March 28, 2022

Where Does Money Come From? with Michael McMahon

Today we bring on the sexy topics of fractional reserve lending and quantitative easing with Michael McMahon from the Bank of England and Oxford University.

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Today we bring on the sexy topics of fractional reserve lending and quantitative easing with Michael McMahon from the Bank of England and Oxford University.


Richard Kramer:Welcome to Bubble Trouble, conversations between the economist and author Will Page and myself, independent analyst Richard Kramer. We lay out some inconvenient truths about how financial markets really work. Today we tackle the bubble bursting threat posed by ever rising interest rates, and get a qualified explanation, if that's possible, of quantitative easing. More in a moment.

Will Page:Uh, Michael, great to have you on this podcast. We're honored by your presence. It was great to see you speak in Bristol and to hear somebody as eloquent as you make sense of the spaghetti of economics. But first, let's toss you the microphone and ask you to introduce yourself, your work, and especially for our listeners, where they can follow you.

Michael McMahon:Okay, uh, my name is Michael McMahon. I am a professor of macroeconomics at the University of Oxford. I have spent my career working in central banks and advising governments and teaching governments. Um, and that's what I continue to do, including my research. And if you want to follow me, I'm on Twitter @mcmahonecon, all one word.

Will Page:Fantastic. And I think this is gonna be a very rewarding half hour for our listeners, 'cause there's term, quantitative easing, which people talk about with, you know, passing reference. But to actually understand it is the goal of the next 30 minutes. But let's start with the basics. This is the book that I've got in my basement. I'm convinced that economists today don't actually know where money comes from. If you say, fractional reserve lending, what's that? If you ask what LN stands for, and [inaudible 00:01:36] they don't know even... the acronym stands for.

So I want to fix this by just building up from the very basics, and understand, how does money enter an economy? So I mean, back to Tom and Jane's island basics here. Imagine a country, and I've seen you speak. Your word's like a paintbrush. You just paint pictures with your voice. So paint me a picture, an island, which has a couple of people on it, and they wanna start a central bank and issue money. How would that begin? How does that process kick off?

Michael McMahon:I- I'm gonna take a step even further back. If the island is small enough, they probably don't need money. When we think about why money exists, a- at a very basic level, you can carry out trade without money. Um, the problem really comes, uh, as the island gets bigger. There's more people, and there are more types of goods and services. Because where we could barter, eh, when, you know, when there's just fish from the sea, and, uh, maybe one person provides the services of cooking the fish. Then the- the gig would be simple. The person who fishes, fishes. They go back. Give it to the person who's- who does the cooking, and then they agree to sit down and share the spoils. And maybe one job is, maybe, let's say the cooking is much harder, so we agree that two thirds of the meal goes to the- to the chef, and-

Will Page:Mm-hmm [affirmative].

Michael McMahon:And- and- and one third to the fisher. But that's just about prices. But there's no need for money for that transaction. Where it becomes very difficult. Now, imagine the island's a little bit more complicated, and you know, there's seasons, and there's also a place where there's some fruit that grows. Now, maybe the person who grows the fruit, they grow a lot fruit in the summer, but in winter, they have nothing. And they actually need to strike a deal with the fishing crowd to say, "When we have fruit, we'll give you some fruit. But come the winter, when we have no fruit, we'd still like to get your fish."

A- again, we don't need a central bank at this point, but what would be really useful is a system of IOUs. And that's all money is. It's an IOU. Why do we get a central bank involved? Uh, as sort of a- a- a central authority to issue IOUs. And the reason is, again, once that island gets big enough, once there are lots of these groups, the centrally issued IOU, potentially. Not definitely, but potentially solves all these issues we would have of, Will, I would have to not just trust your IOU, I would have to trust Richard's IOU that he gave you, that you might pass on to me.

Will Page:Mm-hmm [affirmative].

Michael McMahon:So as the economy gets bigger and bigger, there's a lot of trust issues there.

Will Page:Yeah.

Michael McMahon:Um, and so it's a bit easier, and- and this is how central banks operate money. They take a role that says, "I will be the only person who is allowed to issue these special IOUs." Um, now, these are the IOUs that you or I can take out of our wallet, in old terms. You know, go into a shop, take out of our wallet, and buy something with. Why are they accepted? Well, they're accepted because the shopkeeper expects that when they go into another shop, or when they go to their suppliers, they will accept the IOU, because it's issued by an authority we trust. So let's say the island does get big and complicated enough.

Will Page:[laughs]

Michael McMahon:How do they form the central bank? Well, they agree to give one entity the power to issue these IOUs, and then those IOUs form the basis of all these trades. But until it gets complicated, you probably don't need it.

