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ALTIF Transcripts: A Nation Deep in Debt (Part One)

UK Bond gilt

“Let us be, say I, a free Nation deep in Debt.. rather than a Nation of Slaves owing nothing.” So wrote a pamphleteer in 1720 about the remorseless rise of Britain’s National Debt. At a time of mounting concern about the public finances, we launch a two-part series on the National Debt, starting with its ups and downs over two centuries with historian James Macdonald.

Presented by Jonathan Ford and Neil Collins.

With James Macdonald.

Produced and edited by Nick Hilton for Podot.
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Jonathan Ford 00:05

Thanks for listening to a long time in finance with Jonathan Ford and Neil Collins in partnership with briefcase news for service that brings intelligent curation and analysis to your media money. No man whatever having lent his money to the government on the credit of a parliamentary fund has been defrauded of his property. The goodness of the public credit in England is the reason we shall never be out of debt. Let us be say I, a free nation deep in debt, rather than us nation of slaves owing nothing. Now, these words from an anonymous pamphleteer dating from 7019, believed to be I think, Daniel Defoe strike a strikingly positives note about deficits and public borrowing. In more recent years, however, people have started to question the goodness of the public credit. 20 years ago, Britain’s National debt stood at around 30% of GDP, the measure of national output. Now it’s around 100% and scheduled to go higher. The recent mini budget showed that public tolerance for large deficits even in advanced economies is not infinite. Long term interest rates which set consumer borrowing costs such as the mortgage rate have ballooned, and Jeremy hunts recent budget was explicitly designed to undo the damage and repair relations with the bond markets. But this leads to a whole host of questions How high is too high? What causes the erosion of public confidence? And are there lessons we can learn from the past, we decided to do a two part series on the national debt. The first episode, we’ll look at the history of Britain’s National Debt, how high it’s been, and how it was managed. And the second next week, we’ll look at where we are and the lessons. So for this first episode, we’re very pleased to be joined by James MacDonald, a financial historian, and author of a fantastic book on the history of state borrowing a free nation deep in debt. James, welcome.

James Macdonald 02:08

Well, thank you very much for having me on the show..

Jonathan Ford 02:09

Now, before we go into the journey of Britain’s public debt over the centuries, I really want to start at the beginning which is, I guess, 1694. Maybe you can explain James a bit about why the national debt starts from that point. Where does the idea come from? Is Britain copying other ideas?

James Macdonald 02:26

Yeah, Britain is definitely copying ideas. Its a relative late comer to this game. It’s not there hadn’t been any public debts in Britain before. But they’ve been very small, and generally speaking, very badly handled as compared to some examples elsewhere. The most striking thing that happened, of course, just before this was the Glorious Revolution of 1688, where you suddenly got a Dutch King on the throne. And, of course, Holland had been the most remarkable practitioner of the arts of public borrowing, and in fact, borrowed its way more or less to independence from from Spain in the first half of the, of the 17th century. And so one of the things that happened, as soon as he got off the throne, he immediately pulled into the into a war with France against Louis the 14th. And suddenly, there was need for a large amount of public borrowing. And so the fact that he got going, then in the UK, on a large scale is no coincidence at all. And when it grows very, very quickly, well, it because it was in wartime. I mean, there was that, you know, you were immediately plunged into the war that you the War of the League of Augsburg, which lasted until 97. And then, of course, with only a brief pause, you were back into the war of Spanish Succession in 1702. And so public debt simply ballooned at incredible speed in the next 20 years.

Jonathan Ford 03:44

And in the early days, there is this idea is there not that you should try and repay the national debt, it’s not a permanent fixture. And indeed you have in France and in Britain in the 1710s. This idea that there are schemes sort of almost debt to equity swaps being proposed by various entrepreneurs to get rid of the public debt,

James Macdonald 04:05

The public debt is odd in that you’ve got two things going on, sort of simultaneously. One is that the sort of almost the earliest form of public debt that was created other than some very short term borrowings, just from merchants, or something of that sort, was in fact permanent debt that the consoles which came to be very characteristic of British public finance until they were finally repaid, were in fact, following continentally examples, and they were perpetual debt. So the reason really goes back to the usury laws, which in the Middle Ages made any form of interest payment, unacceptable. perpetual debt was almost a sort of a strange scheme because if you didn’t have the obligation to repay the principal, you can repay it whenever you like, but you don’t have to repay it, then you couldn’t really quite easily classify it as a debt in the same way as if a debt had a sort of specific maturity. So the very earliest form The public debt which were invented in the Middle Ages, tended to be perpetual. So you start off this concept with with the idea of actually of debt being potentially perpetual, but at the same time, a strong feeling that you wouldn’t have too much of it. So you immediately get into a scheme of how to repay them. And one of the solutions is the sinking fund, which was goes back to the Middle Ages, where you set up a fund, and that is dedicated to rebind, repurchasing the debt in the market at very often a lower price than the nominal price. And then, of course, after all the wars are spent in succession, yes, then you get all private equity swaps coming in, which is a quite a remarkable story.

