Saturday, April 2, 2011

Can You Handle the Truth?

I'm not good at titles, so collapse from time to time to the needlessly sensational. Please forgive me my foibles and weaknesses. This will be a very short post since I have much to do and am dog-tired to boot.

Maybe there's an innocent explanation, but a response I posted on an MMT thread (here) did not get published. My original comment is there—questioning the 'nets to zero' part of MMT theory—but my answer to DanF's criticism has (so far) failed to get through quality control. It's been two days.

Here's the nub of it. In MMT theory, which interests me greatly, it is asserted that private bank credit-money has no effect on money supply over the long run since it nets to zero. The reasoning behind this assertion is that debts are expunged upon repayment, and the interest comes from the existing money supply to the bank. So no gain, no loss, just movement of 'real' money around the economy. I wrestled with this in previous posts at Econosophy (here, here and here), and have consequently come to the conclusion that 'nets to zero' is too gentle or forgiving a position to hold on bank credit. At risk of sounding aggressive, banks are the scum of the earth.

I see a number of problems with the MMT position.

1. People do get indebted and that acts as a drag on economic activity. Banks don't forgive loans with a shrug, because, hey, it wasn't real money anyway.

2. Credit-money is used and accepted as payment, becoming 'real' money from the payee's point of view—from the system's point of view too—upon moving from one account to another. When it lands in the payee's account, the hosting bank can use it as reserves for further lending, even if it's the same bank that issued the credit.

3. Repayment of debt is 'asymmetrical,' not neat and tidy. Defaults mean not all credit-money returns to the source to meet its doom. See my article on this concept here.

4. Only notes have serial numbers, and even they are not traced through the economy. The banking system makes no effort whatsoever to 'two-track' the monies, 'real' and credit, flowing through it as cash. When I pay bills online, I have absolutely no idea if the bits and bytes I'm transferring originated as credit-money or 'real' money, and neither does the system. (And anyway, bank notes are promises to pay the bearer the amount written on the note. You can exchange your $5 for $5 anytime you want.) I can use 'real' money to repay credit-money. Does 'real' money then get destroyed? Is that allowed?

5. 'Real' money, notes and coins, represent a tiny fraction of the money supply (3-5%). If the interest owed on all loans everywhere were 3-5%, the banks would in effect 'own' all the economy's real money. But interest owed is far higher than that; think mortgages and credit card debts. Banks own everything and then some. For there to be more than enough money in the system the govt would have to print notes and mint coins far more than they do now. Then and only then would there be enough money in the economy to pay off debts. However, money does not distribute itself equally, so the results of such govt action are hard to impossible to predict. One thing is certain though, while we see money as wealth, as a 'store of value,' there will be entrenched rich and poor divides.

I'm pretty sure my reasoning is sound, but like to check it with the experts. That they will not engage me makes me suspicious. Dear readership, have I missed something obvious? Does private credit-money creation net to zero?

8 comments:

Toby said...

My second comment on the MMT post over at New Economic Perspectives hasn't appeared, but there is a reply from the author, which I find a little odd:

"TO TOBY,
MMT is completely consistent with private money creation. I urge you to look at Wray’s paper “The Credit Money, State Money, and Endogenous Money Approaches”. Bank loans create deposits (at the stroke of a pen/they do not NEED reserves to lend) and deposits create reserves when the Fed accommodates the banks' need for reserves, in order to maintain its interest rate target. The private sector can extend to itself more credit to pay interest on past debts and on and on. It’s a problematic process which Michael Hudson also explains very well.

The Fed as the lender of last resort is the watchdog and must regulate what these private lending practices are and what systemic risk they may pose. Obviously the Fed didn’t do that. When the Fed provides reserves through OMOs, they only take eligible collateral, no questions asked about the overall health of the bank. But when they lend through the discount window they can look at the borrowing banks books (frequent discount window borrowers are subject to audit). We’ve said many times that the Fed doesn’t understand the power of its discount window.

In any case, MMT is completely consistent with private debt creation processes. Whenever private debts evolve from Hedge-to Spec-to Ponzi finance (see Hyman Minsky) and we have crises, the Fed saves the day by purchasing (or lending against) those private debts and replaces them with reserves."

I never claimed MMT was not consistent with private debt creation, I claim private debt creation does not net to zero. As for private banks creating credit and the Fed being able to 'absorb' or buy up crap, that goes without saying, though I am not sure the Fed has saved the day. That they have to 'save the day' strongly implies there's no netting to zero.

I shall read the recommended article in due course.

Greg said...

Toby

I look forward to your updates on the work of that Professor Hoerman. I really like what he has to say.

Here is how I understand the "nets to zero" statement, although I might not be consistent with all the MMT writers.

