The failure of central bankers to understand the fundamental concept that I'm about to explain in the most simple and unbelievably entertaining way ever devised is one of the root causes for many of the problems that society has faced for decades.

If more people understood this stuff, it could be a game changer. Read carefully and prepare to be amazed!

The Abacus Analogy

Imagine an American football game between the Dallas Cowboys and some team of little kids who don't even have helmets. It’s going to be a high scoring game and the organisers have decided to use an abacus to keep score.

Plan A
The game kicks off and the Cowboys begin scoring touchdowns again and again. As they do, the beads on the abacus are shifted from one side to the other, keeping track of the score. But very quickly, the abacus runs out of beads.

Plan B
The pundits ask “do we need to stop the game?”, but some clever-cloggs points out that they can just borrow more beads. So, they send the score keeper out to borrow some and then the game resumes.

But it doesn’t take long before they run out of beads again. The score keeper isn't in the best of shape and doesn't have the energy to go looking for more. “We can’t keep borrowing beads forever”, he complains.

Plan C
The organisers think hard and come up with a plan to get each team to give back one third of their points so that they can shift one thirds of the beads back across to the ‘unused’ side of the abacus. The game continues, but then they run out of beads again.

The Solution
They give up on the abacus and decide to use a computer so that they can keep score. There’s no need for beads - they just key in the numbers. They will never run out of numbers with the computer.

Borrowing

In the old abacus-style system, if a national government didn't have enough gold, silver, foreign currency or whatever it was that they needed before they could issue their own currency, they had to borrow.

Today, the national government continues to borrow by selling securities (which we’ll call bonds) at an auction that only certain banks can attend. But what they call borrowing isn't really borrowing.

Under The Covers

Some of you will have a chequing account (also called a deposit account) and a savings account at your bank. Well, banks also have the equivalent of chequing accounts and savings accounts. They're often referred to as reserve accounts and securities accounts, but I’m just going to call them chequing and savings accounts. The accounts are usually held at the central bank (though, in Australia, the savings accounts are actually somewhere else).

When big banks buy bonds at the government's auction, they use the money in their chequing account to buy them.

Revelation

But what do bonds look like? Are they pieces of paper with fancy writing that say how much money is owed?

Nope - they’re balances in an account on a computer. Where are these balances stored? In the banks’ savings account! Where is the account? That’s it.

So, when the banks buy bonds, three things happen.

• Balance in bank chequing account decreases
• Balance in bank savings account increases by an equal amount
• Balance in government's account increases by an equal amount

When you think about it, all that’s happened is that banks have shifted their balances from their chequing accounts into their savings accounts and the Government has created an equal amount of money.

Mainstream economists believe that, by doing this, they’re reducing the spending power of everyone other than the government by x amount so that the government can spend x amount.

They’re incorrect - people aren’t saving the money they would have spent on the things they wanted - they’re just saving the money that they never intended to spend in the first place.

The National Debt Isn't Really A Debt

But we need to point out something else here that challenges people's’ beliefs, and it can be difficult to accept if you’re hearing it for the first time. The National Debt isn’t really a debt - it’s mainly just the balances of the savings accounts that banks have at the central bank.

If I have savings in my bank account, do you need to endure hardship so as to pay off my savings?
Don't be ridiculous!

If banks have savings in their accounts, do we need to pay them off?
No! That’s not how numbers work! Economists need to get the abacus-style thinking out of their heads and understand that money is just numbers on a computer. Money is the score that is kept of government spending.

AAA Ratings

In Australia, 99.998% of all Government debt is in Australian dollars. Seen as the Government can never run out of Australian dollars, it’s pretty clear that there’s no valid reason for them to miss a payment on any of this. So, why has there been so much talk in the Australian media about the AAA rating being under threat?

It’s because the economists at the rating agencies are still thinking in terms of the abacus-style system. If the debt existed because we borrowed beads from someone, then there’s a reason for concern as we need to get more beads from somewhere in order to pay them back. But our National Debt isn’t even a debt - it’s savings!

Australia should not be downgraded to a AA rating. We shouldn’t even have a AAA rating. We should have an infinite A rating! We can never run out of numbers! We can never run out of dollars! Our government can buy anything that's for sale in Australian dollars!

And the same goes for New Zealand, the UK, Canada, the USA, Thailand, the Philippines, Japan and any other country that has control of it's own floating currency (sorry Eurozone, you messed up in a big way by surrendering control to the ECB).