Wednesday, August 17, 2011

Money, Debt, Reserves, Money and Debt

[ADDENDUM (yes, here at the top!): This post contains factual errors which were pointed out to me by Sigi. Happily (in my eyes anyway) my error, when corrected, does not lead to a different conclusion. The voluminous comments to this post are therefore a very important part of it. And, no doubt, I shall be returning to this topic and MMT generally, in due course. 22.08.2011]

I had a wee exchange last week (I think) with rebeleconomist over at Naked Capitalism, who suggested I did not understand that banks have reserves backing their loans (or some such formulation of same). Rebeleconomist appears to support, or think sound, the current money creation system of FRB (fractional reserve banking). Today I had a look at Steve Keen’s “The Roving Cavaliers of Credit” again, wanting to brush up on the data of money creation upon seeing it referenced in Eisenstein’s “Sacred Economics”, so copy-and-pasted the article into a word document at work (naughty me) for leisurely perusal. As I reached the bottom of the web page I noticed , scrolling into view, a comment-exchange between Steve Keen and “Spike1606”, along the lines of ‘the amount of money in existence at worst only equals debt, but mostly exceeds it’. Steve Keen appeared to agree with this assessment (the chat happened early April this year) despite his article demonstrating the opposite. He also claimed not to be expert enough on the fine details of Central Banks and commercial banking generally. I was shocked. I still am. Naturally I ran straight to Wikipedia.

“Within almost all modern nations, special institutions (such as the Federal Reserve System in the United States, the Bank of England, the European Central Bank, the People's Bank of China, and the Bank of Japan) exist which have the task of executing the monetary policy and often acting independently of the executive. In general, these institutions are called central banks and often have other responsibilities such as supervising the smooth operation of the financial system. There are several monetary policy tools available to a central bank to expand the money supply of a country: decreasing interest rates by fiat [encourage lending—Toby]; increasing the monetary base [government borrowing—Toby]; and decreasing reserve requirements [encourage lending—Toby]. All have the effect of expanding the money supply.

The primary tool of monetary policy is open market operations. This entails managing the quantity of money in circulation through the buying and selling of various financial assets, such as treasury bills, government bonds, or foreign currencies. Purchases of these assets result in currency [synonymous with “money” it seems—Toby] entering market circulation (while sales of these assets remove money from circulation).

Usually, the short term goal of open market operations is to achieve a specific short term interest rate target. In other instances, monetary policy might instead entail the targeting of a specific exchange rate relative to some foreign currency, the price of gold, or indices such as Consumer Price Index. For example, in the case of the USA the Federal Reserve targets the federal funds rate, the rate at which member banks lend to one another overnight. The other primary means of conducting monetary policy include: (i) Discount window lending (as lender of last resort); (ii) Fractional deposit lending (changes in the reserve requirement); (iii) Moral suasion (cajoling certain market players to achieve specified outcomes); (iv) "Open mouth operations" (talking monetary policy with the market). The conduct and effects of monetary policy and the regulation of the banking system are of central concern to monetary economics.” [My emphasis.]


The middle paragraph is key. Though brief and incomplete it wields the jargon of banking in precisely the manner which so confuses the layman (me included). What is money? All sorts of things, like M0, M1, M2 and so on? Sort of. Is it debt? Not according to orthodox economics. The money which is really really money is “high powered money” (see italicized sentence in quote below). Hence selling debt-instruments into the economy takes ‘money’ out of the economy in exchange for bonds, treasuries, etc. What would that ‘money’ otherwise be doing? Creating inflation, one assumes—in that it is (part of) commercial banks’ reserves which enable the extension of credit—hence the need to remove it from the economy. Is it exclusively high powered money which is removed from the economy when these sales occur? How could anyone know? High powered money is not marked to denote it as such, though I suppose its ‘initiating existence’ in particular accounts at commercial banks is a kind of marking. If these accounts were repositories only for transactions with the Federal Reserve, and if bonds and treasuries bought from the Fed could only be purchased with money out of these accounts, that might be a way of tying high powered money directly to such federal monetary operations. And yet even if things were that tight, such money, though “high powered”, was created as debt and is owed back to someone, somewhere.

So what is high powered money? Wiki again:

“In modern economies, relatively little of the money supply is in physical currency. For example, in December 2010 in the U.S., of the $8853.4 billion in broad money supply (M2), only $915.7 billion (about 10%) consisted of physical coins and paper money. The manufacturing of new physical money is usually the responsibility of the central bank, or sometimes, the government's treasury.

Contrary to popular belief, money creation in a modern economy does not directly involve the manufacturing of new physical money, such as paper currency or metal coins. Instead, when the central bank expands the money supply through open market operations (e.g. by purchasing government bonds), it credits the accounts that commercial banks hold at the central bank (termed high powered money). Commercial banks may draw on these accounts to withdraw physical money from the central bank. Commercial banks may also return soiled or spoiled currency to the central bank in exchange for new currency.” [My emphasis.]


(I suspect that 10% figure is quite deliberate, or dependent on whichever definition of money is required to produce it; everywhere else I see assertions of 3-5%. Perhaps it needs to be 10% because FRB requirements are, classically speaking, 10%. Neat, huh?)