Will Page:Okay. Very, very helpful. We have money. We understand, you know, the role of money here. Now let's expand on how it's being circulated, and how its supply is controlled. I mean, we talked about physical money, printed money. Do banks actually print the money that we see being referred to in the Financial Times and Bloomberg? And do they actually hold that physical money. Or all this just illusionary? We just invent the money that we hold, but a sort of IOU in the background.

Michael McMahon:It's changed a- a lot over time. Um, you know, at- at some level, the central bank that we've described, they do actually print money. So in all countries now, there is at least some circulation of physical notes, uh, and- and- and coins. But it's a tiny proportion of the actual money. So, so, for example, in the UK, it makes up around 3% of what we would measure as the total amount of money in the system.

Will Page:Wow. Just 3%.

Michael McMahon:Just 3%.

Will Page:[laughs]

Michael McMahon:So-

Will Page:You learn something every day, Michael.

Michael McMahon:Uh, so actually, I just looked up the numbers before we came on. In December 2021, the sort of total amount of money in the UK was about three trillion.

Will Page:Okay.

Michael McMahon:So about- a- a- about 3,000 billion. And about 94 billion of that is notes and coins.

Will Page:Wow. That much...

Michael McMahon:You know, so- so yes, there are notes and coins, but you know, we just go out, and we- we spend on our card. And when we spend on our card, it's just... you know, there's accounts at a bank where they move the electronic balance from mine to yours, Will. And when you pay Richard, it shift to him. So- so a lot of it is created within the financial system.

So- so that sort of ge- you asked a question, how is it supplied? How is it circulated? A- actually, most of that money is... I'm gonna use a very sort of wonkish term, but I'll then explain it. So there's inside money created by the central bank, let's say.

Will Page:Mm-hmm [affirmative].

Michael McMahon:But then there's outside, broader money. And that broader money is created by banks. So who creates most of the money in the system? Commercial banks. How do they do this? Well, there's an old model. And you actually mentioned it. You mentioned the idea of fractional reserve banking. And it still appears in a lot of textbooks, and it's still often used as a kind of, like, introduction to students. So how money might circulate. But it's not at all how money circulates.

If a commercial bank wishes to issue a loan, they issue a loan. That sounds very tautological, but all they have to do is say... Richard comes to me, and I'm a bank, and I say, "I think you're a good borrower, so I'm gonna give you money." How do I do that? I put a credit in your account to the amount you're borrowing, and I also put... I give myself an asset, which is the fact that you now owe me that money. So- so I can expand my balance sheet by just creating an entry on each side. I- I put money in your bank, which is a liability. I have to give it out to you. But I also create an asset, which is, you have to give me the money back.

Richard Kramer:Since- since the name of podcast is Bubble Trouble, and you've just described something that seems like an open invitation to create bubbles, maybe it's worth reflecting, or- or helping our listeners understand that there are actually limits to how much banks can just issue in terms of that credit.

Michael McMahon:That's right. Um, but they're limits determined largely by themselves.

Richard Kramer:That is scary. That is a- that is a moral hazard, is it not?

Michael McMahon:[laughs] Well, yes and no, in the sense that why- why do banks do this? They'd do this because they'd like to make a profit. You know. Richard, if you turn up to me, and- and you say you're gonna take all money, and you're gonna go to Vegas, I might think, you know, there's a good chance he's gonna lose. And- and that's not gonna be good for me, 'cause if I give the money to you, and you don't repay that, then that's on me as the bank. That's... you know, I've- I've put it out there, and- and then I take a loss. So they do have... they have reasons why they wanna have self-control. It's also true, and this is the bit where the central bank does still play a big role, is that, if you think about this as being just one bank in the system, it looks like you can do this for free.

You know, you create the loan, and then you get a deposit, and then you can do another one, and you have more deposits, and your bank just gets bigger and bigger. But the bottom line is, people don't borrow to leave the money sitting in their account. They borrow, and they use it to pay someone else. When I lend you the money, Richard, you're at my bank, and I've created the asset and the liability. As soon as you decide to pay Will, who banks with another bank, I have to transfer resources to them. And if I don't have access to those resources, I have to borrow them, and I have to pay an interest rate for that. So the price could be the limit.

But what's the aim of the banks? As- as I see it, this is, like, this by really ha- having never been a banker. I apologize to any of your listeners who are bankers. But I-

Richard Kramer:Well, congratulations. Please keep it that way.

Michael McMahon:Uh, I'm going to, uh, I'm going to sort of trivialize banking. As I always tell my students, banking 101, commercial banking 101-

Richard Kramer:I love this.

