“How to Pay for the War,” or, Just about Anything! – Keynes 1940

Whenever a progressive party proposes a better education system, a better NHS,  better public transport or whatever,  the killer question is always “How are you going to pay for it?” The implication is that someone will have to pay by way of an increased tax bill or the money will have to be withheld from some other worthy project to compensate.

Our parents’ and grandparents’ generation had a similar, but much harder, problem to solve when it came to the question of how to pay for the war against Nazi Germany in 1939. If the principles of ‘sound finance’ which held that government budgets must at all times be balanced had been rigidly applied then surrender would have been the only option. Fortunately, the Liberal Party, and the country, had at their disposal the best economic mind of the 20th century in John Maynard Keynes who explained, in his 1940 book “How to Pay for the War” how an inadequately armed country of 40 million people, with an economy which had been performing poorly in the inter war years, could at least start to function well enough to take on a much better performing country, at least economically, of twice its population.

Keynes was anxious to avoid the economic mistakes made in WW1 when increased spending on armaments simply increased the wages and therefore the purchasing power of the average person. This led to not only inflation rising to over 20% but also created an economic incentive to industrialists to supply the home market rather than the war effort. In 1940 a similar inflation problem was developing. Keynes saw that simply increasing taxes on the average worker would not only be inadequate, it would also be counterproductive to morale. He had the insight to see that savings, which subsequently were made compulsory, were just the same as taxation in this respect.

Of course some of the wartime measures, like rationing and strict price controls, would probably be unacceptable to us now. But Keynes’s ideas did work. Inflation was kept under control in the later war years. We shouldn’t say that Keynes showed us how to pay for everything. Clearly that is not possible, but if we understand what he was saying about savings we can also understand that we can afford to pay for much more than we do. This is only subject to the constraint that the available resources, such as people wanting to work, are there in the economy to provide for the things we need. In other words, we should not overlook that Germany now is our biggest saver, selling us twice as much as we buy from them. Germany likes to run a trade surplus with us and to save the excess money it receives as pound sterling denominated bonds or gilts. We can, and we do, use those savings instead of tax revenue. We call it a deficit.

So, if Germany and other savers, like it that way, why should we feel bad about it?

* Peter Martin is not a LibDem party member but has voted LibDem in previous elections.

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19 Comments

  • Barry Snelson 25th Jan '16 - 2:31pm

    Good Lord! John Maynard Keynes won World War II.

  • John Roffey 25th Jan '16 - 4:45pm

    Although I do agree that:

    “Of course some of the wartime measures, like rationing and strict price controls, would probably be unacceptable to us now.”

    I do think that rationing energy that is produced from fossil fuels might be accepted after the climate change conference in Paris – with each individual given units that can be used however they choose for their private use and some tax on suppliers that relates to the fossil fuel used in delivering goods and services. After all – if the battle against climate change is lost – the outcome will be worse than losing WW2!

    The latter would significantly help the economy by pushing imports down – at the same time helping local economies.

    How much fossil fuel does it take to transport each ton of steel from China?

  • JamesMurrayLaw 26th Jan '16 - 1:25pm

    Peter,

    You do not mention the other Keynes idea of Sovereign Money Creation (SMC) – printing money.

    If this is so repugnant, how is it that, over the years, the Government with no problem was able to insert some £60 billions of notes and coins from the Royal Mint into the economy?

    The B of E runs just the Treasury accounts and credited with the extra cash – just a couple of keystrokes.
    Double entry sticklers are relieved to see the B of E did debit a notional ‘notes and coins’ account to make the books balance.
    This account has no importance, and does not appear as a balance sheet liabilty.

    Keynes, idea was the same free-money can be had by the Treasury without actually printing it.
    It issues interest-free loan bonds with no redemption date (just like sterling paper notes).
    This time, the B of E ‘buys’ these bonds off the Treasury by keystrokes in its computer accounts – like it did with the above minted money.
    The Treasury’s account is credited with the money with a notional debit in a perhaps-named Sovereign Money Account.

    And again, as the bonds are notional (no interest or redemption date) they have no effect on the National Debt.

    This means that as the Government spends the money – on tax reduction, infrastructure, or whatever – the money supply is increased by that £X billion.
    Economist students, and most LibDemVoice readers, will be aware of the ‘Multiplier Effect’.
    As this £X billion is received by those infrastructure workers in wages or by taxpayers’ extra cash it is soon respent and its injective effect is multiplied by some ~10 times

    Now please appreciate that where there is ‘slack’ in the UK economy – i.e. room for more growth this will NOT cause Weimer wheelbarrows of inflation.
    With deflation/recession/low growth the economy will simply suck up the injection, there will be more economic activity, and the GDP will get a much-needed growth boost.

    However, if it is done repeatedly by greedy politicians and into an already overheated economy, then all bet are off – it will indeed cause inflation.

