UK Monetary System … Misfiring on some cylinders!

Having read our model, we can take a closer look at our economy and monetary system. It is only once we get rid of all our preconceptions that we can understand and reach rational conclusions, and then only if we can free ourselves from our own vested interests.


The economy is about Money.


In our case we have chosen not to relate our money to any physical asset, or even any fixed set of rules. By fixed set of rules I refer to many concepts, we could choose another country's currency or even some fixed set of rules that define the rate at which we allow the amount of money to expand.


Money expand?

Good grief, I always found it shrank!


Most countries choose to set the limit of money expansion by way of making government debt the controlling factor. Banks are required to hold a fixed proportion of government debt related to deposits on their books. This gives governments the ability to control the level of debt expansion (money creation) within the economy. Also depending on the level of that ratio it also defines the maximum level of risk to the depositor.


The Euro Zone takes that a step further and insist that, save in times of stress and subject to consent of fellow members, the individual governments will limit their annual deficits to no more than 3%. This percentage is basically designed to allow economies to grow at slightly more than population growth. Growth any faster than population growth is unsustainable in the long term.


John Maynard Keynes at Bretton Woods suggested that all countries in the World should fix their currencies to a World Trading currency that bore a fixed relationship to gold, but had the flexibility to grant countries overdrafts to deal with short term problems. That each country be forced to devalue or revalue their own currency in the event of a deficit or surplus in their foreign trade. (I will touch on this further in a later post)


A physical Asset has a lot of attractions, but comes with both advantages and disadvantages.


Any system will work as long as we understand it's limitations.


The UK system.


In 1998 we passed the Bank of England Act.


This did away with any obligation for our Banks to hold Government Debt as a form of security for the depositors and a mechanic to limit their ability to create money. We therefore chose to tie our money to nothing!


If you look at “GDP and Monetary System explained” you will see that the sum total of money within a closed economy, which bases its money on our system, is exactly zero!


There is no money!


Simply a series of IOUs which once they are all added together total zero.


Perhaps it is clearer if we simply say that our money is only a giant Ponzi scheme, and in common with all Ponzi schemes, it works as long as the chain is not broken nor is there too much leakage.


From the above article we showed a potential break in the chain, when the people start doubting the prudence of the banks they might decide to withdraw “their money” from the banks, creating a run on the banks (Northern Rock) with the potential to bring the whole scheme collapsing around our ears.


"It is confidence,

dear fellow



I also showed that leakage will occur if imports exceed exports. Leakage also has the potential to collapse the system, ears, because foreigners are not bound by any law to accept our money, they might insist on hard currency or assets instead, while we by law are forced to accept our Ponzi money! Other forms of leakage include our investing abroad, indeed any transaction that has the effect of moving “money” out of the country can be a form of leakage that starts placing the scheme at risk.


In yesteryear (pre Margaret Thatcher) we protected against that by having exchange control … strict limits on what was allowed to leak out of our system. The relaxation of exchange control brought a flood of foreign money into the UK far more than enough to handle leakage. It looked a good decision.


Why this big inflow?


Fairly simple, because the UK taxes are based on residence, coupled with the lack of exchange control, makes the UK an attractive tax haven for foreigners!  We express our concern about what the little Tax Havens are doing to us but happily ignore what we are doing to other countries! Little wonder the CIA calls “The City of London” the money laundering capital of the world!


Well this should stop our needing to worry about the leakage in the system. Sorry, since late 2007 the flow has reversed. Our certainty of money flows is much less certain. There are other factors at play as well, we are seeing ownership of businesses move offshore. Perhaps we should look a little closer at our Ponzi scheme.


If we studied the little model based on a primitive society, we would have observed that the flow of money was from consumers to businesses. To keep it running that money was going to need to flow back into the hands of the consumers. As I showed the consumers had to borrow from the banks to complete the second round of transactions. Normally the consumers would also be employees of the businesses and the money would flow back to them by wages and or dividends (the way companies distribute their profits to the owners). Owners of the businesses are also consumers, they also need food to eat, clothes to clothe themselves and a roof over their heads!


As most of the shares in the big corporations are not held by individuals but by institutions like pension funds we tend not to see these dividend flows. However the Pension funds ultimately end up paying pensions to consumers and the natural flow is completed.


The companies will retain some of their profits to fund their future growth, however we should be seeing a flow back to the consumers over a two or three year period. Naturally this all works if ownership of the businesses vests in members of the community. As soon as we see ownership moving outside we are seeing another form of leakage!


Which brings me back to Amazon.


Their tax structure is totally legal and indeed far less complex than I first envisaged.

Their trading company is registered in Luxembourg.

In the UK they have Distribution Companies. These simply receive the books and handle customs clearance and dispatch to customers. They earn their income by charging the trading company a fee designed to cover their costs in the UK.


A few points arise.


  1. The charge by the distribution centres to the trading company is recorded as an export from the UK. While it does represent money coming into the UK, this is only an accounting construction.

  2. When they sell a book published in the UK to a UK citizen, the margin element (usually between 25 and 30%) emerges in the Luxembourg company and should really be recorded as an import, as it represents money leaving the UK. However this is not the case, as our figures for imports of physical goods are derived from Customs and Excise records.

  3. Most of what they sell would probably have been sold anyway, by booksellers on the High Street. In which case the profits would have returned to the chain and been available for new transactions.


Very clearly, if Amazon's UK sales amount to 4 billion, there is around 1 billion leaving our economy that is not being recorded as an import in our National Accounts! That is the real cost to the UK, as that “money” will never be available to circulate in our “Ponzi scheme”, interestingly because of the way we record imports and exports we are totally unaware of this … it is simply leakage!


Returning to the theme.


There are other issues that also affect the efficiency of our “Ponzi scheme”. Examination of our little model would show that it could continue working indefinitely, provided Imports did not exceed Exports, and the money flowing into the business sector flowed back to the consumer, by way of wages or profit distributions.


Which brings me to the subject of “hoarding”. Obviously hoarding or storing of our money has the effect of, either temporarily or possibly permanently, removing from the system and represents a form of leakage.


I will return to this issue in a later blog, and in the meanwhile I will leave you with this snippet from Ernst and Young.


At the end of 2012 the cash being held by, non financial corporations had risen to £ 729 billion (47% of GDP) up from £ 289 billion (26% of GDP) in 2002




We have no money … our ponzi scheme is leaking like a sieve!




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