Within the private sector a bank loan is said to NOT be a net addition of a financial asset (most MMT authors would prefer to shun the term money since so many things can be money but NOT be a financial asset like a "dollar") because while you do get a loan of x number of dollars which you can use to purchase something, you also get a debt that needs to be paid back with interest. So really you are net dollar poorer. You borrow 100 dollars to buy a 100$ item and pay back 110$ out of your income stream.

This is the fundamental insight of MMT for me. A purely bank credit driven financial system will always crash, because income cannot service a continuously increasing amount of credit. This where "currency issuer" comes in.

MMT writers recognize that that bank debt is money, i.e can be used to purchase a good but it is NOT a net creation of a financial asset. It is actually a net drainer, which is where currency issuer ( Or Net Financial Asset issuer) comes in and can restore a balance. Now this cannot go on to infinity obviously because of hyperinflation but NOT having an addition of NFAs (as some conservatives seem to wish for) will always lead to bankruptcies and defaults.

SO I think most MMT authors would agree that increasing private credit DOES increase money supply because credit is money but it doesnt increase net financial assets except by the amount of interest which is actually paid back. IOW getting a loan for 1000$ and buying a good does not increase net wealth (nominal wealth) the same way a fresh $1000 bill handed to a person would, or an electronic increase of $1000 in a reserve account say.

MMT authors see the Central Bank as important for 2 things 1) to keeping the payment settlement system open and operating 2) to monitor and regulate the private credit system

They do #1 well and #2 poorly of late.

Its my impression that it is the non MMT economists who ignore the role of private debt in the economy and in fact wrongly equate public debt and private debt, which is ridiculously wrong.


Cheers

Toby said...

Hi Greg,

implicit in the MMT position you lay out very well is the notion that some money is wealth, a point I deeply disagree with (hence my fascination with Hoermann's thinking).

One of the problems this credit-money real-money theory faces is that the system does not distinguish, cannot distinguish between the two, once they are out there swishing about from account to account at the speed of light. Once you have credit-money 'out there' functioning as money to all intents and purposes, on which interest is owed, you have money-scarcity, unless and until the government is prepared to meet interest obligations equally with its spending. And even then, because of hoarding, there's no way of preventing scarcity where there is poverty. Imbalance/division is a necessary property of money-as-wealth economies, since money is bound with scarcity by definition.

Also, repayment of debt is not neat and tidy. Even without govt money, an economy pumped into life with only credit money, a pure ponzi system, can function while there is growth. While the hot competition ignited and fueled by scarce money meets increases in goods and services for sale, and a growing population too, credit-money is ok (ignoring the environment for a moment). Some of it becomes 'real' or 'un-owed' by virtue of the unevenness of firms' and peoples' successes and failures. The 'real' world is messy, does not function like the famous island with 100 people receiving $100 loans at 10%. Even with govt money mixed in--the system we have had for decades--credit-money, driven by profit-maximization and greed, drowns out the rest. For example, back in the sixties, the UK had something like 30% govt money in the economy. It now has approx 3%.

And even 'real' money, notes, genuine legal tender, are but promises to pay the amount written upon them, hence are 'wealth' only to the extent that the broader system sustains our belief that they are. This is true too of credit-money. It is belief and supporting environmental conditions that render money 'genuine,' not something intrinsic to it. In the end I'm with Frederick Soddy on this point: "Money is the nothing you get for something before you can get anything." Hoermann holds the same position, on which more from me later.

MMT, despite the enormous strides it has made in unraveling the curious mystery of money, remains, for me, too rooted in a broader orthodoxy which cannot make sense. It is not growth we need, which MMTers seems to want, not banks, not govt money or market money, but resources/environment prioritized and organized wisely by something applicable planet-wide. Maybe a point system as envisaged by Hoermann is the right direction, maybe demurrage, maybe 100% reserve banking, I'm not sure. But for certain we have to have a socioeconomics which allows us to prioritize the environment above all else. Everything else must flow from that. We only need banks and credit money if logic and common sense leads us to that conclusion.

Greg said...

HeyToby

Dont mistake my description for an endorsement per se. I was simply trying to clarify what I think MMT means by nets to zero.

I cant disagree with much of your comment except to the idea that MMT as a school of thought endorses the continuation of the current banking cartel. Mosler has been adamant about our financial system being more trouble than it is worth and most of the writers want to do away with govt bond issuance and just credit peoples bank accounts. They completely support a guaranteed basic income although they present it as a "job" guarantee.

I would also say that the idea of money BEING wealth is not endorsed by most MMT economists. Wealth is real stuff and "money" is just a way of putting a price on the stuff.