Jonathan Ford 05:40

Can you just sort of sketch out for us, particularly that the law scheme and why it failed.

Neil Collins 05:46
That’s, of course, John Law, rather than some legal scheme, just for our listeners, who may not know John Law?

James Macdonald 05:53

John Law was a remarkable Scotsman who managed to transform French public finance, and to some extent, the whole of European public finance for a very brief period of about a year and a half, he had a vision of using this vast public debt swap, to expand the French economy, probably virtually up to the level of doubling in size can conceivably in his grand vision of things. But even his vision was not the first to do a public for private equity swap, because what people early at least did in Britain, and France reckoned that it was easier in some ways for the state to borrow. If it was an indirect borrowing, the very first stable borrowing that they got in Britain was, in fact, with the invention of the Bank of England, because the first thing that the Bank of England did, was to lend a large sum in perpetual annuities. And the people who were the investors in the Bank of England, therefore, the largest amount of their capital was, in fact indirectly debt to the government. And this was the cheapest and most successful form of debt that the British government was able to borrow in this early period. And people looked at this as some kind of model, then when you got to the end of the war, Spanish Succession, and you’ve got a very large amount of rather messy debt built up in the UK, then you came to the South Sea ski, which obviously was the parent or the A Few Years Later of the South Sea bubble, which was Britain’s answer to John Law,

Jonathan Ford 07:22

Just to hop in, the thing that links John Law scheme, and the South Sea bubble is in both cases, the promoter of the scheme, the South Sea Company, or, or law himself, is saying to hold us of these perpetual annuity T ‘s government debt, swap it for shares in an enterprise, in last case, to do with the Mississippi colony that France had in in Britain to do with trade with the South Seas.

James Macdonald 07:51

They were both as it were colonial enterprises. And this was the beginning of the great age of imperialism and the huge amounts of money that could potentially be made with great trading schemes. And they thought it would be cheaper for the state to borrow from these companies, and then these companies to raise shares in the market. So John all was following on from from a scheme that had already worked. It’s just he had a grander vision, and took on more debt than anybody had ever imagined, where he took the whole of the French public debt, equivalent to probably in excess of 100% of GDP, at the time and plan to swap it for shares in a private company, which was an extreme and astonishing vision.

Jonathan Ford 08:30

Now, these schemes both fail, why do they fail?

James Macdonald 08:34

They fail for slightly different reasons. I mean, they are in John last case, because he was planning to reduce French borrowing costs, which had been pushing northwards towards 10%, down to 2%, because he thought that if the shares in his scheme were correctly priced, he would be able to lend to the French government, effectively as low as 2%. Well, this was an extraordinarily radical scheme. I mean, if it had been satisfying, saying, We’ll reduce it to 5%, or 4%, which might have been something resembling a normal market, he might possibly have had a better chance of getting away with it. But a 2% The only way to do it, he’d previously set up a state bank, and basically he flooded the market with money. So you could end up with shares worth four or five times your your initial investment. And so he stoked an enormous, basically speculative boom, in order to get his share price up to a level where it looked as if the French government was able to borrow at 2%. But the end result was the amount of paper he floated was hyperinflationary. And the whole screen collapsed basically out of hyperinflation. But a few years later, the French basically cancelled everything to do with his scheme burnt all the records and reverted to where it had been before the whole thing stuff.

Neil Collins 09:50

Oh, well, I think our current Treasury would like to do the same thing with with all the debt that’s outstanding, but that’s another question

Jonathan Ford 09:59

Are those when those schemes fail is that the point when the idea that the national debt is going to be a permanent feature of the skate scene?

James Macdonald 10:08
It just gradually, people come to accept it because you never seem to get a chance to repay it. I mean, it’s not as if you don’t repay bits and pieces, at least in the UK, it was basically always awarded. And if you were in peacetime, you ran surpluses, and you started repaying it, there was no doubt that did happen, whether through a sinking fund or just by paying things off, which you could always do. I mean, all the perpetual debts, you could pay off anytime you like, there was no restriction. But the wartime debts were always vastly larger than the peacetime surpluses so that all it did through the 18th century was just to man up and up and up till it reached an extraordinary total of about 250% plus of GDP by the time you get to the Napoleonic Wars. And so all the repayments have become relatively meaningless. I mean, you get David Hume, the great Scottish philosopher claiming that the debt is going to bankrupt the country. And you get Adam Smith warning that when it gets too big, there’s no solution except to inflate it away. I mean, there are constant warnings about the size of the debt.

Jonathan Ford 11:06

And so as you say, the debt mounts up to about 240% of GDP.