Michael McMahon:... is to earn more on your assets, so on the loans you give out, than it costs you in terms of the liability. So if I can get Richard to pay me back 3%, and I can borrow resources when he transfers the money out at 1%, I make that difference. Now, the cost comes if he doesn't pay back or the risks or whatever. But this is exactly the objective. And so what's constraining? So let's go back to that question of what is potentially constraining me just doing this again and again and again, until I get proper, you know, Ponzi scheme bubble problems?

The answer is, I'm trying to make sure, and hopefully this is the incentive of the banks, that I make a profit on the transactions. And again... I'm- I'm not just making a profit. I'm doing a whole bunch of other things which are kind of useful for the economy. I'm transforming maturity. So most of the people who deposit their money in the bank, th- they want to have access to it regularly. But most of the people who borrow, for a mortgage, or a corporate loan, they want to borrow a 10 years, 20 years, 30 years. So I provide that ser- that's very useful. I also pool risks. I do a whole bunch of things, and that's what... that- that's the service I'm providing to the economy.

But yeah, it scares people when they think about this in a one bank system, 'cause yeah, you're right. You could just keep doing it, because the deposits never leave, and you never have to actually pay that interest rate. But in reality, the- the- the money circulates, and then the bank has to be ready to potentially borrow from other banks or from other people in order to- to- to sort of balance their books.

Richard Kramer:And this, presumably, is why you get the system-wide contagion that we saw in 2008 with Lehman Brothers, and the pride of Will's home country, RBS.

Will Page:Ah.

Richard Kramer:Where Fred the Shred had built up a two trillion dollar book of liabilities. Uh, and that maybe was a good example of the contagion that spread, and was ultimately... had to be bailed out by another famous Scot that we'll, uh, is- is well acquainted with Mr. Darling.

Michael McMahon:That's right. You know, and I think the aspect of the crisis that I think is- is probably the most, um, the most striking in terms of why we got such sort of, I'm gonna call it violent contagion, is the amount of leverage that was in the system. So Song Shin and Tobias Adrian famously pointed this out around the time. But we had banks that were so highly leveraged that even a really quite small drop in the value of their assets essentially could wipe out their equity. And once your equity looks like it's being wiped out, the only things you can do is delever. And if you, to delever, for my listeners, what I really mean is, you got to sell assets to pay back your debts.

Richard Kramer:Wow.

Michael McMahon:But if- if everybody starts selling assets at the same time, like, it doesn't matter if we're talking about mortgage assets that they're selling or stopping lending, or if we're talking about cars in the used car market. If everybody tries to sell the same asset at the same time, economics 101 says the price drops. But that just amplifies the problem. And so you get what- what they call fire sales. And so this is where, you know, a lot of the bail outs that we saw in the financial crisis were about stopping that.

That doesn't really... that takes us a little bit away from the point of them creating money, but you can see how the amount of money in the system is reliant on the commercial banking sector, and- and- and it gives you some hint as to why some of the interventions around the financial crisis were really about preventing a full-scale collapse in that, because you- you would be talking, then about a full-scale collapse in the monetary system. And that- that doesn't seem like something that's desirable in modern economies.

Will Page:No. We have a- we have a recurring joke in this podcast when Richard and yourself discussed moral hazard, which is, if you ask a banker what do they think about the moral hazard, they're familiar with the second term, but they have no knowledge of what the first means.

Michael McMahon:[laughs]

Will Page:[laughs] To be continue. Um, my last question before I toss it back to Richard to take us to the break, is just with debt. Square this circle with debt, which is, a government controls money supply. It creates a central bank. It runs an economy. But then we hear our government here in the UK has to pay all this interest on debt. So this is confusing, which is, who does the government owe the money to? How can a government owe money? It creates the money. So can you just explain for listeners at a very basic level, and a way that only you can, who are they paying the debt to, and why?

Michael McMahon:Well, so- so the way the government borrows, you know, at some level, the description you're- you're putting out is one way. They could just print the money themselves.

Will Page:Right.

Michael McMahon:And at- at least theoretically, a lot other countries could do that. Historically, countries that have done that have fared very badly. Because if we go back to my very fundamental point about why this... having a central authority issue the IOUs, why is that a good thing? And it was about trust. But if the person what's issuing these, if you don't know if they're gonna issue, you know, one or just so many that they're gonna become worthless, then you know, you're not gonna want to use them. And so we wanna protect the- the sort of credibility of the money supply.

