduce tax liabilities, weaken the currency and lose fx reserves.

That being said, if the tax liabilities happened to grow faster than government spending due to the nature of the tax structure and the institutional lending structure, such growth could be associated with currency strength.

With a floating rate currency however, interest rates are set exogenously
( there's no such thing as bond vigilantes interest rates are set by the central bank) and fx reserves are not at risk. Therefore full employment policy can achieve full employment with no risk of loss of fx reserves. However, the currency could depreciate.

Japan has proved this for decades now and has completely debunked mainstream economic theory on this issue. As you can quite clearly see from the link provided below

The argument can be made that full employment policy could result in the depreciation of the fx value of the currency. However, one must look at the effect on imports and exports to determine the policy implications. If total imports remain the same, and only the distribution of imports changes, the macro effect is only the redistribution of the consumption of the imports. If imports increase, at the macro level the welfare of the population is enhanced. The only reason to trade at all is to import. So only if total unit volume of imports falls could the case be made that welfare has been diminished.

Likewise, exports are the macro cost of imports. The combination is called the terms of trade. Maximising unit volume of imports relative to exports is how a population maximises its terms of trade. For example, if unit volume of imports increases more than exports due to currency depreciation, the country is better off.

I have yet to see anyone make the case that full employment policy decreases the terms of trade through currency depreciation, induced by any additional national income due to increased net government expenditures.

Furthermore, without full employment, the concept of comparative advantage does not exist, and trade often simply serves to facilitate a race to the bottom. Business and production flows to areas with the most unemployment and the lowest labour costs. So to attract foreign enterprise a nation must maintain high levels of unemployment as well as offer high profit potential. Neither is good for the domestic population. This pitiful yet near universal policy is being further perpetuated by a fundamental and costly misunderstanding of how currencies operate.

A job guarentee is how you do that. You concentrate on domestic demand.

MMT economists are concerned about how you provide full employment *and* price stability. We already know from the post war approach that if you go for full employment you get inflation. The existence of wage/price spirals is in the preface of the 2nd edition of 'Full employment in a free society' and was a concern in 1960 before it blew up completely in the 1970s. And we know from the neoliberal era that if you hold inflation you get unemployment - so much so the mainstream redefined unemployment as 'full employment' as a workaround. The problem in both cases is that they address only aggregate demand, not effective demand.

The job guarentee allows you to stabilise both aggregate demand and aggregate supply by removing capital's power to dictate wages *and* capital's power over supplying the source of wages and the output it generates.

As Warren Mosler puts it - the Job Guarantee *is* an incomes policy.

The majority of just want to put back in place Beveridge style aggregate demand management without anything substantive to address the price stability issue.

Anyways I've forwarded the currency white papers to Prof Bill Mitchell and other MMT economists to analyse. Who are experts around the accounting and flow of funds sectoral balances approach.

Stephanie Kelton manged to convince the Bank Of England to use this approach last Summer.

I'm pretty sure the white papers are going to be torn apart because they are very confused indeed.

Derek Henry

Fri, 06/23/2017 - 15:05

It's a very bad day for us when all our opponents need to do is use wikipedia to debunk our main message.

" In a pure flexible exchange rate regime or floating exchange rate regime, the central bank does not intervene in the exchange rate dynamics; hence the exchange rate is determined by the market. Theoretically, in this case reserves are not necessary. Other instruments of monetary policy are generally used, such as interest rates in the context of an inflation targeting regime."


Fri, 06/23/2017 - 15:52

"For the purposes of this paper, a more typical sum of 20% of GDP shall be demonstrated, which for Scotland is approximately $40 billion (approximately the same value of foreign exchange reserves as Denmark)."

This is madness. indy Scotland, with zero track record and a university drop out as finance secretary would have to come in at the very top end of the scale or the markets will not have anything to do with it.

And Denmark has £75B in reserves. £52B in currency, £3B in gold, and £20B in other assets.

"$16.2 billion may be secured through a reasonable division of the UK’s foreign exchange reserves under a debt and asset negotiation" - You mean "exceedingly generous". You've allocated 10% of the reserves to Scotland when the population share is 8.5%.

"£4.462 billion worth of hard Sterling currency is in circulation within Scotland. If half of this is converted into the new Scottish currency and the Sterling held by the Scottish Central Bank, $2.9 billion may be raised for the foreign reserve. " Theoretically, I suppose. However, unless taxes are raised and services are cut to create a primary budget surplus, this sum will be exhausted within 6 months.