So, “purchase of these assets” involves “high powered money”, which is money credited to accounts at commercial banks, money which can be notes and coins. Where does this money come from? Thin air in effect, but in terms of being ‘backed’, it originates from the Government—not from commercial banks—that is, it is backed by The People’s future labour. The CB ‘creates’ ‘new’ ‘money’ in exchange for acquiring and then selling on government debt (in the form of bonds, treasuries etc.). So this “high powered money” originates as debt. This “high powered money” is (part of) the “reserves” of commercial banks.

But what does that mean, "reserves"? In which accounts? Government accounts, business accounts, private accounts … bank accounts! So that money belongs to the various account holders, not to the bank, and yet it represents reserves, debts which are assets (or is that the other way around?). Furthermore, all high powered money is owed by the government to the central bank (or other owners of the initiating debt instrument) upon maturity of the debt (plus interest of course). Who owns the central bank? That is the topic of many books, but private interests it is, otherwise it is The People borrowing from themselves at interest. Which is weird. Even the British Central Bank, “purchased” by the Labour government shortly after the second world war, was paid for by borrowed money which came from unnamed entities. Do you think the British Government have paid that debt off? Austria’s central bank was recently nationalised. I wonder where the government got the money to buy it. Perhaps from the ECB. Who owns that? Smaller European central banks. And so on.

So “high powered money” originates as debt, becomes “reserves” which are monies owned by account holders and owed by the government to holders of the corresponding debt instruments, “reserves” which act as a base from which new money can be lent into existence in the commercial sphere by commercial banks. And loaned money can buy things, so always ends up in some seller's account and can be exchanged for notes and coins. I.e., commercial bank credit-money can be 'transformed' into high powered money. Throughout the system, the monies mingle with rampant abandon. Some of it might be in your pocket right now, or in your bank account. And, legally, you own it, owe it to nobody. And yet it is owed, by someone, somewhere.

(And this is only the conventional theory. “The Roving Cavaliers of Credit” demonstrates that it is actually commercial banks which initiate expansion of the money supply. The research the article cites shows how the central bank is forced, from time to time, to fill the holes in commercial bank balance sheets in order to keep the system going. (Also known as TBTF.))

In the end, money is either created as an explicit debt, or it is not. This is an inescapable binary. Whether we reference reserves or high powered money, treasuries, gilts, or notes and coins, we are denoting money created somehow. The differences are of liquidity, or ease of use in economic exchange. Money does not grow on trees (or does it?—are not economies as natural as trees, are trees ‘lazy?’), so, logically, must be created by something somehow. Is it owed back to its source (plus interest), or isn’t it? If, at every step of the way, ‘money’ is created as a debt, and furthermore as a debt bearing interest, then the amount of ‘money’ out there cannot be more than the debt owed. Money is always debt if it is created as debt. And because of interest, principal must be less than what is owed. P < P+I. Always. The only way to assert otherwise is to have jargon definitions of ‘money’ in its various forms, such that only “high powered money” is money, and the rest is somehow vapour, or “nets to zero”, or is ‘credit’ to be expunged, etc., and yet even with that concession, with reserve requirements at around 10% (allegedly), the claim that ‘money’ exceeds debt in the system seems untenable to me. Bank run, anyone?

Look at the third paragraph of the first quote, which informs us the Central Bank’s goal is control of short term interest rates (with an eye to inflation). The interest rate is like the gas flame under the economy’s pot. Control it, and you control the intensity at which the economy cooks. That’s the theory. What we see today after years of historically low interest rates (“cheap money”) and anemic to zero ‘growth,’ is that this theory is obviously insufficient. Japan is a case in point. The system ‘works’ when the economy can grow, but breaks down when it can’t. That’s happening now, with government repeatedly forced to borrow on behalf of us all. The explanation for this phenomenon is debt collapse in an economy at peak debt levels (including a slowly changing Zeitgeist), which equates to a collapse of the (effective) money supply, in an economy which is not growing, which means it can no longer borrow more money into existence. All that fresh “high powered money” out there finding no matching economic activity to make it ‘real,’ except in commodities, stocks and other stock market shenanigans, the rises of which we might see as deferred inflation. Apparently, all those jargon distinctions are of no real use. Label it as you will, money created as debt is debt.

What backs debt? Put another way; what backs money? Certainly not reserves or high powered money, since that originates as debt. Money does not back money (yes it does: “I promise to pay the bearer on demand the sum of five pounds”!), as gold does not back gold. Perhaps a thought-exercise would be helpful:

Imagine I create a trillion TDs (TobyDollars) at home for my family to become an economy at last. There it is, TD1tr. Sitting on the kitchen table, twinkling in the moonlight. What is it valuing? At first, absolutely nothing. I have to spend it into our wee economy for it to have any meaning. Before we Russells have economic activity between ourselves, the money has zero ‘value,’ or no utility. Maybe I start paying my daughters for smiles, and they pay me for hugs and play time together. (I won’t list what my wife and I might pay each other for. Too boring.) At first, a hug might cost TD100m, a smile TD10m, but as the number of things we do for one another ‘grows’ (tying each other’s shoe laces, pouring each other’s milk, buttering each other’s toast, massages, story telling, use of the piano, etc.), so the price per exchange falls in classic, market style.