So most countries, including in the UK, have separated the issuance of currency to the central bank, the Bank of England. And you know, the debt side of things, which is run by the government. And actually, in the UK, there's a separate body called the Debt Management Offices, the DMO, that sort of manages that. But that's a sort of separate point. They- they're doing that to get efficient sort of interactions, uh, selling at the right time, et cetera.

But so, even if you think about the consolidated position, the answer about who owns the government debt, who do they owe it to, the answer is actually all of us. Probably indirectly, but anybody who has a pension, their pension fund has probably got some holding of UK government bonds, if they're based in the UK.

Richard Kramer:Wow.

Michael McMahon:If you put your money in a bank account, you- you deposit it there because you hope that at some point in the future, it might be tomorrow. It might be in a month. It might be in five years. You will go back and get it out, and in the old world, it would come with some positive interest as well.

Richard Kramer:[laughs]

Michael McMahon:Um, but what they were doing with this, they were investing that in government bonds as well. So again, you're not buying them directly, but indirectly, you are funding their purchase. So the idea that we just cancel this, you know, that's sort of, I think where you're going. You know, why- why can't we just say, you know, "We owe it to ourselves. Let's just wri- write it off." We don't really owe it to ourselves. The government has borrowed it, and some of us hold some of us, some others hold different parts of it, and it would be a bit, a little bit random. So instead what we could just do is the government could pay it back by taxing all of us. And maybe they tax us all the same, maybe they tax us differently. That's politics. But somebody owns it. And actually, quite a few foreigners also own it. So potentially international investors have bought these government bonds. So it's not quite as simple to say, "We owe it to ourselves. We just write it off." Um, we- we've sort of ruled that out.

Will Page:And that tees up [inaudible 00:16:42]. Richard, you want to take it to the break?

Richard Kramer:Yeah, I- I guess, there's so many of these basic issues that I'll just say in wrapping up part one, people don't think about. And the- the- the simplest questions are always the best ones. How does money get created? Who does all government debt get owed to? Who issues that money? And I- I think just to start to think about some of these things is- is refreshing, given all the- the technical jargon that gets thrown around probably in no small part, to bamboozle people and keep them from focusing on the fact that we're all on the hook for that government debt, and if we wrote it all off, we'd have a big hole in our pension funds. We'll be back after the break to talk about the ins and outs of that super sexy topic, quantitative easing.

Michael McMahon:[laughs]

Richard Kramer:Welcome back to the second part of Bubble Trouble, with Michael McMahon, economist and Oxford University professor of macroeconomics, that is. Not microeconomics. Let's draw the distinction there. And Will, I'm gonna hand it over to you to see if you can tease a reasonable explanation out of Michael about what this quantitative easing, QE, that I think we're on the fourth or eighth or 12th round of it now. If you can get him to explain that-

Michael McMahon:[laughs]

Richard Kramer:... in layman's terms, so that my mother could actually understand it, then you'll have performed miracles.

Will Page:Well, I'm thing not just your mother, but there's a rule in newspaper editing, and I think the Times has this rule, which is the edit for 11-year-olds. So you have a complex subject, and then the subeditors have to make it digestible to an 11-year-old. So we can keep that 11-year-old in mine, we're gonna cross the ball to Michael, who's sitting in the box, ready to header it in the back of the net, which is quantitative easing. We want to know, what is it? Like, it landed from planet Mars. What is this thing? Why did it come about? What has it achieved? Which is gonna be a taboo topic, and I can see Richard latching onto you with that one. But also, what would have happened had we not implemented it? So for that 11-year-old, quantitative easing, take it away.

Michael McMahon:Okay. So 11 is a big ask because, uh, I hope the 11-year-old has at least paid some attention to, uh, basic accounting. Uh, but I'll- I'll try to keep basic accounting out of it. So the description I gave of money, and- and some of the control that these central banks had over, uh, the supply of money. I- I previously said they would set an interest rate, and then, you know, that interest rate was potentially the cost to a commercial bank, if they needed to borrow money. Maybe from other banks. Maybe they paid a little more than the central bank rate, maybe from the central bank. Maybe they'd have to pay that to their depositors, which is another form of borrowing that they did.

Now, at some point in 2009, in most, in- in many advanced countries, we, a- as part of the financial crisis response, we cut interest rates a lot. And we cut interest rates to the point where they hit, let's just call it zero. It some country, it's a little above zero. In some countries, it's been a little bit below zero. But ballpark to zero. But they couldn't do anymore. And the reason you can't do anymore is if you start charging people to put their money in the bank, they don't have to... They could just hold it as cash, as notes and coins. So if you remember the earlier discussion where I said 3%. We could just have all of the money that's currently electronically held, that could all just go into actual notes and coins. And- and- and the central banks commit to make all this- all those notes and coins available if people want it. So- so that was what we call a bound on interest rates. You couldn't do any more.