"An equivalence between the new Scottish Currency and Sterling over the transition period will ensure prices initially stay the same." That is a peg that has to be defended, and you haven't got enough money to do it.

"$13 billion would be raised via a foreign exchange swap with the Bank of England to aid the mutual stability of both the economies of Scotland and the rest of the UK." - This will never happen for the same reasons that currency union was rejected in 2014. It makes indy Scotland Westminster's problem, and gives the SNP all manner of hostage-taking opportunities.

€8 billion Euros ($8.8 billion) will be raised via the issue of a Euro bond. Funds raised will be partially converted into other reserve currencies such as Yen and Renmimbi. Obfuscation. Borrowings have to be paid back, which make them a terrible basis for a reserve account. Furthermore, you can only go down this route if the market has confidence in the currency - you can't use this route to ESTABLISH confidence in the currency.


Fri, 06/23/2017 - 15:59

@ Derek Henry

"Even wikipedia states in a free floating system you don't need to protect your foreign currency reserves. It's why most countries moved from fixed exchange rates to free floating ones."

It would be suicidal for indyScotland to let is currency float freely against sterling in the early years.

Furthermore, the "theory" you claim does not match up with reality. Every prosperous country, regardless of whether its currency is pegged or floats, keeps billions in reserves on hand so it can respond if crisis - or speculators - hit. For a small-to-medium size European country, it is usually around one to two quarters of GDP.

Derek Henry

Fri, 06/23/2017 - 16:58

No it wouldn't.

All that would happen is Markets forces will function to adjust the trade balance to reflect foreign desires to accumulate financial assets denominated in the new currency.

That's all the trade balance is. It's the whole point of a floating rate it adjusts.

The worst case scenario for a short while might mean import controls to ensure that needed items are imported (and matched to the foreign currency earned by exports) first, and where that is insufficient rationing of needed items.

Needed items being things like food. Unneeded items being things like lear jets.

You also declare all speculative capital flows that are not providing a risk insurance to real producers illegal.

You ban banks from engaging in speculation and introduce capital controls. A flexible exchange rate is not the same thing as open slather for hedge funds.

If we become independent when you create your own central bank that floats its currency there are many other things you have to do as well to complement this change.

All listed here.... Not that you'll understand any of it Maurice. I mean c'mon you don't even know where your taxes go once you've paid them. So what chance do you stand.

Running a modern money economy - putting it altogether.

Derek Henry

Fri, 06/23/2017 - 17:06

I also love the way people like Maurice declare it would be a disaster as if it has not been tried before.

As if Scotland was the first country ever to become independent it's hilarious. How many examples do people need before they wake up one day and say to themselves, What's the big deal.

Take Iceland for example they should not peg to the Euro or any other currencies. A population of what 350 thousand people.

A move to peg the Icelandic exchange rate to the euro would be disastrous. Only slightly less than actually entering the Eurozone as a Member State.


Fri, 06/23/2017 - 17:12

@Derek Henry
Have a look at South Africa's currency situation this decade and get back to us.

What country has become independent that shares the following characteristics with Scotland?
*public sector spending over 45% of GDP
*millions dependent on the welfare state
*finance as the largest private-sector employer
*economy accustomed to large public-sector deficits

Derek Henry

Fri, 06/23/2017 - 17:11

What a disaster it was for New Zealand to create its own central bank and float. It was such a disaster New Zealand crashed and burned and no longer exists in the world.


It was a brilliant success.


Fri, 06/23/2017 - 17:14

@Derek Henry
If you want to argue that in the long run indy Scotland will be a brilliant success, you can do so. However, what the voters are going to be fixated on is what will the costs of independence be in the first and second generations after independence. And they are going to be enormous.

You can't waive examples from a different period in history about and expect people to accept them as definitive proof.

Derek Henry

Fri, 06/23/2017 - 17:16

Why what's South Africa got to do with it ?

Your comparing apples and oranges.

As a country. We would never use our skills and resources the way South Africa uses theirs. Our central bank would know what it is doing for starters not stuck in some neoliberal la la land.

You should read links I provide you with with otherwise your just going to make yourself look stupid.

We've listed what we would do with our skills and resources.

Derek Henry

Fri, 06/23/2017 - 17:28

So please list those costs and how they are paid for then ?

Well how can you if you think taxes fund government spending and you don't even know where your taxes go once you've paid them.

How can you debate any of it if you don't even know that ? How can you possibly list the costs when you don't even know the basics.

This is how it works in reality.....

Please feel free to point out the bits that are flawed in that analysis. I bet you can't pick out any.

C'mon Maurice your grown man but you can't tell me where your taxes go when you pay them. That's inexcusable.