James Macdonald 11:15

By 1816, the end of the Napoleonic Wars, people are constantly saying it’s gone too far. And then there are people questioning whether you shouldn’t repay it on the cheap. I mean, one thing which had happened in the Napoleonic Wars, there’s been a lot of inflation, particularly in the last 1010 years. So there was one of the thoughts was that you would repay the debt, you could either do it at market value, which was obviously lower, because a lot of this had been raised at relatively low interest rates, and prices have fallen during the war. Or you could repay it at some complicated calculation. So the owners got it only at the price level that they had actually contributed the debt in the first place. But none of these came to anything, probably more than anything else, because people realise, and there were a lot of people writing this, but the fact that it had run its public finances so successfully, and never defaulted on its debt, unlike the French king, was the reason why it was able to outspend France, in spite of being a considerably smaller country in those days. So the fact that could outspend France successfully was all to do with the ability to borrow money cheaply, I want to then turn to what happens over the long years of peace in the 19th century, there’s no war. So unlike the 18th century, where the national debt has climbed and climbed and climbed, it declines substantially as a percentage of GDP down from that 250% to about 30%. In 1900. Is it for them very, very far. I mean, it’s almost fallen back to where it started. Mostly, it’s done through economic growth. I mean, that is by far the biggest factor, that GDP from 1815 to 1914, has grown by a huge amount. The debt has however shrunk, but that’s gone down by about 200 million during that period. So it’s not as if there hasn’t been debt repayment. And in fact, on my calculations, you have about 360 million that was repaid over the course of 100 years. So it’s not insignificant. It’s a very gradual process.

Jonathan Ford 13:06

And the main source of public expenditure in those days is, is military. Once you’re in peacetime, you don’t have huge state spending.

James Macdonald 13:14

And the main source of spending immediately after Napoleonic War was in fact, public debt interest. This was running at levels that were close to 10% of GDP, I mean, levels that it’s never come anywhere close to since I mean the most it’s ever got after any war, or threatened with being even nowadays, or anything’s about 5% of GDP.

Jonathan Ford 13:32

But so during the 19 century, the bond vigilantes presumably melt away because there’s nothing really for them to complain about?

James Macdonald 13:38

They’re paid very well. And of course, the other thing that happens is that interest rates fall because they’ve they’ve risen in peacetime, so that you’ve been borrowing at a cost of five and a half percent, maybe for long term debt, when you have this perpetual debt. And it was all pretty much in the form of perpetual debt. So how can you reduce the interest costs well, because it can always be repaid apart anytime, if interest rates fall, the market value of these bonds will rise above par In the way that you know, interest yields, and market prices are operating inverse. So the moment it rises above par, you can threaten people with repayment at par unless they accept a reduction in interest rate. And this happened regularly throughout the 19th century to the last Greek conversion in the 1880s. Where they persuaded the entire market to accept a reduction down to two and a half percent debt interest have fallen by 50%. With with a huge reduction in interest cost, of course, so interest as a percent of GDP from before and from 10% down to something that was almost vanishingly small.

Jonathan Ford 14:41

So the 19th century is a is a golden age and age of peace. But then we come to the 20th century, which is a century of war again. Certainly the first half, you see a very different dynamic.

James Macdonald 14:52

Yes, the two world wars are fought at a level of intensity and financially also fought at a level which makes them early on it was looked like sort of pale into insignificance, the levels of of deficits that they engender, it took a long time for public debt to rise, but from sort of virtually 0% to 250%. But you know, in the First World War, it goes from 25% of GDP to well over 100%, in just a few years. And the same with with the Second World War, right, again, in just a few years, it rises from sort of something under 100% to 150%.

Neil Collins 15:27

But by then the market is a lot more sophisticated than it was. And it is sort of vulnerable to what we might call today, financial repression, particularly in the Second War. So that’s the sort of slightly different calculation?

Jonathan Ford 15:43

Before we get to the Second World War, I just want to talk a bit about the interest cost as a percent of GDP. So after the war, it continues to climb, and it gets to about seven and a half percent, which is not quite as high. But it’s a Yeah, it’s a pretty substantial number.

