All types of money creation are accounted for in the same way, with mirrored claims and liabilities for both parties. And all debts look the same on the balance sheets, whether the government owes money to the central bank or Marta owes money to her bank. Yet, in reality, not all debt are the same. The debt of the Canadian government and the debt of an individual like Marta have very different implications. If we as private individuals have debts and cannot pay them back, we face serious legal problems. We are threatened with lawsuits, bailiffs, foreclosures, legal enforcement. We owe money that we cannot create and therefore we have to find a way to procure it when it is due. Even the commercial banks, which can create deposit money, are only users of the actual currency and dependent on the credits of the central bank. They go bankrupt when their equity goes into the red. Then it is up to state institutions whether to close, rescue or nationalise them.
Government debt, however, is of a different nature. Because the state has a monopoly on currency, it has the right to produce the kind of money it owes. The state’s own central bank, unlike a normal commercial bank, cannot go bankrupt. And if the government owes money to the central bank, then the state ultimately represents both roles. You can see this difference very well in our Canadian example.
When the term of the government bonds matures and the Finance Minister has to pay back the money – will she be in trouble? No! Because unlike normal debtors, the Finance Minister does not have to desperately find a source of money to settle government debts. She can simply issue a new bond and make the central bank create new money to pay off the old debt. Thus, old debt is just replaced by new. The amount of debt and bonds stay the same, only the due date is postponed. No trembling, no uncertainty for the Finance Minister – the Canadian central bank is legally obliged to cooperate (and even the interest that the Finance Minister pays to the Bank of Canada returns to the government budget at the end of the year). Therefore, although the government’s money creation is properly recorded in the balance sheets of both parties with debts and claims, it is basically a business of the state with itself. Because of its currency monopoly, it is both creditor and debtor at the same time; it creates the money.
This story does not change much if the central bank has sold the bonds to banks and private investors or even foreign investors in the meantime. When the bonds are due, the Finance Minister will do the same: she will replace old debt with new by selling new bonds to pay off the holders of the expiring ones, whoever they are. The Canadian Finance Minister can sell the new bonds again to the central bank – or directly to the banks as in most countries. If she sells to the banks, she can count on the central bank to create and lend the necessary money to the banks, manipulating them with the key interest rates to buy the newly issued bonds.
This ensures that the state can always place new bonds. Thus, there is no risk that the government cannot pay back a due bond, independently from who is holding it. The only difference with the private sector holding the government bonds is the interest and whether there is a positive interest rate. The Finance Minister then will have to pay interest to banks and private investors and will not get the money back at the end of the year (as it does if the central bank itself holds the bonds).
But also, in times where the central bank has to set high interest rates to control inflation, if the interest creates too big a cost for the state budget or is having undesired effects with regards to distribution – the government could always tax the beneficiaries of high interests and thus provide compensation.