Fri, 06/23/2017 - 17:37

@ Derek Henry
"Why what's South Africa got to do with it?" - it is a convenient example of what a currency crisis looks like.

"We would never use our skills and resources the way South Africa uses theirs. "
Quite a statement from someone who just admitted he doesn't know the first things about South Africa.

Your crank monetary theories are a diversion.

Derek Henry

Fri, 06/23/2017 - 17:38

Maurice, this is where your taxes go to die everynight of the week. They fund nothing.

The taxes graveyard. It is neither political or ideological it is accounting fact.

When the government spends it writes a cheque on its account held at the Bank of England. The cheque is deposited into an account of a commercial bank. The commercial bank reserves rise by exactly the amount of the cheque as the Bank Of England debits the treasury account and credits the account of the commercial bank for the size of the cheque.

Fact 1: Government spending increases aggregate bank reserves.

Therefore, when the treasury receives funds into its account at the Bank Of England the reverse is true. For example if a tax payer sends a cheque to HMRC. The tax payer’s bank and the banking system as a whole loose an equivalent amount of reserves. As HMRC deposits the cheque into the treasury account at the Bank Of England.

Fact 2: The payment of taxes decreases aggregate bank reserves.

So if the government ran a daily balanced budget whereby the government spending was offset by taxes. There would be no effect on bank reserves.

However, this is impossible to predict with the millions of transactions that happen daily. This can vary by £millions. Government spending and taxation will never off set themselves. This causes huge problems for the Bank Of England. As commercial banks are required by law to hold an amount of reserves against some fraction of their deposits but earn no interest on reserves above this amount. Therefore the commercial banks would prefer not to hold substantial excess reserves.

Fact 3: Government spending will leave them with more reserves than they desire and taxation will leave them with fewer reserves than is required.

This is where the overnight interbank market comes into play. This allows commercial banks to rid themselves of excess reserves or get hold of reserves that they need. When there is excess reserves in the system caused by government spending the commercial banks will attempt to lend reserves in the interbank market.

Which also means when there is a shortage of reserves in the system due to taxation. Commercial banks will look to get hold of reserves in the interbank market to meet their requirements.

The problem is when at the start of the day they all had an equilibrium of reserves. Lending reserves will not help them to get rid of the excess reserves. When the system is flush with excess reserves there will be no bids for the excess. Which means the overnight interest rate will fall to zero.

Likewise when a shortage of reserves persist nobody will be willing to sell what reserves they have and if they do it pushes the overnight interest rate higher and higher.

This process does not only effect the overnight interest rate as it is the anchor for all other interest rates.

Fact 4: Government spending and taxation put different kinds of pressures on the overnight and other interest rates. By adding or draining reserves. Although some commercial banks might be able to eliminate their shortages or excesses it is impossible for the banking system as a whole to do so.

The only way the banking system as a whole can do this is if the government steps in to do the adding and draining of the reserves for them. They do this by selling or buying government bonds.
In order to keep a positive overnight interest rate, either the Bank Of England or the treasury would be forced to sell bonds to drain excess reserves. Commercial banks who do not earn interest for holding excess reserves would be falling over themselves to exchange non interest reserves for interest bearing treasury bonds.

The reverse is also true in order to lower the overnight interest rate they would be forced to buy bonds back from commercial banks to add to the reserves. Commercial banks who get punished for not holding enough reserves would be falling over themselves to sell their non interest reserves for interest bearing treasury bonds.

As you can clearly see from these daily operations between HM Treasury, The Bank Of England and the commercial banks. It is impossible to do a reserve drain ( taxes and issue bonds) before a reserve add ( government spending and buying bonds). It is impossible to do it in reverse.

The Treasury always spends first and collects taxes later ( how else would tax payers get their hands on £’s to meet their tax liabilities)
Infact, taxes are not capable of funding government spending when they are paid using high powered money ( by cash or cheque in a fiat money system) In order for HM Treasury to “get its hands on” the proceeds from taxation it must place these funds in the treasury account at the Bank Of England. As it does and as described above the banking system as a whole loses an equivalent amount of desired or required reserves immediately. The equivalent amount of high powered money is destroyed.
Similary, reserves are drained and high powered money is destroyed immediately when the treasury issues bonds. In contrast government spending from the treasury account creates reserves and injects the equivalent amount of new money ( M1,M2 etc and high powered money.)

Fact 5: We can quickly conclude from the operations that the adding and draining of reserves is used to control the overnight interest rate. Fiscal policy is to do with determining the supply of high powered money. Both taxation and bond sales drain reserves from the banking system. Neither provide the government with money with which to finance its spending. Both taxation and bond sales lead ultimately to the destruction of high powered money.