So then the question was, the economy was still really not doing well. And we wanted to try and support the economy. Enter QE, quantitative easing. What was the idea? The idea was that the central bank, rather than just setting a price, would actively go into financial markets and start buying assets directly. Why would it do that? Well, it would do that because it would help the banks themselves. I was describing a world where asset prices were falling, and the banks were sort of then try to sell them because that's what they had to do, because they were highly levered. Because they were basically on the verge of bankruptcy.

If you could support asset prices, you could not only give them, you know, a- a sort of platform from which to continue lending, but you might, or at least the hope was, you would encourage some more lending. And that extra lending or making it cheaper for big corporations to borrow, making it cheaper for households to borrow, would encourage people to spend more money. And that would be what helped the economy get back on its feet.

So when people say quantitative easing, what they really just mean is, we're switching from thinking about the price of money, to actively trying to buy assets and make it cheap in other ways for people to borrow and invest.

Richard Kramer:But if I- if I wanted to be a little bit cynical, to intervene here, isn't it mostly people who can borrow a huge amount of money that benefit from those lowest interest rates, not the average person?

Michael McMahon:Um, I mean, if you- if you were to track what happened to mortgage interest rates, they've also come down massively. And- and you know, they're the biggest form of borrowing that households do.

Richard Kramer:Right.

Michael McMahon:So, I... and again, so let's think about why that is.

Richard Kramer:But how- how... Can- can you set more... the- the value of mortgages, then, against the value of corporate borrowing?

Michael McMahon:Uh, so in theory you could, and in- in practice, most central banks didn't try to make that allocation decision. They left that to the banking sector. But- but actually, as I'll- I'll describe it in a second, but, um, just to go to why... So think about, why would, and- and, you know, some students, you know, now of economics. In fact, I had my first lecture of my first years just very recently. And for the first time ever, they listed inflation as one of their concerns. Right? They had never lived in this world. But they've also never lived in a world where interest rates were above basically zero.

Richard Kramer:Yeah.

Michael McMahon:That- that- that's the world they've lived in. So what's- what I find interesting a- about this is, you- you ask, "Well, why, if you've got a mortgage in 2006 in the UK..." I mean, depending on how competitive the mortgage was. But you weren't paying less than four or 5% mortgage interest. That's what the rates were back then. Now, well, they're starting to drift up again, but a year ago, you could get a mortgage for under 2%. So- so why did they come down?

Again, if we go back to the reason why- why commercial banks create money. They create money to make profit. And if they think that they can get money from the central bank or from other banks for close to zero, and they can charge me two, 3% on my mortgage, they're happy to lend. That's their profit margin built in.

So- so that was the sense in which, pushing back on- on your intervention, Richard. The- there's an element where it did affect a wider populous of people. Now, I think the compla- or one of the complaints is, what this really did is it boosted asset prices. It boosted, you know, it boosted the value of government bonds. It boosted equities because people who used to hold government bonds now bought equities, and they went up. And it boosted house prices because people who had a house were able to borrow more, and then they bought a bigger house, and there aren't that money houses, so the price went up.

That's almost certainly true. There- there have been unequal effects of this. You know, it's lowered the cost massively to the government, if we think about what most governments did in the pandemic. They increased their borrowing in order to support the economy. In the UK, the UK government was underwriting 80% of the wages of about 20 million people, at the height of the furlough scheme. That basically meant the government was saying, "I will pay you 80% of what you were on. And we'll just cover that." And they did that by borrowing.

So why were they able to do that? Well, 'cause the government was borrowing at essentially 0% interest. You can sustain much more borrowing at that level. Again, through indirect channels, it also fed through. And it's- it's at least potentially allowed the government to do more. But yeah, the complaint that had boosted asset prices I think is actually also right as well.

Will Page:Well, let's just go back to, we're combining post-graduate economics with first-year economics here. So the government borrowed to finance a furlough scheme. Just remind our listeners, who did they borrow that money from, and what is the process of paying that money back?

Michael McMahon:Well, so they- they issued bonds. Bonds are just pieces of paper. They're a different form of IOU. They're a contract with investors. And it could be the pension funds. It could be the commercial banks that bought them. In- in theory. Although it's not so popular here. It's much more popular in Germany. Households can even buy government bonds. A- and so, one place that the many came from is a lot of people had forced saving over the pandemic. You know, again, there's a huge inequality on this. Households that tended to be richer were able to stay at home but still complete their jobs, and so their pay didn't drop. But they stopped going out. They didn't have a summer holiday.

