Thursday, April 28, 2011

Does Banking Require Debt?

“Government spending occurs simultaneously with a credit to a private bank account—that is to a demand deposit at a bank. The offsetting liability on the government’s books is a credit to the bank’s reserves at the central bank (which is the “private” bank’s asset).” L. Randall Wray

‘Spending’ money into existence entails the entry of a number into a private bank account. A government pays for something by ‘depositing’ ‘money’ in someone’s private account. That money is then a debt as seen by the bank where the account resides; it is money that can be withdrawn. To offset this ‘debt’ an equal amount is entered by the government in that bank’s reserve account at the central bank. This is double entry bookkeeping, in which the active and passive sides (double entry) of the ‘ledger’ must balance, a carry over from the middle ages when all we had was pen and paper.

This means that ‘spending’ in the MMT world view must incur a balancing liability, either at the ‘cost’ of whatever interest rate is set by the central bank and/or generated by market forces (treasuries, bonds etc.), or for free when the offsetting liability is created as indicated above. However, this “for free” ceases to be free at the private banks, since the reserves are used to generate more loans (banks exist to make growing profits), so debt-based costs do arise in the economy from all government spending, since the banking system is the mechanism use to distribute money. The economy is one system, no matter how we notionally separate the components.

If we can accept governments ‘create’ money, why the debt, why this insistence on double entry bookkeeping? Debts are only going to be ‘paid back’ with further ‘borrowing’ anyway, especially if all money is spent/borrowed into existence in the first place – there is only debt, its circulating, its destruction, and further creation. Well, the way I’ve read it, we ‘need’ debt for two main reasons, and both are systemic:

1. As part of how money is removed from the economy – without refined and sensitive techniques for cooling the economy down, it will over-heat.

2. Debt is how banks make profits, and though governments, via central banks, do create money, they do this through the banking system, using its techniques. And, at a more fundamental level still, debt is a reason to ‘need’ banks at all. Debt is what banking is about, fundamentally.

The problem with (or cost of!) debt is usury, which inexorably sucks money to lenders (banks), meaning wealth increasingly concentrates to the financial sector over decades, which becomes a drag on the economy. Money will lose value when growth slows (and growth cannot go on forever), if, when less debts are taken out privately and the money supply contracts, government borrows/spends into the economy so that debts can be repaid and deflation kept at bay. This spending creates new debts (of course) which must not only earn banks money somehow (otherwise they die), but also corresponds to no goods and services at market-demand level, or, put another way, does not reflect genuine ‘market’ activity (see China’s Great Mall and Japan’s oceans of concrete). Government demand is ‘fake’ in the sense that the economy can’t really afford it, by definition. If it could, the government would not have to step up to the plate as borrower/spender of last resort. Interest is the heat that keeps the economy hot, active, dynamic, since it renders the money supply scarce. But it requires growth as a side effect, and growth cannot go on forever.

“People just didn’t want to borrow because the economy was collapsing and they were carrying too much debt. [ … ] Reserves, then, are like a bank’s checking account at the Fed. A bank can lend those reserves only to another institution that is allowed to hold reserves at the Fed. Banks do lend reserves to one another in the fed funds market, but since banks already have more than a trillion dollars in excess reserves, there is no need to give them more in order to encourage them to lend to one another.” Marshall Auerback

Marshall Auerback also mentions that Canada’s banking system has no reserve requirement at all, something I did not know. But so what? When people owe too much money, they stop borrowing. Banks can be as flush as possible, but if everyone else is indebted, the economy slows down.

To my mind there’s this odd disconnect—in MMT as elsewhere in orthodox economics—between awareness of the problem of people’s indebtedness on the one hand, and this cavalier attitude to money creation as debt on the other. In theory, money can be created as and when a bank, central or otherwise, believes such to be profitable/sensible. In the theory we get a picture of endless lending, back and forth, from reserves to credit to debt to credit and back again, and everywhere there is endless demand for goods and services, so there’s no actual problem. Except people, consumers and producers alike, get indebted. And then there’s the planet’s carrying capacity which doesn’t even get a look in. All in all it doesn’t add up. Only, in the steam of this theorizing, money is being stripped of its symbolic power. Though no sovereign need default, that hardly matters. Money, in its current form, has taken a beating and clearly needs reform, or revolution, and this requires revolution everywhere else.