What backs money is therefore economic activity, or buying and selling. So if we are to prevent inflation, when we create new money it needs to be met by some amount of new economic activity (new goods and services), as equal in ‘value’ to that money as possible. So, in an economy in which the money supply is forced to expand (P < P+I is an equation for a Ponzi or Pyramid Scheme), growth of economic activity backs money (or debt, the terms are synonymous). In an economy where money is created as debt, such that the created amount is destroyed upon final repayment, leaving only the interest behind in the hands of the lender, we have a screaming need for constantly increasing (on average) lending and borrowing. This is why recessions and depressions are Bad, and growth is Good. This is why economic activity is Good.

And even if money is not created as debt—as in my example above—the (household) economy becomes instantly ‘indebted’ or beholden to money as soon as it is there to be used—why else create it. Money is, in its broader systemic effects, a claim on and a systemic pressure to engage in economic activity, or price-based exchange (buying and selling). The economic principle of thrift we all know—living within one’s means—is in fact impossible to adhere to when money is designed in such a way as to demand growth, since, in time, this can only lead to humanity demanding too much energy from its environment, as well as asking it to process too much waste. And since growth appears to be forced upon us by social hierarchies such as nation-states and corporations (in their current forms), which, in deeper history was selected for as a consequence of attempting to control nature through farming, it is clear that we, as a species, still have a lot to learn about true economics, what we might call the ecology of economics. Right now there’s too much jargon and not enough sense.

25 comments:

Sigi said...

As for the question on "what backs money", I like the explanation by Modern Monetary Theory that it is in fact the government and its ability to tax you exclusively in that currency.

So, the gov't spends the money into existence (or borrows it from itself into existence), and then later drains it via taxation.

The fact that everybody needs to buy taxes (or go to jail) creates a need by the private sector to accumulate the currency.

The private banking (promise to pay) money creation is horizontal to this gov't (high powered) money creation and nets to zero. Reserve fund creation does not net to zero, it creates additional net assets in the private sector (so excess has to be drained somehow, e.g. by bond sales or taxation).

Furthermore, all the interbank and bank-gov't payments are done with reserves (high powered money). The reserves are never lent out, so they don't somehow "mingle" or "leak" into the private sector. That doesn't make sense.

Toby said...

Yes, I always like that idea of taxation as a validation of money, yet I don't think that's really backing the money. The work which generates the wage which is then taxed backs the money.

As to nets to zero, that is a part of MMT I simply do not agree with. You wrote:

"The private banking (promise to pay) money creation is horizontal to this gov't (high powered) money creation and nets to zero. Reserve fund creation does not net to zero, it creates additional net assets in the private sector (so excess has to be drained somehow, e.g. by bond sales or taxation).

All money lent into existence is promise to pay money. If it is spent into existence it is still a promise to be worth something or other relative to some RPI scale, so even then it is a promise. Because money is nothing, or what Soddy calls "virtual wealth", yet exists to facilitate buying and selling, it is buying and selling which backs it, spent or lent into existence. This backing is wrapped up in money's implicit promise.

Reserve (or "high powered") money does not net to zero for the same reason commercial bank credit money does not (effectively speaking). If all debts were paid off there would be no money in the economy, so netting to zero may not happen, cannot be allowed. And whether the govt borrows from itself (what does that really mean apart from the "rigours" of double entry bookkeeping?) or from someone else, either way the money is created with a corresponding and equally sized debt, "high powered" or not.

I did not claim that the reserves leak, I said that 'credit money' travels through the system in an untraceable way, moves into people's accounts where it becomes "reserves" for further commercial bank lending, at which point it is indistinguishable from "high powered money". This is part of the dynamic exposed by "The Roving Cavaliers of Credit".

Sigi said...

I'm reading your blog for a while now, so I know that you have at least shown some interest in MMT, although I'm not sure if you have fully grasped it.

Mind you I'm only a layperson myself, although I've read quite a lot of material on MMT myself lately (being in the comfortable position of not having to unlearn neoclassical economics first, which apparently makes it a lot easier than otherwise to get to grips with MMT).

Having said that, about the points you're making:

When I say "promise-to-pay money", what I mean is that the money is created under the assumption that it will be paid back in full (maybe also plus interest).
Therefore, when the money is created (as a liability for the bank), a corresponding asset is created along with it (the promissory note).
Assets and liabilities are still in balance after this takes place, so no net assets have been created. The combined net worth of all actors has not changed.
Paying back the principal does not change the net worth either.

This is what I mean what I say "it nets to zero", and it sure does, it's a simple matter of accounting, there's no arguing with that. It doesn't even have to do anything with MMT in particular.

New reserves are created without a corresponding liability. The net worth (equity) of the private sector has to increase in order to account for the increased reserve balance.
This, also, is a simple matter of accounting. Even if you insert a convoluted process of bond issuance and whatnot, the accounting stays the same.