An analysis of reserve accounting clearly shows that all government spending is financed by direct creation of high powered money. Bond sales and taxation are merely alternative means by which to drain reserves/ destroy high powered money. The choice then is between alternative methods for draining reserves in order to prevent the overnight interest rate from falling to zero.

Taxes control inflation Maurice they take currency out of circulation. They fund nothing.

Derek Henry

Fri, 06/23/2017 - 17:41

A diversion from what. Oh and believe me, they are certainly not crank but accounting fact.

See you can't even read a link or watch a video I provide and say look that's where I'm wrong.

Derek Henry

Fri, 06/23/2017 - 17:43

The monopoly issuer of a currency spends money created from thin air using computer keystrokes to credit bank accounts. The money does not come from anywhere apart from somebody's index finger. There is not some huge shed on the Isle Of Wight that stores taxes for future use. When the monopoly issuer of the currency start spending once it has started can't be stopped until all of the initial government spending has been returned to the overnight interbank market to be dstroyed. So the BOE can meet it's overnight interest rate.

Let's say they create from thin air and spend £100 million.

Those that received the £100 million had 3 options.

a) pay tax

b) spend it

c) save it

The next person in the spending chain who got it had the same 3 options

a) pay tax

b) spend it

c) save it

The next person in the spending chain who got it had the same 3 options

a) pay tax

b) spend it

c) save it

The next person in the spending chain who got it had the same 3 options

a) pay tax

b) spend it

c) save it

The next person in the spending chain who got it had the same 3 options

a) pay tax

b) spend it

c) save it

So how many people have actually handled this £100 million ??

How many little tax payments did it take to return the £100 million back to the reserves to be destroyed ( cancelled out) so the central bank can meet its overnight interest rate ?

How much did everyone "save" who received it as it travelled around the spending chain ??

Let's say they all saved in total £2 million out of the £100 million and they all paid tax and spent the rest.

Then the budget black hole for this government spending injection was £2 million as the budget deficit = private sector savings to the penny. This £2 million will be returned to the reserves and destroyed as soon as they all individually take it out of their savings and start spending again.

The length of time this takes to return to the reserves depends on what saving vehicles they saved their money in. Was it in a current account, savings account, an ISA or a pension. What the tax rate was. higher the tax rate quicker it returnes to the overnight interbank market. Lower the tax rate the slower it returns.

Let's say one of the big firms who received say £20 million of government spending decided to offshore it in Panama to try and avoid paying tax at all. First of all they need to change it to $'s. To do that they need other people coming the other way that wants to hold £'s. As every fx transaction needs a buyer and a seller.

£20 million --------------------> Panama equivalent in $.

£20 million <------------------- everyone around the world who has equivalent $.

Transaction complete instantaneously and as you can see the £20 million actually went nowhere.

Those that now hold the £20 million now have the same 3 options.

a) pay tax

b) spend it

c) save it

The spending chain starts all over again.

The monopoly issuer of a currency can never run out of currency. The only constraint it has is skills and resources. If there is not enough skills and resources to absorb the £100 million then there will be inflation.

Monopoly issuer of £ runs a balanced budget

They spend £10 and tax 10

On aggregate how much can you now save and spend in the economy ?

Monopoly issuer of £ runs a budget Surplus

They spend £10 and tax £20

On aggregate how much can you now save and spend in the economy

Monopoly issuer of £ runs a budget deficit

They spend £10 and tax £2

On aggregate how much can you now save and spend in the economy. ?

Which is why we're ran budget deficits for nearly 300 years Maurice.


Fri, 06/23/2017 - 17:45

A diversion from the demonstration that indy Scotland cannot afford to have its own currency unless it is willing to endure a sustained period of Gree-style austerity to generate primary budget surpluses.

This is the reason why the SNP keep refusing to talk about currency seriously.

Derek Henry

Fri, 06/23/2017 - 17:51

Try It Maurice be the New Scottish Government for one day with your new central bank and currency.

Be the government for a day

Get yourself a wad of monopoly money, and 100 lego characters and set your own tax rate and go through the spending and taxation cycle yourself.

Give £1000 to the first lego character ( take the tax off) then the 1st lego character passes it to the 2nd lego character ( take the tax off) then the 2nd lego character passes it to the 3rd lego character ( take the tax off) and so on and so on all the way down the spending chain.

What you'll quickly figure out is government spending comes back as taxation unless somebody in the spending chain decides not to spend - They decide to save it instead which then becomes your deficit.