James Macdonald 15:58

This is the exception to these rules. It’s the second world war, because the the rule of thumb, which is one of the reasons you’re been able to borrow relatively cheaply during all previous wars, is that everybody understood that basically, there was always wartime inflation, but it was going to be followed by deflation after the war. And then you would say you have long term price stability. And in fact, if you look at sort of price levels from 1700 to 1900, you can see more or less that that was true. And if that came at the cost of a big recession, not to say, depression, that was a price that you paid, it was the price that had been paid at the end of the Napoleonic War, where there was a very considerable recession, at the time referred to as the revulsion after the war, and that in the late teens, early, early 20s. And this is the time you get the Peterloo massacre, and there’s a lot of political repression. Of course, the problem is that you’ve got a very different political situation, you suddenly now have universal suffrage, you’ve got trade unions, and you’ve got all sorts of things that didn’t occur in the after the Napoleonic War, so that the politics of trying to sort of insist on deflation after the First World War is very tough. You know, and most countries don’t really try it. America tries it. But America doesn’t have the same problems because it hadn’t had the same level of inflation can’t have the same level of war expenditure of war debts on the continent of Europe, nobody tries it, it’s just impossible. I mean, they just go off either into hyperinflation, like all the countries that lost including not just Germany, famously, but all the Austria Hungary is some of the component parts or there, or very, very high inflation like France, and Italy, all of which basically eliminate large quantities, effectively de facto of their debt in the UK tries the old fashioned route. But it is extraordinarily painful. And it comes as an enormous cost. I mean, the 20s is truly a lost decade. I mean, in the teeth of this, you know, worldwide depression, which was I mean, on a scale that is probably unequal before or since. But of course, one of the classes, it’s rather like, unit Black, Black Friday, coming up. I think you mean, yes, I do mean,

Jonathan Ford 18:15

Black Friday saying rather different was a blessing in disguise.

James Macdonald 18:18

Because basically, it enabled the country to start recovering from the depression of the early 30s, it was one of those instances actually rather like the 1990s, the depression of the early 30s, it was one of those instances actually rather like 19 1990s, where the operations of the market were actually putting pressure on the government were
actually beneficial.

Jonathan Ford 18:34

And then we see that in the 30s, in both debt to GDP comes down, presumably because GDP recovers and the interest cost really dramatically declines before the Second World War.

James Macdonald 18:45

Right. Because then they’re able to refinance all the debt with this with this war loan, which basically was only just repaid relatively recently, amazingly enough.

Neil Collins 18:52

Yes. I remember when it when the price, when the price they are more or less, I remember when the price equal the equal the yield, I think it’s about 18 and a half pounds equals 18 and a half percent yield. I remember it happening. I’m that old.

James Macdonald 19:11

Well, I could just about remember it too. I mean, it was just that was just sort of starting out in the in the city when all that happened. I mean, it was completely an astonishing moment. And the opposite, again, of what had happened before. In previous wars. The assumption was that if you lent money to the government at a high interest rate during the when you were taking some risk because of the fugitive who knew what the outcome of the war was going to be you were awarded, not just by being repaid after the war, but also having the price of your bonds go up.

Neil Collins 19:42

This is a unprecedented really, the monetary regime that followed the Second War was in complete contrast to all the ones before then and you failed to get the sort of rebalancing back and the sort of deflation or the falling price. is to restore the bondholders, the Sunless might say it’s sort of been downhill ever since really, and certainly until the first couple of decades.

James Macdonald 20:09

I mean, one thing which did happen after the Second World War was the running of budget surpluses, which seems completely counterintuitive. I mean, after all, the Conservatives were kicked out labour was put in an under the Act, the government were busily going around, you know, people imagine throwing throwing money around the place like confetti in order to establish the welfare state, and this, that and the other. And yet, it managed in by the late 40s. It’s not in the immediate aftermath of war expenses were still very high to run cumulative budget surpluses of 12% of GDP at the same time as bringing in bringing in the welfare state. So there was this postwar retrenchment, in terms of reestablishing budget discipline, shall we say, what there was not was any attempt to keep surly at its own value, I mean, certainly had been sort of pegged artificially during the war. But that was not a real market, of course, you know, the Americans in turn, but for their for a big loan at the end of the war to repay effectively LendLease, insisting that these controls were taken off by 1947, being much opposed by people in Britain, who were terrified about what happened if, if that occurred, because there were massive exchange controls. I mean, Sterling had been after a bit of chaos at the beginning of the war, in fact, just around 444 dollars to the pound, right, a bit lower than its historical rate, but still high, that was considered acceptable as an exchange rate, but they wanted all the exchange controls off by 1947, in exchange for the big end of war loan. But of course, as soon as they took them off, the pan collapsed like House of Cards, and they had to put them back again, within, I think, a couple of weeks or something like that. And by 1949, of course, then they had a big devaluation of not just the patent, but actually lots of currencies, it was quite apparent that the old exchange rates against the dollar, nobody was going to do it, because nobody anymore was going to accept the kind of unemployment that it was going to take to do. So that was the big change from the First World War, Second World War. And it was thanks to particularly to the 30s. But in the States, obviously, with unemployment has got so high, but actually to the whole interwar period in the UK, because unemployment had been high throughout the 20s, as well.