The gov't of course does not "borrow" from itself -- this was merely my figure of speech. The gov't does not even "have" money in the actual sense (neither does it ever "lack" money). It just spends (issues) and taxes ("un-issues" if you will). The government's checks never bounce. If there's a "promissory note" from the government, it can always exchange it for cash (which is also a promissory note, just not interest bearing). Treasury bills/notes/bonds are not that much different from cash.

Regarding your last paragraph: money does not "travel". It is simply accounted for at all times. When you "transfer" money, a few bits flip in bank computers and the banks transact with high-powered money among eachother.

Money does not "become" reserves that are then lent out, not even fractionally. Banks can always make loans if a creditworthy borrower is available and willing to borrow. They can always draw additional reserves if need be. As long as their capital requirements are met, they can make loans, reserves don't matter (some countries, e.g. Canada, don't even have reserve requirements).

Rupert Russell said...

If a government spends into existence on a project, lets say a school complex and the funds are made available to a private contractor to do their thing, and the suppliers and workforce of said contactor get paid in electronic money that they deposit in a 'bank' of their choosing and those funds appear on the balance sheets as deposits, that bank can then lend monies, backed by those funds, at ratios in accordance to the fractional reserve system. Correct? How does this differ from the current system?

Toby said...

Hi Sigi,

you’re right, I hadn’t quite grasped it, and a slice of humble pie is due at my table! There is indeed a difference in debt types, in that when gov’t sells bonds to create new high powered money, though that new money is owed to the holders of the bonds at some later date, it does not disappear from the system upon bond maturity. High powered money stays in the system until taxed out of the system, even if all that happens with taxation is changes in numbers in accounts electronically (no notes and coins touched). My bad. Hence Fed/Gov’t money creation cannot net to zero in the way commercial bank credit money does. That was a large hole in my understanding, so thank you for prodding me on it.

However, interest is identical in effect (of course) in that it transfers money from to those who can afford to purchase bonds (save, hoard) from those who can’t (generally speaking and over time).

That said, netting to zero may not be allowed to happen in total, or rather in the system as a whole, since such would collapse the effective money in circulation by about 90% (or more, depending on how many commercially created debts are included in the thought experiment here). Hence, though credit money is expunged upon repayment of the debt, and the interest earned is merely existing money moved from here to there (electronically); though credit money is ‘merely’ multiple, overlapping claims on high powered money, it is nevertheless both as effective and as vital to the economy as high powered money (if not more so, considering its inherent flexibility). It must grow over time too (due, e.g., to interest and the legal structure of the corporation as a profit-making machine, variants of which most banks are). Furthermore, per the data in “The Roving Cavaliers of Credit” credit money ‘initiates’ Fed created high powered money. Hence, the distinction, though valid in describing the inner mechanics of the system, is unhelpful when analyzing total system effects. That is the thrust of my argument. I never sought to claim that credit money does not extinguish itself on a loan by loan basis, only that the net effect of that part of the system is not zero.

cont...

Toby said...

cont...

So all in all I stand by my assertion that the distinction is unhelpful over the long term, if other aspects of the money system remain unaddressed (e.g., interest and forced growth). TBTF proves this. Even zero-reserve banking as in Canada proves this. In the end—and I suspect strongly that we are moving towards this realizations as a species—a money system does not actually need some ‘gold standard,’ some ‘real’ money backing, whether in the form of a precious metal, or basket of goods, or high powered money. The real backing of money generally—namely work, economic activity and growth—is what keeps the system going, not some ‘genuine’ currency possessing the fabled (and illusory) ‘intrinsic value.’ Money merely facilitates paid work and other economic exchange. The current money system facilitates this up to the point where growth, as we have known it, is no longer possible, and begins to break apart when growth falters. Hence my talk of steady state growth in other posts, which requires a profoundly different set up to today’s. And hence the thrust of my position is unchanged, even though I was wrong on some of the details.

The more I study money, the more fascinating it becomes. It’s like our shadow, or a deep reflection of our cultural understanding of reality. The idea that propelled me to study money was that of a resource-based economy, which requires no medium of exchange. This is far more complicated a concept than a shallow analysis of the idea throws up, since exchange is mediated in all sorts of ways, including language. To me this means that even absent notes and coins, or absent their echoes as electronic bits on computer disks, every society, even one under a resource-based economy, will have some form of money reflective of its wisdom and culture. The very human urge to contribute to the social group, and thereby be important to it, requires a reward mechanism of some sort, which cannot be purely internal to the individual, since then the group and exchange itself would be irrelevant. Reward for contribution must be explicit, arise from society somehow, as must, ipso facto, punishment. The network human society must be necessitates this dynamic. Any reward/punishment mechanism therefore has to have money-like attributes when it is part of societal work and contribution. Where we can be wiser about this aspect of human society, more mature if you like, is the degree to which we allow society to see wealth stored in, and be steered by, money:

Demote money, promote wealth. ;-)

Toby said...

