You have probably frequently heard a politician talk about our need to reduce the deficit. What does this mean? It simply means the government needs to spend less than it collects via taxation and borrowing.

Intuitively this sounds correct. In your household, you know if you spend more than you make, you might have a problem. However, for a select group of countries who have sufficient monetary independence – Australia, Canada, China, Japan, the UK and the US, whose currency, broadly speaking, is not pegged to gold and who have a strong enough economy not to be reliant on purchases of foreign currency – the household budget as an analogy isn’t just off, its wildly and dangerously incorrect. These countries are currency issuers and have the ability to always credit more pounds, dollars or yuan etc, into the accounts of those they borrow from.

Initially, this may sound like an odd concept. In her book The Deficit Myth, Stephanie Kelton explains, step by step using Modern Monetary Theory (MMT), why our thinking around government deficits has been all wrong. I will not attempt to reduce Stephanie’s book to one small blog post; however, I will give a flavour of the economic opportunity this book represents.

If a government runs a deficit, they are spending more than they tax and borrow. For one of our monetarily independent countries, this has no effect. If they recalled all their debt, they could simply issue more currency to cover those debts. With a stroke of a keyboard, sterling could be credited in accounts everywhere. I hear you say, “but more spending will drive inflation”. You are entirely correct. However, one of the interesting points MMT raises is that when governments have run deficits in the past, they have not always been accompanied by periods of uncontrolled inflation. When an economy is not running at full capacity, for example, when we do not have full employment, we operate with a lot of fiscal headroom. Increasing spending only drives up inflation once the economy is running at full capacity, as before it reaches this point, the increased spending drives higher investment and employment. MMT does not mean there are no limits. It simply means the existing limit of a balanced budget we currently imagine is a self-imposed limit we can throw off whenever we like.

The other frequently misunderstood element of government deficits is, what does a deficit actually mean? In the US, you can view a deficit tracker which shows how much American citizens ‘owe’ the mythical Uncle Sam figure. This figure is vast (in the trillions), and when reduced to a per capita figure, it seems insurmountable to all but a very few. Let us reframe what the government deficit means for us.

Imagine the very first pound sterling. It was not an inherent natural resource that our ancestors could mine or grow. At some point, the ruling body (a king for us at the time) created a pound and issued it to someone. This first pound meant the government was effectively running a deficit of £1, but that was £1 in the pockets of its citizens. For every pound the government spends, it is extra pounds in the bank accounts and pockets of its citizens and the economy, funding infrastructure projects, contributing to education and funding the health service. On the other hand, a government surplus is the removal of pounds from its citizens into its coffers. Today, instead of a chest of gold and coins being poured into a vast vault, a few digits are changed on a screen. When governments run surpluses, they have been followed by large scale recessions or depressions in part due to this removal of spending ability from its citizens.

Governments that have monetary independence and issue their own currency can never go broke unless politicians and those holding the purse strings fundamentally misunderstand how the finances of a country work. Countries that are not issuers of their own currency can ‘go broke’ just as you or I can if we consistently spend beyond our means. This is the situation of the eurozone countries, as they are not controlling the purse strings. The European Central Bank does not have to issue more currency to cover their debts meaning that individual countries can get into significant difficulty, as we saw with Greece following the financial crash.

I have left several important questions unanswered, such as ‘What do deficits mean for trade?’ ‘What happens to currency exchanges if more money is issued?’ and ‘Does MMT mean we don’t have to have any taxation?’. As Stephanie Kelton proves, answering all these important questions takes at least one whole book. I would encourage you to think of this small article as an introduction to this different viewpoint on government spending rather than a full explanation of Modern Monetary Theory or a comprehensive debunking of the Deficit Myth. If you have questions or feel I have glossed over certain things, please read The Deficit Myth, where your questions will be answered in full.

To return to the statistic at the beginning, those 55 per cent of people have nothing to fear, in theory, as the government will never run out of money so will always be able to pay a pension. The thing we all have to be worried about is this fundamental misunderstanding of a monetarily independent country’s finances being perpetuated. The only reason for the system of government benefits running out of money is the adherence to the artificial constraint of not maintaining a government deficit.

Patrick Christie is a graduate trainee financial planner at WealthFlow