Say lego characters numbers 3, 10, 26, 41, and 60 all decided to save £5 instead of passing it all onto the next lego character. Then your budget deficit as the government would be £25.

You would have spent £1000 but only collected £975. Your budget deficit equals all of the lego characters savings to the penny.

Conclusion :

All government spending pays for itself with any positive tax rate. The £1000 was created from thin air in the first place and the spending chain it created decided how much tax was paid. From that spending chain you can see what size of deficit you are going to have.

So as the government if you want to balance your books you have to borrow £25. Or you wait until those lego characters spend the £5's they saved.

How you do that is you say to those lego characters that did save £5 each. Give it to me and I promise to pay you interest on your savings. All you are doing is taking back money you have already spent which causes no concern to you as the monopoly issuer of the currency.

The accumulated public deficits equal the accumulated private savings. This in turn equals the accumulated stock of financial assets your central bank holds.

The lego characters would not be able to save or earn interest on their savings. Unless you the government.

a) Spent the £1,000 in the first place.

b) Ran budget deficits.

Get the lego and monopoly out and try it.

The money needed to pay for Hinkley point will be created from thin air by typing the amount into a computer keyboard and sent via the internet to the accounts of the companies in the private sector who is going to build it.

Job Done that's it .

Then get your monopoly money out and your lego characters and see what happens. As these companies pay their tax and spend or save it.

The money needed to pay for Hinkley point, police, education, welfare, social housing, NHS, infrastructure will be created from thin air by typing the amount needed into a computer keyboard and sent via the internet to the accounts of the companies in the private sector who are going to build it or the accounts of people on welfare.

Job Done that's it .

Then get your monopoly money out and your lego characters and see what happens. As these companies and people pay their tax and spend or save it.

It's how all government spending works. As you can see it is never about the cost as the lego characters will play pass the parcel all the way back to the reserves and overnight interbank market.

The real problems happen when you only have 98 lego characters who specialise in building Nuclear power plants and 2 who specialise in farming. That's your real constraint.

Who is going to do the extra work in the police, education, social housing, NHS and infrastructure.

This is when you have too much money chasing too few goods. What you need is

20 lego characters who specialise in police work

20 lego characters who specialise in education

20 lego characters who specialise in social housing

20 lego characters who specialise in NHS

20 lego characters who specialise in Infrastructure

20 lego characters who specialise in Nuclear power plants

So you invest in your lego characters and give them the skills and resources needed to get the jobs done.

Derek Henry

Fri, 06/23/2017 - 17:55

Because its complete tripe Maurice.

If the government runs a budget surplus then the private sector by accounting definition has to run a deficit.

Look at the Graph below even Goldman Sachs gets it.

Well ??

Explain that to me ?

Derek Henry

Fri, 06/23/2017 - 18:05

Then as our sectoral balances show.

There are 3 sectors - They all have to balance to zero.

Government sector

Non government sector - private and domestic

Trade balance or foreign sector

So for example if the government runs a 6% budget deficit then the other 2 sectors have to balance all 3 to zero.

This approach underpinned the work of the so-called New Cambridge approach who were part of the Cambridge Economic Policy Group at the University of Cambridge in the early 1970s. Key members of this group were Martin Fetherston, Wynne Godley and Francis Cripps, who were from a Keynesian persuasion but departed from the usual Keynesian thinking when it came to balance of payments issues. I will leave that discussion for another day.

The Sectoral Balances perspective of the National Accounts also brings the uses and sources of national income together.

The most basic macroeconomics rule is that one person’s spending is another person’s income. At the sectoral level the same proposition holds. Another way of stating this rule is that the use of income by one person will become the source of income for another person or persons. Similarly, at the sectoral level.

So it is a flow of funds approach. But first you have to understand the difference between a flow and a stock.

Remember, that an expenditure flow is measured as a certain quantity of dollars that is spent per unit of time. So for example, in the June-quarter 2015, the Australian Bureau of Statistics estimated that household consumption in Australia was $220,913 millions in real, seasonally-adjusted terms.

Conversely, a stock is measured at a point in time and is the product of prior, relevant flows. For example, the Australian Bureau of Statistics estimated that total employment in Australia in October 2015 was 11,838.2 thousand. The flows that generated this stock of employment were all the movements of workers between the different labour force categories: employment, unemployment, and not in the labour force.

A flow is like a stream of water measured as litres per second (for example) whereas a stock is like a reservoir level measured in litres at some point in time.

Confusing the two is like confusing miles and miles per hour.

