On the new purpose of government debt Frances Coppola has whipped up an absolutely fabulous commentary on the BIS paper on safe assets, which cuts straight to the point. As she neatly expresses, in our new looking glass world... the purpose of government debt is not to fund government spending. It is to provide safe assets. And here's the excellent follow-up to that point: The BIS proposal for ensuring the supply of global safe assets in effect treats currency-issuing governments - especially the US - as the world's savings banks. We can regard this proposal as a form of full reserve banking: government provides a safe deposit facility for investors, borrowing large amounts of money but putting it safely in a vault so there is no possibility of not being able to return it. This is not simply an analogy: producing debt in excess of spending needs will mean that governments become cash-rich, and if governments are running primary surpluses as well then they will be awash with surplus funds which they dare not release into the economy for fear of triggering inflation and a run on their supposedly safe assets. They will inevitably place these funds on deposit at their central banks, which amounts to putting them in a vault. Meanwhile - BIS assumes - these governments will continue to maintain strict control of public spending. Quite how the public would respond to a government that was borrowing heavily and placing excess funds on deposit at the central bank while holding down investment in the real economy would be interesting. Sometimes I think bankers forget that governments are elected by real people, who don't give a stuff about safe assets when they are facing unemployment..... However, there is one very important point to the BIS proposal. It eliminates once and for all the idea that monetizing public debt inevitably leads to hyperinflation. The BIS model shows that monetizing debt can be done at at little risk of inflation. And for BIS, sovereign default is a disaster, because it destroys safe assets and risks the stability of the financial system. That reason alone is sufficient to justify debt monetization, given central banks" responsibility for financial stability. The IMF, the EU and - especially - the Bundesbank should take note. Better to load the central bank up to the skies with its own government's debt than risk a catastrophic sovereign default and global financial system meltdown. In a nutshell it's all about balance. Balance between output, spending desire, investment desire and the relative abundance or scarcity of consumable assets. In the process of achieving that balance, money takes on the characteristics of either debt or equity. And when it makes sense for a private entity to hold its liabilities in debt form, it makes sense for a government to equitise its liabilities - and vice versa. Currently we're going through something of a "corporate liability switch," where it's becoming increasingly logical for corporates to turn equity into debt. The opposite, however, is true of central banks, which are de facto equitising their own governments" debt. After all, what else do you call the process by which a central bank guarantees to backstop its own government debt no matter what, and promises at the same time to absorb gains or losses - from what is effectively a position in national equity - onto its own book? So, just like a game of whack-a-mole, if you push too much into one area without releasing it elsewhere, it inevitably springs up somewhere else. For a while, global imbalances and capital transfers may have disguised many of these realities. But now, with the system increasingly working as one, it's time to remember exactly what government debt is anyway. The clue, as Chris Cook has relentlessly pointed out, is in the original meaning of the term "stock": For several hundred years, the Exchequer financed and funded English sovereigns by issuing IOUs, in the form of wooden tally sticks (pictures) split into two parts. Individual creditors were given the Stock as a receipt and as a credit token which was returnable to the Exchequer in payment of taxes: the Exchequer retained the counter-stock or foil to be matched against returned Stock. This is a point that the BIS is now clearly remembering. Meanwhile, we really do recommend Coppola's entire post. Related links: Why a "free" market changes everything - FT Alphaville In an economy not so far, far away - FT The robot economy and the new rentier class - FT Alphaville When governments become banks - Coppola comment