The “balanced budget paradox” is an interesting paradox as the implications of it are obvious but many remain oblivious to them.

It would seem that hiding in plain sight remains an excellent strategy for our private banks.

First off – a balanced budget ‘objective’ means that the government tries to tax as much as it spends. In other words for every dollar it pumps out into the economy by spending it extracts it back again by taxing. That raises an important question. If

the government succeeds in taxing back every dollar it spends what is left out in the wallets and bank accounts of the wider population?

The answer of course is bank created credit as public money (people cannot as a matter of law maintain deposits in any other institution than a ADI – yep that is what makes a bank a bank in our system).

All those banking system deposits created by private bank lending activities are all that there is at the end of the day – if the government truly taxes back each dollar it spends. Every dollar of publicly created money extinguished by taxation.

Thus the demands for “balanced budgets” makes perfect sense in the context of an environment where inflation is a constraint.

Inflationary pressure = (Too much credit creation by private banks) + (too much public money creation by the public sector)

If you wish to avoid inflationary pressures and maximise private bank credit creation it is necessary to cramp the style of the public sector and demanding a “Balanced Budget” does that very effectively.  Even those so called moderates who only want a “Balanced Budget over the cycle” are asking for much the same.  Though as we have seen recently a ‘temporary’ exemption may be granted when Zero Interest Rate Policy (ZIRP) approaches and private bank credit creation starts to fail. Mr Morrison’s efforts in racking up deficits of $500B are a case in point – though even he still rabbits on balanced budgets as remaining his ambition. Old habits die very hard it.

The demand for balanced budgets is nothing more than a demand that the public sector vacate the money creation space and thereby allow more room for private banks to go about their business of highly profitable interest bearing credit creation.

And that demand is very consistent with the “free market” “privatise the commons” ideology because from that perspective what could be better than the complete privatisation of public money creation that is implied by a balanced budget objective.

Now all of this might be fine IF the evidence confirmed the claims of the free market ideologues that only the private sector can efficiently allocate capital and resources (in the form of private bank credit creation) to the most productive purposes.

But as we know from our own lived experience in Australia over the last 30 years, when their credit creation is ‘deregulated’ the private banks have an overwhelming drive to create credit for the purposes of speculation in asset prices.  Particularly when economic vandals like Howard discount the CGT to make unproductive speculation even more attractive.

So what is the solution to this paradox?

Simple really

1. Start restricting credit creation as public money by banks so that as far as possible it is only allocated to clearly productive purposes. Lending for new productive capacity – new housing, new factories, startups etc to be favoured by lending and tax policy. Lending secured by existing productive capacity (existing housing in particular) to be limited.
2. Expand the public sector creation of public money by running a non-inflationary deficit financed directly by the RBA at zero interest (it does not make much sense for the publicly owned RBA to be charging interest to the government as the government collects the RBA profits). The only key requirement being that the deficit part of the budget must also be limited to clearly productive purposes. If there is any question regarding the benefits of the projects posed then the money should simply be left in wallets of the public to allocate to projects they consider to be of benefit. Raising the tax free threshold to leave more after tax income in the hands of workers might be the simplest approach.
3. Continue the above strategy and if necessary, and this is highly likely given past experiences, remove the credit creation as public money privileges of the private banks entirely.   They should be quite happy operating as pure intermediaries as much of the ‘red tape’ that is designed to control their credit creation as public money activities will be unecessary.

But according to some, often those most frustrated by the balanced budget paradox and the practical limits it imposes on public money creation (govt spending), such a simple solution is nothing but money crankery.

Perhaps that is because they don’t really understand what makes a bank a bank in a our modern monetary system and the connection between that status and the “balanced budget” mania of the FIRE sector media outlets and their pet economists in academia.