So if you a running a trade deficit and a government budget surplus then that is economic suicide for your private sector. Non govermental sector.

To understand it fully you have to understand this question.

National accounting shows us that a government surplus equals a non-government deficit. But that doesn’t mean that if fiscal austerity ends up generating a fiscal surpluses that households and firms will be running deficits.

The answer is True.

And here's why..

Look at the chart

For the question to be true we should never see the government surplus (T – G > 0) and the private domestic surplus (S – I > 0) simultaneously occurring – which in the terms of the graph will be the green and navy bars being above the zero line together.

You see that in the first four periods that never occurs which tells you that when there is an external deficit (X – M < 0) the private domestic and government sectors cannot simultaneously run surpluses, no matter how hard they might try. The income adjustments will always force one or both of the sectors into deficit.

The sum of the private domestic surplus and government surplus has to equal the external surplus. So that condition defines the situations when the private domestic sector and the government sector can simultaneously pay back debt.

It is only in Period 5 that we see the condition satisfied (see red circle).

That is because the private and government balances (both surpluses) exactly equal the external surplus.

So if the British government was able to pursue an austerity program with a burgeoning external sector then the private domestic sector would be able to save overall and reduce its debt levels. The reality is that this situation is not occuring.

Going back to the sequence, if the private domestic sector tried to push for higher saving overall (say in Period 6), national income would fall (because overall spending fell) and the government surplus would vanish as the automatic stabilisers responded with lower tax revenue and higher welfare payments.

Periods 7 and 8 show what happens when the private domestic sector runs deficits with an external surplus. The combination of the external surplus and the private domestic deficit adding to demand drives the automatic stabilisers to push the government fiscal outcome into further surplus as economic activity is high. But this growth scenario is unsustainable because it implies an increasing level of indebtedness overall for the private domestic sector which has finite limits. Eventually, that sector will seek to stabilise its balance sheet (which means households and firms will start to save overall).

That would reduce domestic income and the fiscal position would move back into deficit (or a smaller surplus) depending on the size of the external surplus.

So what is the economics that underpin these different situations?

If the nation is running an external deficit it means that the contribution to aggregate demand from the external sector is negative – that is net drain of spending – dragging output down.

The external deficit also means that foreigners are increasing financial claims denominated in the local currency. Given that exports represent a real cost and imports a real benefit, the motivation for a nation running a net exports surplus (the exporting nation in this case) must be to accumulate financial claims (assets) denominated in the currency of the nation running the external deficit.

A fiscal surplus also means the government is spending less than it is “earning” and that puts a drag on aggregate demand and constrains the ability of the economy to grow.

In these circumstances, for income to be stable, the private domestic sector has to spend more than they earn.

You can see this by going back to the aggregate demand relations above. For those who like simple algebra we can manipulate the aggregate demand model to see this more clearly.

Y = GDP = C + I + G + (X – M)

which says that the total national income (Y or GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X – M).

So if the G is spending less than it is “earning” and the external sector is adding less income (X) than it is absorbing spending (M), then the other spending components must be greater than total income.

Only when the government fiscal deficit supports aggregate demand at income levels which permit the private sector to save out of that income will the latter achieve its desired outcome. At this point, income and employment growth are maximised and private debt levels will be stable.


Fri, 06/23/2017 - 18:05

"Because its complete tripe Maurice."

And yet, it is the statement that is 100% consistent with the way every successful country in the world manages it currency because it is the statement that is 100% consistent with what has to be done to make people confident enough in the currency to be willing to accept it in exchange for a more established currency.

Economics is a branch of human behavioural studies, not the mechanistic Lego playground of your crank theories.

Derek Henry

Fri, 06/23/2017 - 18:15

Maurice, All government spending pays for itself each and every time with any positive tax rate.

If you were given £1,000 by HM Treasury ( it does not come from anywhere else) and the one condition was you had to spend all of the £1,000 given to you and everyone in the spending chain it created also had to spend all of it.

No personal saving is allowed into a savings account, pension fund, ISA etc etc etc.

With a let's say 10% positive tax rate how long do you think it would take your £1,000 to return to the reserves and the overnight interbank market where it is destroyed ?