  • JamesMurrayLaw 26th Jan '16 - 1:29pm

    Sovereign Money Creation has a well-thought out history and goes back to the Chicago School of Economics in the 1930s, and as well as being supported by Keynes, Milton Friedman also put it forward as the answer to recessions/deflation/slow growth.

    Lately it has been supported by Lord Adair Turner of the FSA, Bert Bernanke of the Fed, and Martin Wolf of the Financial Times – all have come out in favour.

    The tenets of SMC were discussed at length at the House of Commons on 20th November 2014 at an all-party debate.
    http://positivemoney.org/2014/11/mps-debated-money-creation/

    And do check out how a £10 billion injection of Sovereign Money would have had exactly the same effect on real UK growth as the whole of the £375 billion QE that was ‘whistled up’ to drag us out of the financial crisis.
    See http://positivemoney.org/2014/06/waste-375-billion-failure-quantitative-easing-video/

    Yes, you read that right. Just £10 billion.
    And we will need to do it again if the BRICS continue their slowdown,
    So fellow LibDems we had better study SMC, and all it stands for.

    SMC has a well-thought out history and goes back to the Chicago School of Economics in the 1930s, and as well as being supported by Keynes, Milton Friedman also put it forward as the answer to recessions/deflation/slow growth.

  • nvelope2003 26th Jan '16 - 5:54pm

    Councillor Mark Wright: You state that if we had not fought the Nazis the UK would have become a concentration camp. Is this true ? Were Norway, Denmark, the Netherlands, Belgium, Luxembourg and France concentration camps ? Many would argue that our principal ally, after it had fallen out with its ally Nazi Germany, the USSR, was a concentration camp and after the war those countries which we had allegedly gone to war for were handed over to the USSR. The war was fought to defend Britain’s commercial interests and its Empire and had nothing to do with saving democracy, the Jews or Poland, Czechoslovakia etc as as soon as we decently could we gave them to Stalin.

  • Alan Depauw 27th Jan '16 - 7:09am

    nvelope2003: My parents were in occupied Belgium. They lived in constant fear and relatives were arrested and died in Ravensbruck. In the early years their only hope came from the BBC, transmitting the fortitude of the British people and their Prime Minister’s inspiring speeches. Fortunately for their children and their children’s children my parents survived to be liberated by British troops. Your rewriting of history is offensive.

  • JamesMurrayLaw 27th Jan '16 - 11:40am

    Peter,
    Not quite.
    The Government only ‘create’ the 3% of the money in the nation’s Money Supply and that is as I said, when it commissions the Royal Mint to print it.
    All the remaining 97% is created in computers, and you are correct about that, but not those of the Treasury or the B of E.
    It is solely in the computers of the private banks that have created the approximately 2 Trillion of our Money Supply.
    They so this every time they make a loan.
    Many people, even some economists, and most economics textbooks, get it wrong.
    They believe the banks merely use their deposits to lend out and thus are some sort of conduit pipe from depositor to borrower.
    In fact, when a bank grants a £100,000 loan it merely credits the borrower’s account with that amount for them to spend and debits the borrower’s loan account at the bank – all a computer exercise.
    Banks are able to do this because of their power of Fractional Reserve Banking so that at the height of the Financial Crisis they were lending over 50 times the money they had on deposit….!
    See http://positivemoney.org/how-money-works/how-banks-create-money/
    Fascinating!

  • Alan Depauw: I did not wish to offend anyone and I am very sorry. I was asking a question because the reasons given for Britain’s involvement in the war do not make any sense, particularly in view of the outcome for Poland and Czechoslovakia. Just as many people in the ruling elite were taken in by Nazi propaganda, likewise many were fooled by Soviet propaganda but no Government goes to war except to protect its own interests, however terrible the conditions in another country maybe. I do not dispute that people in occupied countries suffered during Nazi and Soviet occupation but the people of the United Kingdom suffered terrible bombing and the destruction of their homes and property.They had to be given an acceptable reason to endure this.

    At the start of the First World War the Germans committed atrocities in Belgium but Britain did not go to war for that reason, although it was used to get British people to support the war. The war was fought because the world’s greatest power, Britain, feared that Germany wanted to and would take its place. Despite two devastating defeats Germany is now the leading power in Europe and the US has taken our role as the greatest world power. In other words we bankrupted our country to pursue an illusion.

  • nvelope2003 27th Jan '16 - 2:36pm

    One question. Obviously the Government traditionally created money by issuing notes and coins but why do banks still try to increase deposits from the public by paying interest and encouraging people to put their cash in current accounts by things such as free banking and various incentives if they can just create money to lend at the press of a button ?

  • So the commercial banks cannot create money – well that is a relief.

  • J George SMID 1st Feb '16 - 3:05pm

    He had the insight to see that savings, which subsequently were made compulsory, were just the same as taxation in this respect – it is the savers who are paying for the current mess. Is it a mere coincidence that my pension fund and the Greek debt were both marked 75% down? It was the savers after both wars who paid as well: the inflation saw to that. It is all very well to control inflation with price controls but remove the price control and the stoke up inflation explodes

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