What Government "Borrowing" Actually Is

As we've established, the government doesn't need to tax or borrow money since it creates money itself. But the government does borrow, right? That's what we're told constantly - either we have to raise taxes to pay for stuff or we have to borrow more. Reporters talk about increases in government borrowing, who the government owes money to, how much interest it has to pay. That sure sounds like borrowing. What else could it be?

Let's start with what it isn't. It isn't borrowing to fund upcoming expenditure. That would require the borrowing to happen first. What actually happens is that the UK government spends money into existence and then, to 'balance the books', issues bonds to investors equal to the value of the spending. These bonds are essentially tradeable savings accounts with a fixed term and interest rate.

But why are they necessary if the money has already been created?

Short answer: They're not necessary to fund spending.

Longer answer: They are definitely not necessary to fund spending but certain ideologically imposed rules (primarily the 1981 full funding rule) tell the government that if it wants to spend on public services it has to also issue bonds for the same amount. 

Investors are then able to convert their reserves to bonds which removes money from circulation temporarily. When wealthy individuals and institutions swap reserves for bonds, they're parking money that might otherwise be spent or invested in ways that drive up prices. This money isn’t lent to the government for spending, it is simply converted to another form - bonds.

This makes bonds similar to taxation in function - both remove money from circulation to prevent inflation. The key difference is that taxation removes money permanently, while bonds remove it temporarily and (to simplify slightly) return it with a premium to the bondholder.

The main bondholders include:

• Pension funds managing retirement savings for ordinary workers
• Insurance companies backing policies
• Foreign governments managing reserves
• Wealthy individuals and family offices
• Banks meeting regulatory requirements
• Foreign investors of unknown origin

Many people benefit indirectly from bonds through their pensions so I’m by no means saying abolish them (at least based on what I know so far) but the mandatory nature of the Full Funding Rule means we've turned a potentially useful tool into an absolute constraint that says "government can only spend what wealthy surplus-holders are willing to convert to bonds."

So in practice, government "borrowing" means: giving investors a place to store their wealth risk free and with a guaranteed return. That’s all. It can be a good thing - pension funds benefit hugely from an arrangement like this, but importantly the money wasn't needed for spending - that already happened. It's just an accounting exercise that happens to enrich bondholders.

This isn't theory or ideology - this is literally what happens. The bonds are real. The interest payments are real. Money creation is real. Modern Monetary Theory gets its name because it describes the mechanics of modern monetary systems as they actually operate, not as economics textbooks pretend they should.