You pay your 10% tax and then buy a new TV with your £900, The supplier of the TV then buys his wife a new dress with his £810, the dress maker then buys her husband a new watch with her £729, the watch maker then buys a new window for his shop with his £656, the window maker then buys a new garden shed with his £591, the shed maker then buys a new fish pond with his £532, the fish pond maker then buys some carp with his £479, the carp breeder then buys his daughter a pair of ear rings with her £432, the ear ring maker then buys a holiday with her £389, the holiday providor then treats themself to a hand bag with her £351, the handbag maker then buys a month shopping with her £316, the shop keeper buys some new stock with his £285, the wholesaler buys his wife a pair of shoes with his £257, the shoe maker then buys a nice coat with her £232, the coatmaker buys a meal at a resteraunt for his sons graduation with his £209, the resteraunt owner buys a new set of pans with his £189, the pan maker buys a new set of tyres for his car with his £170, the tyre maker buys a new sign for his shop with his £153, the sign maker buys a wedding cake for his daughter with her £138, the cake maker buys some advertising for £125, the advetiser buys a carpet for £113, the carpet maker buys some paint for decorating for £102, the paint maker buys some oils for £91, the oil maker buys a new door bell for £82, the doorbell maker takes his family to the cinema for £74, the cinema owner buys some pet food for £68, the petfood maker buys etc, etc,etc,etc..

(Rough figures) above for a 10% positive tax rate. The higher the tax rate the quicker it returns to the overnight interbank market. The smaller the tax rate the slower it returns to the overnight interbank market.

However, i'm sure you get the message the Original £1000 is returned to the government over time as long as everyone in the spending chain spends everything they earn. This is what happens each and everytime with a positive tax rate. Your spending became someone elses income and so on and so on and so on.

So the question then needs to be asked. What if the rule is lifted and everyone is allowed to save some of their income.

The answer is very simple those savings become the government budget deficit to the penny.

Without a budget deficit on aggregate nobody will be able to save.

At this point you always get some loon ball fiscal conservative who says it does not work like that. They go on to talk about closed and open economys.

Well it does because of our sectoral balances.

Read the links

Closed economy

Open economy

Not political or ideological but accounting fact.

Derek Henry

Fri, 06/23/2017 - 18:26

Oh no, not the confident enough to hold your currency nonsense.

Dearie me Maurice your not falling for that one are you. Give me a break.

Japan destroys everything you've just posted and has done for nearly 30 years.

Read the link.

So Greece and France and Germany issue their own currency do they ??

" Banging head off desk"


Fri, 06/23/2017 - 18:26

Once again I must repeat: your crank economic theories do not add up to an explanation of how indy Scotland can establish a currency that the market will accept in exchange for other currencies without demanding a steep discount.

Derek Henry

Fri, 06/23/2017 - 18:35

There you go with your "Crank theories" again.

Yet, not once in even though it is actual accounting with not a theory insight can you point to where I'm wrong.

Look mate. I'm obviousley waisting my time with you because you refuse to believe you've been brainwashed.

You believe there is a huge shed out there somewhere holding our taxes to be used for future use. You also somehow believe the monopoly issuer of £'s needs your £'s before they can spend. Without even realising it's the only way for you to get your £'s you need to then pay your taxes.

Even though we've ran budget deficits as a country for nearly 300 years. That shed would have been empty 299 years ago.

Good luck getting through life your going to need it. I'm sure if you switch your TV on it will tell you how to think and what to do.

It clearly has in the passed and turned your brains to paper mashe.

Peter Dow's picture

Peter Dow

Fri, 06/23/2017 - 18:41

If the new Scottish £ currency floats, there's no need to have any foreign currency reserves WHATSOEVER.

On the other hand, any foreign currency reserves Scotland did have should not be wasted foolishly trying to operate a doomed one-sided peg of the exchange rate of Scottish £ whether to the English £ or to any other currency - that's a proven way to get ripped off by foreign currency speculators and to lose all your foreign currency reserves in the process.

An independent Scotland retaining the £ Sterling in a currency union with England would be a good seamless solution if the appropriate fiscal framework could be agreed with Westminster.

Mutually pegging the Scottish £ to the currency of another White Knight country which offered a mutual peg is another good option.

So there is NO NEED to "build up foreign currency reserves" to manage a new Scottish £ currency. There is no such problem as this paper is trying to find a solution to.

Thank you Common Weal, but NO THANKS.

The job of Finance Minister of a Scottish government in an independent Scotland is MINE for the taking, if this "think tank" is anything to go by.


Fri, 06/23/2017 - 18:39

@Peter Dow
"If the new Scottish £ currency floats, there's no need to have any foreign currency reserves WHATSOEVER."

Use the space below to list all the countries all the countries in the world with free-floating currencies that hold no foreign currency reserves WHATSOEVER.

Or you can list just the European countries that fit that criteria if you are pressed for time.

Derek Henry

Fri, 06/23/2017 - 18:42

Once again I must repeat you've been brainwashed.