Hi Rupert, to me the key difference would be the word "spend". As far as I am aware governments only borrow money into existence (certainly this is true of the larger nation/states). To spend into existence is to print money--a no-no. QE is kinda spending into existence, in that the gov't buys its own debt instruments thus borrowing from itself (not so crazy, huh Sigi?), which, to me, means we need not associate an explicit debt with all monies created.

Sigi said...

"those funds appear on the balance sheets as deposits, that bank can then lend monies, backed by those funds, at ratios in accordance to the fractional reserve system" (Rupert)

You have it somewhat backwards. A bank can always make loans. Maybe the bank's reserve account will be "overdrawn" after making the loan, but then the bank can always borrow money from the central bank at the overnight rate to put its reserve account back in balance. Reserves do not constrain the amount of loans a bank can make (bank capital and available borrowers do).

Toby wrote "credit money ‘initiates’ Fed created high powered money" which is correct and illustrates my above point: when there are borrowers, and loans are being made, the amount of reserves in the system will possibly increase (after the fact, so to speak).

If you take that into account, you will also understand why all the "Quantitative Easing" did not stop the private sector from deleveraging. Pumping additional liquidity (reserves) into the banking system did not have the desired effect of increasing loans being made -- because there aren't enough people right now who actually want to borrow, as they're busy paying down their debt.

The money multiplier is a myth (well it's actually an after-the-fact observation with no predictive power). Current reserves don't "multiply" into a money stock. It doesn't work that way.

"in that when gov’t sells bonds to create new high powered money" (Toby)

Let's see: the gov't selling a bond means that it does take cash OUT OF the system. Bond issuance actually drains reserves from the system, as opposed to creating them. And now there's no point for the gov't to "keep" that money somewhere and hoard it, as they can always spend by issuing currency when the need arises.

The bond issuance does not fund the gov't.

Bond auctions are a way for the Fed to control its target interest rate.

BTW I agree with your general sentiment towards credit money, and I find it important to keep looking for a way to transact which protects the environment and works in a zero-growth situation (soon on a planet near you).

Another thing: the points that MMT makes do not apply to the European Monetary Union. EMU members do not have currency monopoly, they're merely users of a currency issued by somebody else. They are revenue constrained and can't spend money into existence either.

Anyway, I can only recommend to study MMT some more. In my opinion it's the best description of the current fiat money systems, and it helps to understand the current problems we are facing.

Warren Mosler, Billy Mitchell and Cullen Roche run excellent MMT blogs with a ton of well written articles and a civilized discussion by readers.

Toby said...

"Let's see: the gov't selling a bond means that it does take cash OUT OF the system. Bond issuance actually drains reserves from the system, as opposed to creating them. And now there's no point for the gov't to "keep" that money somewhere and hoard it, as they can always spend by issuing currency when the need arises."

I think that depends on a number of different factors. If China buys US bonds 'cash' moves from China to the US, adding liquidity to gov't accounts in commercial bank accounts. When new high powered money is created the Fed credits gov't accounts with new money and sells the bonds and treasuries (or buys them itself a la QE). Otherwise there could be no new money, and all that would happen is movement of existing credit money. With what, for example, would a Goldman Sachs of JPMorgan buy bonds and treasuries? High powered or credit money?

Got to rush. Haven't proofed this, probably full of errors.

Sigi said...

When China buys treasury bonds, the money does not move from China to the US.

What actually happens is that the money moves from one Chinese account with the Fed ("checkings") to another ("savings"). You can treat Chinese held tsy bonds as being in a "savings account" with the Fed (interest bearing dollars).

Now, China might hold a bucketload of USD (those would be in their reserve account with the Fed), but that doesn't mean they can buy up the USA or that they fund the USA. China is not the banker of the US.

Bonds can only be bought with high-powered money (reserve accounts are debited when that happens). No money is created at that moment. As mentioned, this actually drains reserves.

New money is created when bonds are bought back by the Fed and reserve accounts are credited.

Now, as I've mentioned earlier, the bond auctions are first and foremost there for the Fed to meet its target interest rate. NOT to fund the gov't operations.

Please read the following article for clarification: DOES CHINA FUND OUR SPENDING?

Toby said...

So gov't raises future money at a bond auction, while draining the system of high powered money upon sale? That means, after a bond auction the reserves of commercial banks fall. When they mature or are bought back by the Fed the money that was drained from the system reenters it into reserves. Where is the creation? Does it come from the interest? And you can't buy more bonds than are there, so how the money growth of such rapidity over recent years? There is something wrong with this picture.

By the way, I'm not discussing MMT per se, more the nitty gritty of central bank processes. My main focus is on the nature of money as a component of society rather than the mechanics of its production since we've had fractional reserve banking. So I'm going to point out again that the distinctions between high powered and credit money are unhelpful over the long term. Also, money does travel, even if all that happens is the flipping of bits on disks. Were this not the case, defaults would be impossible, lending would have no meaning at all, and indebtedness would not happen. You paint too neutral a picture, as if banks have no power to ruin the economy. The ineffectiveness of central banks to 'reignite growth' is a clear demonstration that all this talk of bonds and auctions and how and when new 'real' money is created serves only to bring the details of the existing system to the front, but does nothing to address the system's obvious flaws. If banks aren't lending, for reasons of anxiousness about the economy, the amount of their reserves, and people are too indebted anyway, no amount of high powered money can help. Only wiping out the debt can, but then peak oil, peak soil, peak water and peak everything else comes into play. In the end, money is nothing but a poorly abstracted guess as to the value of goods and services 'out there'. The price system, the so-called 'free' market, is not generating accurate information, for multiple reasons (e.g., externalities), hence the money, real or credit, sloshing around out there, is telling us very little except that things are very screwed up.