Jonathan Ford 22.16

So in the post war period, we see once again, there’s down leg of public debt to GDP goes
down, really almost retraces in steps from the 19th century from 250% in 1945, to about 30%
in 1992, which I think is the low point. I want to focus on one decade, though, because it’s one
that people often talk about in the context of where we are now, which is of course, our old
friend, the 1970s. There obviously are a series of what are called guilt strikes, I think and
definite evidence of bond vigilantes prowling around in the 1970s, even though the debt is
obviously coming down as a percentage of GDP. What is the dynamic there? What’s driving all

James Macdonald 22:58

Well, I mean, I think that what has happened is that you’d had a period of gradually rising inflation, which then completely become unleashed in the 1970s, then you’d had interest rates which adopted had been, had been very low at the end of the war, partly because of financial repression during the war, they’d been able to borrow it 3%, more or less throughout the war. financial repression is when you have a series of controls, most obviously exchange controls so that people can’t take their money out of the out of the country. So that means they’re a captive audience more or less. And then you basically have the government through the operations of the central bank and the Treasury, meaning that people’s money, they’re not really free to do what they want with their money in various shapes or forms, through a combination of tax policy, through a combination of what they can do in terms of investment. So it means that basically, the government can borrow money at sort of whatever price it likes.

Jonathan Ford 23:54
But what happens in the 70s? Why does even though we still had exchange controls in the 70s, the government clearly can’t borrow money at whatever price it likes, in that decade?

Neil Collins 24:04

No, well, of course they can’t, because the in the end, the suckers got fed up with being suckered and after having lost their capital, both in terms of the nominal value, and see it in eroded by inflation at the same time, they got to the point where they decided that they were prepared to strike and there were actually bio strikes where the government had to issue stock at a ruinous price in order to persuade the buyers to come at all quite right.

James Macdonald 24:34

This is what happened. But I think one has to bear in mind this was not just the product of an oil crisis. That was just the final straw. But basically, this was the product of the entire post war period, the government was borrowing at either zero or negative real interest rates for basically from the war on and by the 70s these negative real interest rates had ballooned, but there’d been high inflation was pushing 678 percent for years even before you got to the crisis, slowly but surely, the bond markets have had already started pushing borrowing costs up towards 10%. By the early 70s. I mean, this was a slow, gradual process, but even 10% turned out not to be enough. You can imagine that even when you call interest rates up to 10%, and then you suddenly get inflation at 25%, I mean, it is going to strike. And the other thing that is really notable about it is once you’ve gone through this period, which is really decades worth of build up to these buyers strikes, and but when you do start to get impatient in the 80s onwards, it takes a long time of very high positive real interest rates, before the markets willing to lend you money ever again, sort of a cheap rate.

Neil Collins 25:52

I can remember, I’m afraid that in 1976, the government had to pay 15 and a half percent for 20 year money. Yeah, which seems incredible. But it was true in the US too.

James Macdonald 26:03

I mean, at that moment of crisis came under Volcker in the second world crisis, but they were paying 15% At the peak, you know, which is even more amazing for the US that you’ve got the privilege to pay almost what it like, but the same process to a lesser degree that happened there, you know, years and years and years of negative real interest rates,
which was the market failure.

Jonathan Ford:

Already, I want to just touch on one aspect of this, which we haven’t talked about so far, which is the changing nature of the state and its responsibilities. And the extent to which that changes, changing nature of the state and its responsibilities. And the extent to which that changes, attitude to the public debt, ie, we’re now I think, in a world where the idea of running a 12% surplus as they did in 1946, or whatever it was, if we ever run a 12% surplus, again, I should eat my hat. But to what extent does that thing where these big buildup of permanent expenditure, like the welfare state takes place? Does it change things?

James Macdonald 26:59

I mean, there are probably two things happening at once. One is the influence of Keynesian economics, as a byproduct of the 1930s Depression, the feeling that you should never be allowed deflation, again, that also that public debt is really not some sort of moral obligation so much as a vehicle of economic management in order to keep the economy working properly. And that therefore, more or less constant borrowing is a fact of life. You add that on to the ever increasing role of the state in public life, which has been true everywhere, and you get a recipe for constant borrowing. And so even though the debt levels have fallen percentage of GDP, rather similarly, as you said they did in the 19th century, this is not because debt had been repaid. And it’s just simply a question that GDP has gone up faster, because of course, now you’ve got even when inflation Calm down, eventually, at historically high inflation, throughout the 80s. If not on 70s level remotely, then you start getting central banks being given inflation targets of 2%, it’d been useless giving them an inflation target in the 80s. Because inflation rates were still running, you know, higher than that. But then it was it was conceivable, but 2%, by historical standards is very high, nobody would have accepted that 0% was the only conceivable rate of inflation that anybody thought was normal over the long term, not over the short term, but over the long term. So all this built in a scenario that if you’re gonna keep debt to GDP ratio, stable, you basically have to borrow the whole time.