Will Page:Yeah.

Michael McMahon:They- they didn't, but...

Will Page:Costs fell for more than income fell.

Michael McMahon:Yeah. They- they ended up getting this big excess of saving. Let- let's say you did nothing. You're- you're a bit like me. You're- you just sort of leave the money passively in the bank. My bank used some of that money-

Richard Kramer:Wow. [laughs]

Michael McMahon:... to buy government bond.

Richard Kramer:It's so [crosstalk 00:26:22].

Will Page:So- so- so who funded it?

Michael McMahon:I did.

Will Page:[laughs]

Michael McMahon:I did. I- I- I-

Will Page:It's crazy. All right, so now I'm gonna commit the cardinal sin in podcasting, which is asking you to describe a chart. That's not an easy chart. But you did do a good job describing it in Bristol. And the chart comes from Resolution Foundation, and the way you explain this. And again, take that paintbrush of yours and explain it to our audience, is there is a point where it really has come full circle in terms of the IOUs between the government and central bank. There's as much going out as there is coming in. So just walk me through this chart from the Resolution Foundation, because it... I found it just fascinating to try and comprehend the scale of QE that's in the economy right now. We'll make sure that this chart is available on our website with a... to accompany this podcast as well. So our listeners can find it.

Michael McMahon:Yeah, so this is- this is a chart which, yeah, as you say, the Resolution Foundation calculated the data. And actually, I... I actually find it quite easy to explain, given the conversation we've had.

Will Page:Mm-hmm [affirmative].

Michael McMahon:So I said that the- there was a body separate from the Bank of England. A government body called the DMO, the Debt Management Office. So, but if you think about them just as the government, the government, when it borrows, issues bonds. Now, of course, day-to-day, sometimes they issue a bond, sometimes they have to pay one back that they issued a while ago.

What the chart shows, and if you do look at the chart, these are big blue bars. But it shows from the start of the pandemic in March 2020, to the end of, uh, of last year, December 2021. It shows how much extra debt was issued by the government. So this is them writing these contracts to borrow from people.

Will Page:Extra on top of what?

Michael McMahon:Extra on top of the existing money that they owed.

Will Page:Okay.

Michael McMahon:So- so- so it's what's called the net issuance because-

Will Page:Okay.

Michael McMahon:... some... they probably issued more bonds, but some of those were just to pay back, to get money in to pay back mat- what we could call maturing bonds, or loans that came due. But the- the extra, the extra on top of that, was about 500 billion. Now, at the same time, the Bank of England is doing this QE. And I said the QE was just the central bank deciding to buy assets in the economy. One of the asset's that they're buying are government bonds.

So now, Will, we are back to your description that you had before. We have, you know, the government issuing, and a part of the government, if you want to think about them like that, buying. And it turns out, what the Resolution Foundation chart shows, and it varies from month to month. But over that whole period, the Bank of England bought about 450 billion, where the government had issued about 500 billion new.

Will Page:[laughs] That's crazy.

Michael McMahon:So it sort of feels like I've- I've taken with my left hand, and used that to pay my right hand. You know, just repeatedly over the process.

Richard Kramer:I guess one of the questions I've got there, though. And again, this is to the fundamental issues of inequality we were talking about in our last podcast with Kurt Anderson, is hasn't a lot of that- those QE purchases by government been, um, of bonds in the private sector that may not have been government bonds. It may have been private debt. But it was the debt that the banks didn't want to hold anymore. The- the low quality debt, or the debt that might have caused them problems down the road. They were able to get the government to back stop them for in this difficult time.

Michael McMahon:Okay. So- so some of that went on initially, and the chart that they created was actually the... it was only the net purchases-

Richard Kramer:Okay.

Michael McMahon:... of government bonds. But- but they wee also potentially... They were potentially buying some other things. Um, so- so they- they bought a- a- a- a bit of, uh, corporate bonds, et cetera. So, and absolutely, that- that benefited those corporates more than it did you or I directly because, you know, they- they didn't call around to my house and say, "Michael, would you like to sell me anything? And- and I'll buy it off you."

But again, thinking about the effects of this, you have to think about the wider fallout of the effects. And if you think that those big, blue bars were supporting 19, 20 million workers through furlough, the effects of that action were also, you know, probably of wider benefit.

Will Page:So one last question from me, then Richard to take us to the finishing line here. And this has just been one of the best conversations I've had on this podcast. But I- I'm just going to frame it this way. If I was to run for prime minister, and my campaign was to say, "I've understood everything Michael McMahon's said. I now get my head around quantitative easing. I get where money comes from. Fractional reserve lending. You know, 3% of all the money in the world is actually money. Okay, bamboozled enough. But this is where I'm at.