Because the banks are already setup to support it and make money doing so. It's very straightforward.

Derek Henry

Fri, 06/23/2017 - 18:45

It becomes easier to see if you think about it from the point of view of a net exporter to the rest of the world.

If you export to excess you gather foreign currency. You have no choice because there is insufficient imports to swap all your earnings to the local currency.

So how - as a net exporter - do you pay all your staff who want local currency?

Answer: you sell the foreign currency to your bank who then creates the local currency for you in return.

This is obvious when you think about it. Foreign currency is an asset - a loan to a foreign nation. Once the bank has hold of it in the asset column it can just mark up your local currency account and 'credit' you with the exchange value.

And this is how net exporters work in aggregate. They hold foreign currency hostage (or foreign currency bonds if they can get them) so they can discount the correct amount of local currency against it. It makes the accounting look good at banks and central banks and has the added advantage of draining domestic circulation abroad making more space for your goods and services exports.

Now think about it in terms of multi-national banks. If I'm banking with HSBC there will be a local branch in Japan and a local branch in the UK. If a Japanese company has an excess of Sterling it needs Yen for, then the local branch in Japan will move the Sterling to its account at the UK branch (HSBC Japan - Sterling Asset a/c) and then mark up the Japanese company's account in Yen. The Sterling then becomes just an intra-company loan of no significance to the overall accounts. If there is a build up of Yen on the UK side, the bank can do an internal swap to eliminate the currency on both sides and shrink the balance sheet (which reduces the liquidity ratio requirements on both sides).

So if you eliminate interest paid on UK government assets and force foreigners to hold just currency, they will likely continue to hold it within their banking system as the offsetting asset to local currency creation. Because that's what you have to do to continue being a net exporter in a floating rate currency (the alternative is to get 18 other countries to sign up to use your currency Eurozone style).

They may have to go through a cycle or two of excessively high currency rates (and therefore we have low currency rates) and trade collapses before they get the message. It all depends how astute the foreign politicians are and whether they care about their own economy or some other political end.


Fri, 06/23/2017 - 18:45

At last you acknowledge that what you are arguing is a fringe mechanistic theory that has never been tested in the real world.

Now: imagine trying to get 2 million people to vote for that.

Derek Henry

Fri, 06/23/2017 - 18:52

International Car manufactures (and all international manufacturers) run an internal treasrury department that managed how much of each currency they have to reduce risk exposure and ensure that the correct supply of money is available to all the subsiduaries. Essentially it is an internal bank. Sometimes it's a real bank (See GM Financial Services for example).

Firms are never short of money. They always have access to the other banks even if they are not a bank themselves.

3) The trick is to avoid paying interest to people. That's an income they haven't earned. If they hold Sterling, they should hold it solely for its insurance purposes, or its 'hard asset' purpose. The mainstream deny such a thing exists of course (hence the hot potato effect and why you have to 'persuade' people to hold the money with interest payments).

Once you remove interest, then if they park it that is their loss and we accommodate that saving via further government spending.

Anyways Maurice I've better things to do.

Try a night class or something or at least pop down to Threadneedle street knock on the door and ask where your taxes go once you've paid them.

At least that what be a start to unbrainwashing yourself. Keep away from those 15 min sound bites on TV. It's very clear they've done you no good at all.

gjm's picture


Sat, 06/24/2017 - 11:47

Well done to Common Weal, Peter Ryan etc. Cracking return I get on my DD

Scott Egner

Sat, 06/24/2017 - 13:21

One thing to critique this work but it would be good to get the heterodox to come up with a proposal for a Scottish currency. That's something I would happily help to crowd fund.

Scott Egner

Sat, 06/24/2017 - 13:42

The 'crank' economists are the ones running the treasury Maurice and obviously the ones in the city funded by the banks telling us that we need to run up more private debt to add to the £5 trillion already in existence.

The same crank economists forecast that we should have super high interest rates by now due to the amount of 'borrowing'.
Their blind belief in market equilibrium still exists even after the mother of all financial crises - explained away as a 'black swan' whilst it had been predicted a decade in advance.
Much of the mainstream still sees banks as financial intermediaries - incredible.
As for 'indebting future generations', its surprising none of the mainstream complain about the policies of full employment exercised during the 70s.

Again when you have the head of the CBI insisting that the economy is just like a household, you know your economy is screwed.

Finally with reference to foreign reserves. They are important if you have fixed interest rates. Foreign denominated debt can be redenominated by international convention into a country's sovereign currency. It's known as lex monitae.

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