Jonathan Ford 28:31

Can I ask about one other aspect, which is the nature of the public debt? And I think it might be a consequence of the 1970s is the introduction of interest linked debt. So debt that changes its interest rate in response to inflationary circumstances? Is this designed really as a way of saying, we’re not going to have any more inflation? So we’ll give you this free kind of assurance, which is that if it does, you’ll get a higher interest rate?

James Macdonald 29:00

It certainly I mean, it came in in the UK, the UK was a leader, at least amongst the g7 countries introducing it. And it was precisely in the wake of the events of the 70s. One of the things which is quite striking about it’s in the UK is that not only the amount, and it’s now 25% of all public debt is in the form of indexing, but also that it’s very long term. And I think that in the wake of all these buyers strikes, because obviously it’s long term debt that is most vulnerable to inflationary, having inflation linked to issues enabled you to keep a long term structure to the debt because people are willing to lend you much more readily over the long term if they think they’ve got inflation protection. So it was thought of a mayor culpa for all the events of the post war era, I think, yes, the reason

Neil Collins 29:43

Why they did it was because it looked cheaper than trying to issue conventional long term debt. And indeed, until very recently, it has proved to be much cheaper because the buyers were prepared to accept a much less Our return for the comfort of the indexation. And when inflation seemed to be cured 2% or less, that looked like cheap money for the government. We know a bit better now.

James Macdonald 30:15

Yes, absolutely. And for a very long time, it was, of course, now you’re suddenly caught on the horns of a dilemma with two very difficult situations going on, which has never historically applied before, of having a lot of index linked debt, so that your ability to inflate the debt away is considerably limited as compared to what it was after the Second World War. And also, because of QE, a huge amount held by the Central Bank, which is in an inflationary environment, supposed to be busy, busy selling it all off, in order to sort of bring inflation down. This is This is unprecedented, quite and quite dangerous situation. One thing it does do, between these two events of QE and index linked, then it gives the government a very strong incentive to bring inflation down, because the cost of not doing so is going to be very hard to deal with. So to that extent, you could argue that’s very interesting, because because the QE problem will also go away, if they can get inflation magically back to 2%, which, of course, they probably can’t almost undoubtedly go, then all these problems basically evaporate.

Neil Collins 31:17

But it needs I’m feared the medicine is high short term rates in order to achieve that?

Jonathan Ford 31:23

Given your sort of long view of the national debt. And and the whole question of debt sustainability, public borrowing crises along the way? How would you cite this one that we’re now in? In the context of the past? Is it possible really to see historical analogy? Can we learn something from what happened in the past?

James Macdonald 31:45

I mean, there certainly have been cycles of rapid inflation, a spike followed by inflation disappearing, in fact, it was it was sort of normal. I mean, the idea of real interest rates was not one that entered into the minds of people in the 18th and 19th century, because they just assumed that they may assume that unless people really tampered with the currency, the fact was, the price levels and the long term were probably steady, because why wouldn’t they be sort of thing. But within that, if you look at price levels, they were not in any sense, like they are now. And I think the biggest reason, probably more than anything else at this is pre industrial revolution, or early stages of industrial revolution. So agriculture was a much bigger part of the economy, food prices are intrinsically much less stable than industrial prices, because you’ve got crop variation. And so the idea that you suddenly might get wheat costing, you know, 50%, more than it did last year, or 50%, less than it did the year before, it was something that people were quite used to. And they could think that that was a big impact on people’s living standards. And it could go either way. So you can certainly find, again, it was people were used to the idea that there would be wartime inflation, on top of what might just be the natural variation of food prices, because of demand pressures, which would come off at the end of the author. And you can see it if you try and create a price in this disease of this as people have, they’re much more variable than they are now. So in that sense, there is a history whether it’s relevant to now, I’m not sure because as I say, industrial societies operate in a different way. And this I suppose, the only historical equivalent is flipping out of the 1930s into the 1940s, where you come out and about which considered to be fundamentally deflationary. And the biggest risks to finance were, in fact, deflation, and you’ve gone seemingly overnight into the opposite. That’s not the separatist.

Jonathan Ford 33:51

Well, I think we’ve covered a huge amount of ground, you’ve done a fantastic job.

Neil Collins 34:00

That was a long time in finance with Jonathan Ford and Neil Collins. Reduction editing by Nick Hilton. And our sponsorship partner is briefcase dot news. If you enjoyed the show, please rate and review it on your podcast app because that will help new listeners find us.

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3 Responses

  1. John Locke’s intervention into this moment of experimentation exposes in a really valuable way the changing philosophical bases of money, the market, and the economy. That is to say, he shows us how the old way of making money and the new way of making money are based on and perpetuate very different ways of thinking about the market and the economy. To leap to John Locke in particular, what he articulates and captures about the new method is that it’s based on the notion that individuals determining their own profit will be, in his view, the best agents for the economy and are the way to understand the economy. That is, we should understand the economy as an aggregation of individuals acting for their own profit. The reason that he comes to encapsulate this view is that he understands money–when you go back and look at his work–as something that people all converge upon for their own interests.