But a third of the stock of debt this country has is QE, which is this IOU between the Treasury and the central bank. And we're looking at austerity measures. We're looking at public service workers getting no pay rise for year upon year upon year. We're looking at inflation. We're looking at a central bank governor who's on, what? 800,000 pounds a year, saying, "Hey, people, don't be too aggressive in your pay increases," which was, I wouldn't ask you to comment on that, but for me, disgusting. What if I was to say, "Vote for me, and I'll just cancel that third stock of debt off the boot." 'Cause I'm gonna have a debt jubilee. This circular carousel of cash makes no sense to me. Wipe it off. Clear my boots, and let's just grow the economy out of the pandemic and make tomorrow better than today. Would I get your vote?

Michael McMahon:No. So let me explain why. I- I think there- there's elements of your plan that I'm- I probably would be happy to vote for. But I do think that the impact of a loss of credibility. 'Cause what you would be basically saying is, "We have made a bunch of promises in the past." That's what the bond is. It's, you say, "I'm gonna issue a piece of paper. You're gonna give me money, and in the future, I'll give you money back." Because that's how lending works.

Or if you think about money, if pull out a UK bank note, it says, "I promise to pay the bearer on demand." Maintaining trust in that system is important for the system to keep working. Now, so if you turned around, and you said, "I'm just gonna wipe off a bunch of this stuff," partly, it's gonna hurt ourselves because you know, our pension funds hold it, so they just-

Will Page:Mm-hmm [affirmative].

Michael McMahon:... suddenly lose some money, and we're all a bit worse off through that.

Will Page:That I agree with. I get that part.

Michael McMahon:Right. Now, what about- what about all the other stuff? Well, if I'm an international investor. 'Cause some of the government bonds are bought internationally. They're gonna look at the UK, and go, "there's no way in hell." I- I, you know, those guys are... they might just turn around and go, "Well, we don't want to upset the voters, but people from abroad? I mean, they don't vote." That'd be ideal people to- to wipe off, their- their loans to.

A- at that point, they stop lending, and that... Certainly, you get this mass depreciation, which causes inflation. And what do we know about inflation? We're seeing it right now. Again, these students who've never seen it before. Inflation hits the lower income classes much more than it hits the higher earning people. So, yes. You can imagine a, sort of a beautiful world, where you just click your fingers, and this is all wiped out. It's a such a complex system. It... You know, it's gonna be very costly, and the fallout of damaging credibility is gonna be huge.

Now- now, there are other ways you could do the type of things you're saying, right? You could offer to tax people a bit more. That's a political choice. But political narrative has shifted that we somehow all are obsessed with low tax, low spend worlds. That doesn't have to be the case, but that's a political choice.

Will Page:But you- you do say that would create inflation. But for the public, it's got to be a challenge to say, "You can invent all this money to subsidize banking, but you can't wipe off debts that we owe ourselves." In regards to credibility, we do mark our own homework. I mean, it's a- it's a... In today's climate, it's a tough one to take, isn't it?

Michael McMahon:Oh, sure. I mean, the... so, the difference, and you know, the difference between this QE being just purely, I've printed the money for myself, which is the kind of Zimbabwe problem, where they had their hyperinflation-

Will Page:[laughs]

Michael McMahon:... in places like Zimbabwe. You know, that's a... that's a... that was a world where we were issuing bank notes for 100 trillion dollars, a year after they were issuing bank notes for one dollar.

Will Page:[laughs]

Michael McMahon:All right, prices were doubling within the day. You know, I talk about my students having never experienced inflation. They're only experiencing inflation now of seven, 8% this year, problem. [laughs] I mean, we're talking about 100% a day at one point. Not quite, just below. But- but I agree, yeah. People will find... You know, the idea, it's very alluring. You know, it seems like it's sort of the cost-free, print a bit of money, no cost.

Inflation is as... Economists call it the inflation tax. It's obviously not a the ax that you levee, but you print the money. You get- you benefit from it, but everybody then pays through the inflation. And- and- and I think part of the attraction of it is that people have forgotten how costly inflation is. And in particular, at a time where wages are not going up. So i-- I was talking about inflation yesterday. And someone asked me, they said, "Oh, you know, it's- it's not so bad, right? Because inflation now, we're talking numbers like seven, 8%, whereas, you know, in the '70s. I think 1975, it was over 22% in the UK."