As far as growth goes I sense that many (Bill Mitchell for sure) see growth in a different way than it is popularly conceived. Growth in economic activity does not have to mean a growth which consumes all the valuable resources. People can be transacting with money at an ever increasing rate due to population growth without that rate being destructive. Think recycleable economy where efforts are made to use and reuse everything we have regardless of "price"

I'm not trying to persuade you to become an MMT acolyte or anything, I simply want to present it as I understand it through my time of following Mitchell, Mosler, Wray and others.

I honestly dont think any of them would disagree with the sentiment you are expressing here;

" It is not growth we need, which MMTers seems to want, not banks, not govt money or market money, but resources/environment prioritized and organized wisely by something applicable planet-wide. Maybe a point system as envisaged by Hoermann is the right direction, maybe demurrage, maybe 100% reserve banking, I'm not sure. But for certain we have to have a socioeconomics which allows us to prioritize the environment above all else. Everything else must flow from that. We only need banks and credit money if logic and common sense leads us to that conclusion"

We definitely dont do money right, right now.

I am hopeful that Hoermanns thinking takes root real soon.

Toby said...

Hi Greg,

thanks for the 'heads up.' My exposure to MMT is through Bill Mitchell principally, plus various articles here and there. Bill Mitchell seems very focused on growth and full employment, which I then read between the lines of other MMTers, having had my all important First Impression from Bill M.

It's clear that MMT does not say money is wealth explicitly, but there is, in my reading (perhaps wrongly) an implicit connection arising from the need to distinguish between 'real' and 'credit' money and how this--I think ultimately unhelpful distinction--leads to 'nets to zero.' Again, I'm reading between the lines and pursuing arguments to the deepest logical conclusions I can. Maybe I've seen something others haven't, maybe I'm seeing ghosts.

And don't worry, I want to be corrected where I'm wrong, and know you well enough (the Internet you anyway ;-)) not to feel attacked. I hope you realize that I am not attacking you either! Sadly time is limited: full time job, father of two school-girls, writing a blog and a book, studying everything I can lay my hands on. MMT sort of dead-ended for me after I found the leak in the 'nets to zero' position. I shall take up my research into MMT again thanks to you. So thank you.

One final thing though, full employment is very different from guaranteed income. With the former, you end up giving people stupid jobs doing any old thing just to 'earn' enough to live. With the latter you say 'all should benefit from human ingenuity and planetary abundance.' 'Earning a living' is a concept we have to reform/revolutionize/destroy, whichever is most sensible.

Toby said...

"Growth in economic activity does not have to mean a growth which consumes all the valuable resources. People can be transacting with money at an ever increasing rate due to population growth without that rate being destructive. Think recycleable economy where efforts are made to use and reuse everything we have regardless of "price""

I have to pick you/MMT up on this point. (Check out Herman Daly on this 'angelized' growth idea, he debunks it pretty well I feel.)

Why growth4ever at all? What's the point of it? To meet interest payments? Because the planet needs a permanently growing human population? I can't think of one reason, apart from usury. Also, there is no such thing as zero-energy transaction costs. Everything that is a change or exchange requires energy to power it. The only thing I can imagine 'growing' forever is wisdom, and I don't think economics based on money can drive this much further. It's been a necessary part of our journey, certainly, but it cannot take us, as a species, much further.

Also think what it would mean if everyone were engaging in more and more economic activity? Does that include conversation? Blogging? Kissing? Friendship? How much of what we do should we pay for with money? And why should we do ever increasing amounts of it? It's already a rat race, already insanely high-tempo. If it speeds up forever we'll explode from the friction. ;-)

I also wanted to ask if you could recommend an MMT book that covers all the bases?

Martin said...

I agree with you about the currently far out notion that growth should be abandoned for a much saner notion of equilibrium.
But then is MMT moving in the same direction after all, like Greg mentions? Do they not wish to monetize a growth towards no growth at all in the long run? Instead of just paying for goods produced from resources, incentivizing the movement of matter from expired goods back into resources in order to complete a circle? We are a very long way away from something like that, and maybe MMT is the only way to get there without having everyone that hears the plan shake their heads and laugh.

Toby said...

That's kinda how I feel about MMT, Martin, as a healthy and necessary bridge to something very different. However, being a non-academic nobody I can 'risk' being completely honest about my vision and in which direction, I believe, humanity ought to be pointing itself. People who communicate in such uncompromising ways will always be fringe 'nuts,' but in amongst the ravings there can often be found seeds for the future. I'm not saying I'm a raving lunatic of course, but I've kind of appointed myself the role of taking this RBE thing as far as I logically can.

But I'm definitely going to look more deeply into MMT, thanks to Greg's interventions. Who knows, maybe I'll become an MMTer yet!