    Now, if you think about the new institutions, the device that is supposed to run, this new money making machine, is based on an individual incentive to profit. In particular, the investors have the incentive to lend to the government for their own profit. By calculating the amount that they’ll benefit, they’ll determine how much to lend to the government. So instead of thinking about money as something that is a public medium which the sovereign is controlling, we’re now thinking about money as a medium in which the device that’s calibrating the supply will be the incentive of investors to create money when it’s beneficial to them. This is a very unusual way of thinking about money, or thinking about individual profit, because, as you know, in the medieval world, usury, or making money for profit and making profit on money, was considered a vice and a sin. Greed was a sin. It was the office of the church that tried to suppress human motivation for greed and self serving profit.

    By contrast, and what seems important in terms of understanding the governance aspects of this, what the British are doing is they’re institutionalizing the motive for profit and individual self interest at the heart of a public project, which is money making, and they’re understanding that incentive as therefore beneficent. Instead of identifying self interest and the drive to self interest as a sin or as a problem, they’re identifying it as a benefit. You can also see this in the era more generally. Another kind of monetary move that they make that’s very closely related to this is they’re creating circulating public debt. They’re convincing people to lend to the government for their own profit. And so, they begin to issue public bonds. And the way public bonds work is that anyone who lends to the government will be creating a public good, because they’re lending to the government, but they’ll also be doing that for their own profit, because they’ll get interest on the public bond. Now, that’s before sovereigns had borrowed from big financiers, but they hadn’t tried to popularize the incentive to act for your own interest. And they hadn’t identified that as something that would actually be beneficial to the public. So they’re kind of identifying public good and self interest.

    This is all to get back to Locke, which is to say, he understands self interest and the drive to individual profit as something that can be beneficent and can act as a driver in the aggregate of good things. That’s how he understands money in the economy. It’s a way of thinking about the market as private decision making that, when practiced collectively, will lead to good outcomes. And part of what’s fascinating is that this new theory about the way the market works really emanates from these institutional experiments as well as other influences that allowed us to get to the institutional experiments in the first place. But the institutions, are actually creating practices that invite theories that really change the way we think about profit or change the way that early modern thinkers considered profit and greed. It rehabilitates them, if you will, or habilitates them for the first time. By contrast, in the earlier world where we had commodity money circulating, there’s no group of private individuals who have a controlling interest and whose interests are themselves driving the system. Instead, we have the sovereign and public officials tasked with making determinations that are for the good of the whole.

    It is not a democratic, populist order by any means. But the way people are understanding the sovereign’s role is that the sovereign should act, maybe for religious reasons in terms of divine right, for the good of his realm and the people in it. That produces a different way of thinking about money and the market. The case of mixed money, that’s a case in which the decision makers in the court faced and articulated this different kind of theory. In particular, what happens in worlds with coin is that sometimes you have to expand the money supply either because money has worn out and it needs to be re-minted or because there’s some kind of, in this case, military demand and sovereign’s want to greatly expand the money supply. The way you recalibrated a money supply that was metal was by changing the amount of metal in the coin. Usually, that meant debasing it, or diminishing the amount of silver in the coin, either to get all coins to be backed with a certain amount of silver in them, or because you wanted to create more coin to pay for military expenses. And while we might not think military expenses are in the public interest, and certainly many of them aren’t, in the medieval world, the question that often arose was: could a sovereign expand the money supply or change the amount of money and coin for what they consider the public good, such as the defense of the kingdom.

    Well, Queen Elizabeth had done that. She debased the money supply to put down a rebellion in Ireland. This is part of the oppression of the Irish by the English. And so, the question that came up to the British court was: was that exercise by the sovereign, that refiguring of the money supply, something within the power of the sovereign? Despite the harmful ends of military action, the court confronts the issue of public power over the money supply and confirms it by emphasizing the need for the sovereign to protect the realm, to protect the money supply, and to be able to manage the money supply and create additional money when it was necessary to defend the people. What the court does in the case of mixed money is elaborate a theory of money that understands money as a contract between the people and sovereign for the public good that has to be managed in the public’s interest. And you might disagree with the ends here of the use of money, but there’s nothing in the decision about individual profit and that understands the market as an aggregate of people acting in their own self interest. Instead, it’s a decision that understands the market, the economy, and the use of money as completely for public ends and within the control of the public–in this case, the sovereign–not in the control of private individuals or creditors. So the contrast between that way of thinking about money and 100 years later, or Locke’s way of thinking about money, is really dramatic.