As to China, I was saying nothing about its ownership of the US or otherwise, merely that it buying bonds must mean high powered money notionally flowing to the US gov't. Surely China has some say over what it does with that high powered money, regardless of whether it resides in an account at the Fed. About 40 years ago, France wanted the gold the US owed her delivered, a polite but firm request which ended the gold standard. High powered money is the new gold. It belongs to different people, to different nations, who can do with it what they want. Things continue as they do for many different political and economic reasons, but change is happening.

Sigi said...
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Sigi said...
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Sigi said...

So gov't raises future money at a bond auction, [...] Where is the creation?

Gov't does not "raise" money at those auctions. A bond being bought by the private (or foreign) sector means that cash reserve money becomes interest bearing reserve money. Bond redemption just reverses the process.

The money that is used to buy the bonds has to be disbursed by the gov't beforehand -- when the gov't spends.

Reserve accounting is not the same as private sector accounting, in that there's not a liability for the newly created reserves (when the gov't spends).

So, the creation happens when the gov't spends, and also when interest payments on the treasury bonds are made.

The rapid money growth was mainly in the private sector (debt money). If you look at that article you've cited in your original post, you see that in some of the figures included there. (By the way, it's an excellent article very much in tune with MMT, which is not surprising since its author is an MMT proponent as far as I know :).

By the way, I'm not discussing MMT per se, more the nitty gritty of central bank processes.

Which is precisely what MMT attempts to do: exactly describe how modern money actually works, operationally. Therefore I repeat my suggestion that you really should look into it some more and read the primary literature that is available on the various websites.

You paint too neutral a picture, as if banks have no power to ruin the economy.

The banking cartel has spun completely out of control and it's vastly under-regulated. None of the MMT authors that I follow would disagree with that.

In fact, if you read Warren Moslers book "Seven Deadly Innocent Frauds" you will find that he proposes strict regulation of private banks, cutting down their responsibilities to serving the public interest as opposed to going crazy with derivatives.

Policy decisions will still have to be made, but the necessary first step on the way to a good policy is to actually understand how the system works, and MMT sure helps with that. Far too few people in power have that information, they blindly follow neoclassical economists who just don't have the answers (because their paradigm is way off). Well, and of course there are those who know exactly what's happening, but knowingly keep misinforming the public. Misinformation is powerful indeed.

Sigi said...

[MMT only brings] the details of the existing system to the front, but does nothing to address the system's obvious flaws

The "talk" is to explain how the system that we're using actually works, so that the flawed policies based on misconceptions can be corrected. Just look at the Euro: it's a flawed system, and we wouldn't have to cope with all the havoc it causes if politicians understood what's wrong with it. It's much easier to understand what's wrong with it from an MMT perspective, at least in my experience.

About "peak everything", I completely agree without. We've lost control. However, not even understanding how or monetary system operates won't make it exactly easier to correct course (if that's even still possible).

As to China, I was saying nothing about its ownership of the US or otherwise, merely that it buying bonds must mean high powered money notionally flowing to the US gov't.

No, not at all. When China buys bonds, the money notionally flows from a checking account into a savings account, all inside a Fed account.
Surely China has some say over what it does with that high powered money, regardless of whether it resides in an account at the Fed.

Yes they do, but they can't force anybody in the US or elsewhere to sell them stuff (or factories, or land, or anything), unless the seller wants to sell.

Also, China is not interested in killing off the USD by whatever bond shenanigans they could perform. China is heavily invested in a healthy Dollar and in a healthy US economy, because the US is their biggest customer. Hurting the US or the US currency is only hurting China.

You mentioned several times that what we actually should do is look at the "real world" and the "real wealth" instead of at money abstractions (and you're right about that). Curiously, if you do that you notice that a TON of goods are being shipped FROM China INTO the US. The winner are the people of the US, who are receiving all those goods made elsewhere under despicable conditions. At the end of the day, when all the stuff is used up and on some huge dumpster, who cares about a Chinese account at the Fed? THEY'VE SENT THEM THEIR STUFF.

High powered money is the new gold. It belongs to different people, to different nations, who can do with it what they want.

Fiat money is not like gold at all. Gold is limited and physical. Fiat money is unlimited and virtual.

And no, they can't do with it what they want, they can only attempt to buy stuff with it, but that always requires a counterparty who is willing to accept the currency...

Sigi said...

Warren Mosler's book is here:

http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf

Toby said...