It is not that government spending is good or bad per se, nor that market-based money lending is better or worse, but that debt/usury skews the game towards the financial sector, and demands perpetual growth. In that nothing can grow forever, usury has to come to an end some day. That “some day” is happening now, logically at the apex of the banks’ power, making sufficient recognition of the core dynamic difficult to impossible prior to systemic collapse.

Eventually (sooner rather than later) we must dump this forced-growth system, dump debt, dump usury, and invest in steady state growth. This will require a new idea of ‘profit,’ in which societal and environmental health become the primary indicators of how well we are doing, rather than the bank-friendly GDP rate, Number of Billionaires, and Corporate stock prices. Waged-labour will become yet more cumbersome as economic activity becomes a less significant element of societal well being. As Money the Myth dissolves in its own heat, so will monetary wealth fail to be the potent indicator of success it still is.

Happiness, which makes life worth living, can only grow so far. Who would define themselves as ecstatically happy with their lives, and what sort of a system would demand happiness levels grow beyond ecstatic to ever dizzier heights? Change may be the only constant, but from a simple math perspective, increasing GDP has to stop producing increasing happiness, to ignore planetary carrying capacity for a moment. The glow is wearing off. GDP, that is, economic activity, is losing its charisma. Through the centuries the economy has taken us far, now new forms and endeavours must be learned as economic activity becomes less relevant. Will MMT carry on with its current momentum? I believe so, and am happy about that. It is part of the process of demoting money and promoting wealth I feel to be the chief characteristic of what humanity is going through. But I suspect MMTs success will be banking's demise, and technologies like Square (hat tip Steven Malagodi) are going to play a starring role.


PEMPO said...

I agree in almost all your reflections. I´ve been always intrigued why the MMT gurus never mentionGessell.

Anyway,MMT has done a great job and has been the main driver, in my case, of a total change (copernican i would say) in the way i think.

I don´t really see how we can live without debt. Debt is always present in the human relations. In the private-"noneconomic" realm too. With your wife, with your friends,.. Unconsciously, we are recording double-entry bookeeping.

Behind the universal debt is the principle of reciprocity and behind reciprocity is cooperation.

Cooperation is not possible with money system and its dear son , the compound interest.


Toby said...

Debt is a word one can play with. In the way you use it, yes, there is always movement of favours, acts of kindness, etc., that one could call give and take, or provision of services and corresponding indebtedness, but I find this too strong a use of the word debt. It is applying our sense of economics to everything we see around us. As the saying goes, if the only tool you have is a hammer, everything becomes a nail.

My relationship with my wife and kids is not debt-based in the sense of double entry bookkeeping. We are not recording our activities in a book. It is organic, there is a sense of give and take balancing out over time. But to leave our description of our relationships at that is to ignore way too much information. The pleasure of the tilting and leaning, the resolution of tension, the fun of the good times, creative conversations, helping our children, is indescribable, a very rich experience the use of the word "debt" insults with its small mindedness.

When I pick an apple from a tree, where is the debt? When I breathe air, where is the debt? The cycles of nature are restorative, creative, destructive, nurturing, all in waves, in a flow, and somehow, wisdom is accumulating. There is no debt.

When we exchange information in blogs, or get stuff for free in the Internet, where is the debt? If you hear a joke and laugh, where is the debt? When a stranger's smile cheers you up in a supermarket, where is the debt? Things grow and contract, that is all. Pinning it down to numbers and making sure they 'add up' belittles the trust inherent in our relationships with one another and Universe. Gratitude is a much nicer word than debt, don't you think? That feeling of being in love with life, that you want to give, to help things along. Let's not call that debt.

But yes, compound interest is the real killer! And MMT helped me a lot too. The simple idea that taxes are trash was a revelation for me. I just love that idea. However, it is too seductive. Money is nothing, but my goodness this system needs it badly. When Greece falls over finally and has to reprint Drachmas, what will their value be? How will Greece buy oil and other imports? In this system, what will Greece be offering the rest of the world to give its money value?

Questions, questions...