  2. Societies in early worlds might make it out of silver, but really there’s no reason that money would have to be made out of silver. Many different communities have made money out of many different materials, as you know, such as with shells, paper, wooden sticks, and all sorts of things. What the English do, as one of these series of experiments, is decide to make money out of the promises of investors. The catalyst for this new monetary adventure is war. In the 1690s, the British were fighting against the French, as they often were in those days, and the government was very short on funds. The silver currency was going through one of its usual periods of disarray. Often, silver coin, which seems so stable to us, is actually a really hard medium to keep in circulation because it wears down and people begin to hoard or export it. And so, the British were experiencing all these problems in their silver money supply at the end of the 17th century for various reasons.

    Then, the British government decides to experiment. It agrees with a set of wealthy investors to take their promises. It invites them to lend to the government 1.5 million pounds and it will pay it back over a long period of time. The kicker or innovation is that the government agrees to take the 1.5 million pounds from the investors in written promises to pay–in banknotes. And those banknotes promised the bearer silver. So instead of the government needing to have silver, the wealthy investors would have the silver. They make the contract, the bankers hand over the 1.5 million pounds, mostly in banknotes, the government spends the banknotes, and then at some point in the next years, it starts taking back the banknotes in taxes. If you think about it, the government really has to take back the banknotes because it spent them. It has to stand behind them and recognize them as valuable just as it paid people. It will accept the written promises of the bank back in taxes, but once the government does that, it has set up the same kind of credit issue and credit redemption that it set up with the very first tokens, and in turn, with coin. It has set up a loop of credit in which it’s issuing a unit de facto and taking back a unit. In other words, it’s created money without using silver or gold.

    The striking thing here is it’s not clear the British understood exactly what they were doing. People had theorized different bits and pieces of it. But what’s not clear is if they realized that if they set up such a system, then nobody really needed to cash the banknotes, because the banknotes held as much value as the government would give for them as long as the government was taxing, was a serious, viable government, and people had to pay their taxes in something. They might as well pay it in paper as in silver. There was no need to go to the bank to cash the money. So this is an amazing moment where we see this innovation, which is de facto the government creating credit money out of paper through the intermediary of a group of investors in a way that will liberate the government to spend much more paper into circulation than the amount of silver coin that is in existence. The other thing that’s striking about this moment is that there’s no reason you actually need the investors in the middle of the relationship between the government, its taxpayers, and its citizens. In fact, at the same time that the government is borrowing from the Bank of England, it’s also experimenting with just direct issue bills, where it spends English money into circulation and taxes it back. With both of these things, whether you spend the government’s promises into circulation and tax them back, or you spend the bank’s promises into circulation and tax them back, the government’s basically supporting and creating money that depends on its own credit loop.

    Yet, the system that takes off, for many different reasons, is the bank structured system, perhaps in part because the government finds it useful to assimilate and channel the legitimacy of the investors who nevertheless are holding a silver reserve, and perhaps also because the investors are a politically powerful group who find this to be a really lucrative profit making opportunity. And so, over the 18th century, the English basically started developing this relationship with this group of investors who are the Bank of England. The Bank of England is the first really robust national bank that issues what becomes the everyday currency, although it takes a long time. At first, there are only large denomination bills, but over time, the Bank of England will be issuing the money that becomes the English paper sterling. And there are many governance changes we could talk about that are wrapped up in this innovation. For example, the government is for the first time delegating its public power, or its sovereign monopoly over money creation, to investors who will make decisions about when to issue money. Those investors will also have the incentive to police taxation, so they’ll be pressing the government to tax in a disciplined way in order to get repaid. It’s the bank investors who will now profit from this funding technique that allows them to issue many paper promises on a much smaller silver reserve. Anyway, what we’ve done is see that the government, working with wealthy investors, have created an intermediary, a set of creditors, who will now intermediate the relationship between the government and taxpayers.

  3. The go to books on the subject are by Christine Desan, Leo Goettlieb professor of law at Harvard Law School to discuss her excellent book, Making Money: Coin, Currency, and the Coming of Capitalism. Desan argues that money is a constitutional project, countering the dubious “commodity” theory common to contemporary economic and legal orthodoxies. Desan develops her constitutional theory of money through rigorous historical examinations of money’s evolution, from medieval Anglo-Saxon communities to early-modern England to the American Revolution and beyond.


    And Jakob Feinig, assistant professor of human development at Binghamton University, the history of political organizing and activism around money in the United States, from the pre-Revolutionary period to the New Deal era. Characterized alternately by periods of widespread “ monetary silencing” and mass mobilization, the history of money politics that Feinig documents in his research has much to tell us about the present and future of the modern money movement. For more about the history of money politics, see Jakob’s research on money politics in Sociological Theory and the Journal of Historical Sociology.


    His new book Moral economies of money is excellent.

    And of course you have this debate from 12 years ago that challenged some of the statements and logic that modern monetary theorists make – Debates in modern monetary macro


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