There's a lot of misunderstanding going on here. When I said "I'm discussing the nitty gritty" I meant right here in this thread, I did not mean at this blog. The nitty gritty interests me less than the systemic effects. A lot of the to and fro between us is semantic pedantry, and to my eyes, unproductive. However, what it is showing me is that the way the system 'really' works is a matter of debate. Why? How have banks acquired all that power? How do they control the debate, influence perceptions as deeply as they do? Because of the power of money, of their credit money. Credit money must therefore have far more societal power than high powered money; the evidence for that is everywhere to see. Our discussion here is but one manifestation of that general problem.

For example, regardless of exactly how money creation happens, the system is perceived in the various ways it is, and that perception, which is subtle, involved, complicated, manipulated, etc., is what counts. More deeply than most realize. Money creation is important, but more important is why we do so, to what end. Our discussion here has veered sharply away from that aspect.

There was also a misunderstanding again about my words on China. I may as well have said The Maldives. I was not talking about power, or political and economic battles between nations. That barely interests me. My point was enormously general. And again, just because all that flipping of bits happens on Fed disks does not mean changes in ownership are not happening. I was talking about a notional back and forth. And you repeat my point back at me. I said "that things continue as they do" as a reference to the enormous momentum of the system, meaning this show will stay this way for a while yet (China is trapped, but then everyone is), and yet change is most certainly afoot, because growth, which usury forces on us, is over. That breaks this system. Gov't spending to ignite growth ain't going to work. Full employment ain't going to work.

What is abundantly clear, and the main point of my article, was that "nets to zero" is a misrepresentation of the private sector, and you seem to agree with me. It is the private banks that are running the show. Also clear to me (now) is that high powered money is in fact weak money, inflexible and dead. Its monika is deceptive. Credit money has the power. The private sector initiates all money creation, and indebtedness has rendered high powered money more or less ineffective at stimulating the economy. I believe we should be shrinking the economy, not growing it, and growing the commons. I also believe we should be shrinking the number of jobs people are forced to do in the interest of the economy, and increasing the amount of commons-related work. (See Charles Eisenstein.)

As to the government having more control of the money system, I am not for that. I am for smaller government and more money types as a path towards no need for money at all. What the world needs (and I think of the planet as one entity, with a species, the human being, failing to live on it intelligently) is less concentration of power. If large nation-state governments control the money system totally (impossible, but for the sake of argument), that is too much power in too few hands.

Thanks for the book tips. MMT literature has been on my list for a while now. To give you a better idea of where I am coming from, Charles Eisenstein's "Sacred Economics", which is being serialized online and can be read for free that way (the first 6 chapters are linked to at charleseisenstein.com), is very in tune with my thinking. Again, it is money the idea, the thing, its influence on society and our paradigm, and how all these things interrelate, including e.g., the birth of the state, hierarchy, what a living system is, etc. that motivates me. The current money system is but one (small) part of that.

Toby said...

"Fiat money is not like gold at all. Gold is limited and physical. Fiat money is unlimited and virtual."

But only "unlimited" in theory (and one day we may be able to create gold at will, who knows). This is a very important point. We do not control money, even fiat money. In fact I would argue we control nothing, that control is an illusion. Sure, we could print a gazillion dollars for everyone on planet earth, but so what? And it will never happen in practice. Money serves a function. It is a slave to what the economy is doing, how people react to it, feel about the future, the health of the planet's ecosystems, etc. Aren't we learning that now? Fiat is like gold in that way, i.e. not unlimited. And please, don't read me so literally. I said "like gold". That does not mean, 'exactly like gold in every way.' Fiat is also not shiny and yellow. I was pointing out a similarity. Like gold, high powered money 'backs' credit money. Even if you move to zero reserves and pure credit money, the economy would back that money, limit it. We can't escape limits. That was one of the (admittedly hidden) points I was making with the TDs (Toby Dollars).

Nothing has intrinsic value in my thinking, not even gold, nor fiat of course, because value is a relative concept, like beauty. Value arises out of relationships, it does not exist a priori inside 'things.' But that is a discussion for another day also.

Toby said...

So, back to The System itself.

You wrote:

"The money that is used to buy the bonds has to be disbursed by the gov't beforehand -- when the gov't spends.

Reserve accounting is not the same as private sector accounting, in that there's not a liability for the newly created reserves (when the gov't spends).

So, the creation happens when the gov't spends, and also when interest payments on the treasury bonds are made."


I find that very confusing. The gov't gives money to the commercial banks with which to buy bonds? The amount of high powered money is raised, then, to lower that amount, bonds are sold? When they mature the amount rises again, plus interest. That must be the weirdest thing I ever heard. I suspect you are German: "Warum einfach, wenn es auch kompliziert geht!"

No liability, you say? So the US deficit is a lie? What's that about? Was the dramatic debate to raise the US debt ceiling (again) totally theatrical to the point of an out and out lie? If so, that again just shows how powerful the banks are, how irrelevant high powered money in comparison to their credit money.

Sigi said...

I'm going to make two separate responses.

First of all, we have somewhat talked at cross-purposes I guess. As I've said before, I understand your objections with out current system and that it's not well suited to address the problems we will be facing in the future (Peak Everything).