And I said, "You're right. It's not as high a number." But in some ways, what we've experienced now is worse. And the reason it's worse is because in the last 11 years, real wages basically have been flat, by which I mean, adjusting for inflation. In the 1970s, we had high inflation, but we also had high nominal wages. Between 1970 and 1981, wages adjusted for inflation grew by 38%. Between 2009 and 2019, end of 2019, they were flat. Flat.

Will Page:Wow.

Michael McMahon:They fell in real terms for six years. So in some ways, it's worse, right? So again, I-

Will Page:Pass me a bucket. Pass me a bucket. [laughs]

Michael McMahon:The- this is... I agree that we need to do something to get wages growing, but- but I don't think creating inflation is gonna be the way to do it. I think that would hurt more people even more.

Richard Kramer:Now, as we move towards the end of this, uh, episode, we like to ask our guests to get smoking with us a little bit. We ask our guests to come up with a couple of smoke signals. Things that make them go, "Uh-oh," when they observe the behavior of the central banks that you observe so closely yourself. What are the two or three smoke signals you would point to, and what you see happening in the global macro economy right now that you think would potentially be really troublesome down the road?

Michael McMahon:One answer would be more related on the financial side, which would be the issue of... If you ever here the- the expression, this time is different.

Will Page:[laughs]

Michael McMahon:Or the- the idea that something that looks like a bubble. I, you know, on- on Bubble Trouble, I have to mention at least once. If something looks like a bubble, but people tell you, "No, no, no. There's fundamental reasons for this," I think that should be an immediate reason to go desperately seeking and really interrogating those fundamental reasons. I say this as a very proud Irishman, who listened for years as people told me, "No, no. There are fundamental reasons why double digit house price inflation for 15 years is perfectly normal and acceptable."

Richard Kramer:[laughs]

Michael McMahon:Followed by a 40, 50% house price crash. Um, so that's what-

Richard Kramer:Yeah. And- and- and- and by the way, the- the complete defenestration of all of the senior management of every large bank in Ireland.

Michael McMahon:[laughs]

Will Page:[laughs]

Michael McMahon:So that would be on the- on the sort of, what we call the macro financial side where I'd have worries. On the sort of monetary policy side, I think whenever you see central bankers and market and journalists, and everybody, including academics like myself. When we all start agreeing, I think you should start panicking.

Will Page:[laughs]

Michael McMahon:You know, the- the world is inherently uncertain, and I think that one of the healthiest aspects of policy setting is a robust debate about what could go wrong. And as soon as you start all thinking that nothing could go wrong, I think it's a time to start worrying.

Richard Kramer:Group think.

Michael McMahon:Either group think, or just a naivety, or some sense that you have things under control. Because the reality is, as I- I've described it in I hope relatively simple terms, and even those terms are not that simple. That the economy is complex. Managing it is hard. We are constantly living in a world of uncertainty. Uncertainty is the basis for why we have policy makers, and why they will always make mistakes, but you hope they make small mistakes, and they correct them quickly.

So- so, I think those are the... on the financial, macro financial side, I worry about when they say, "No, no, no. Nothing to worry about by what..." If it looks like a bubble... [laughs] It probably is. And then on the, uh, on the monetary side, if everybody agrees, and that... and especially when they all... Actually, I'm no so worried when they all agree it's a disaster, because usually that's- that's when uncertainty is lowest. When- when things have really hit the fan. But when they start agreeing that we're in really calm, sanguine times, and there's nothing at all to worry about, I start to worry.

Richard Kramer:There is no better example of that perpetual uncertainty than the fact that we're... we've been through four quantitative easing, and each one was supposed to be the one and only. And we've had multiple bouts of quote, unquote, "money printing." And yet, it's still something that's discussed. So all of the radical solutions that were supposed to be a one-time only stop gap measure seem to be repeated. And as we said in the last podcast, history may not repeat itself, but it sure rhymes very often.

Will Page:[laughs]

Richard Kramer:So Will, do you want to wrap us up for this episode?

Will Page:Well, my thanks to Richard Kramer, and especially to Michael McMahon, for giving us, uh, a qualified account of quantitative easing. It's been a joy to have you on the podcast, and I hope we can get you back as well. For the next round of quantitative easing, which is sure to come, uh, going back to that 11-year-old, I think the next bit for an 11-year-old to study economics is the boy who cried wolf. I think that's the perfect, uh, a perfect primer for what's going on in this world. But thank you, Michael, and thank you, Richard. This has been Bubble Trouble. I'm back with you next time.

Richard Kramer:If you're new to Bubble Trouble, we hope you follow the show, wherever you to listen to podcasts. Bubble Trouble is produced by Eric Nuzum, Jesse Baker, and Julia [Natt 00:40:49] at Magnificent Noise. You can learn more at Will Page and I will see you next time.