I don't know what the best system, or system of systems would be. Right now, I'm trying to understand what we're presently dealing with, and what got us into this mess -- this is already highly complex and there's so much more to learn. Additionally, there's a lot of conflicting information, because the mainstream is driven by greed, lobbyism and a failure to adapt to the rapidly changing circumstances.

Separating the wheat from the chaff already is a daunting task.

To me, getting a firm grasp on reality is first and foremost. This hasn't even happened for most people.

Franz Hörmann spectalularly blew it in my opinion when he wasted the sudden publicity he got by making unrealistic predictions and claims about the End of Money happening soon, with him and his colleagues then swooping in to implement a much better system. Just like that.

That was tactically very unsound, to say the least. I find his ideas interesting, but I'm afraid it will turn out to be a dud because of poor communication.

Therefore we should first work on finding a working paradigm for the current situation and try to get that into the mainstream before talking about Utopian visions of the future.

By the way, the first time I've heard MMT mentioned was on your blog.

Sigi said...

I find that very confusing. The gov't gives money to the commercial banks with which to buy bonds? The amount of high powered money is raised, then, to lower that amount, bonds are sold? When they mature the amount rises again, plus interest. That must be the weirdest thing I ever heard.

Yes, because it is weird.

Bond sales DO NOT FUND the gov't (at least not for countries with currency sovereignty -- again, the EMU is a different beast). If one does assume otherwise, one will get confused.

The gov't can spend when it wants, and however much it wants. Because it does issue and control the currency. And in order to tax, money has to be spent (created) first, otherwise taxation is not possible.

(Keep in mind that gov't spending and taxation happens with high-powered money).

So it would be absurd to think that the gov't somehow "raises money for itself" through an auction. It doesn't have to, because it can create any amount of needed reserves to finance its own spending.

And it's equally absurd to think that the gov't has to fund itself through taxation, since it's never revenue constrained anyway. Taxation is a money drain, nothing else, and you can only drain what you have created earlier.

Mind you, this is the underlying, operational, reality according to MMT, but it's currently obscured because remnants of the gold standard (bond auctions, debt ceiling) still exist. So what actually happens operationally is not what appears to be happening on the surface, and it's a great source of confusion.

I suspect you are German: "Warum einfach, wenn es auch kompliziert geht!"

Indeed I am, but this convoluted system was not my idea. I'm merely replicating here the explanations made by others, which I found most consistent and logical.

The system is more complicated that it would have to be, because it originates in a time when there was still a convertibility of the currency into gold -- and this changes everything, and it's not that much different from how the Euro works.

No liability, you say? So the US deficit is a lie? What's that about? Was the dramatic debate to raise the US debt ceiling (again) totally theatrical to the point of an out and out lie?

Yes to all of the above.

If so, that again just shows how powerful the banks are, how irrelevant high powered money in comparison to their credit money.

If anything, it shows how uninformed the public, the media and most politicians are.

Sigi said...

One more remark:

I'm feeling uneasy about advocating a paradigm that I have had no part in establishing.

At best I'm only slightly misrepresenting the works of others here.

So I would be happy to read about your thought processes should you decide to put some serious research into MMT and what you make of it.

Frank Powers said...

@Sigi & Toby:

Thanks for that very interesting exchange. It will take me only a couple of days to wrap my head around it, but give up I will not. Money just is very complicated.

Toby said...

And finally from me:

One of the things I find off-putting from the MMT advocacy is their idea that gov't can do anything it wants re. money creation. That it can print money is, in the end, no big deal, because I too can print off my own money. We are constrained (differently, yes, but constrained we are) by the famous 'outside' world, whether we like it or not, whether we are a small Toby or a mighty US Federal Reserve Bank. Add to this the very misleading "nets to zero" and the overall impression is of God-like omnipotence of the sovereign gov't. It is a dangerously deceptive combination in my opinion. And they always seem to be pushing growth too. And full employment. "Men would feel insulted if it were proposed to employ them in throwing stones over a wall, and then in throwing them back, merely that they might earn their wages. But many are no more worthily employed now." Henry David Thoreau.

Money is a nothing, but an enormously important one. It is our abstraction of value, our measurable myth of value, which has been 'organically' apportioned and invested across the planet, across the ages, to end up in a particular set of wealth gaps, power gaps, power relationships, income streams, and so on. Organizing value distribution differently will take a huge effort, most likely including war, even if MMT has the clearest description of the current system. The implications of its perception suggest the end of one era and the onset of another. But owning Control of Value (via money) is a power no right-minded sociopath will lightly give up.

Yes on Hoermann, though he does have till end of October for his doom-laden predictions to play out, then, at the outside, till end 2012. My darker suspicion is that someone has been playing him, or that he is a little too vain. Nevertheless, what interests me is not predictions but ideas. Many of his are very helpful and instructive. In the end it's up to all of us, not one, shining dude riding in to do the glorious rescuing. I will say though; the end of growth is the end of this system. Growth is what keeps new money flowing to the owners of money, via interest, a dynamic which lies behind all that bond/debt nonsense. Right now all the hyper-rich are earning is toilet paper and I suspect they really don't know what to do with it any more. Sadly, old habits die hard.

Roger Lewis said...

Hi Toby, I seem to be stepping into the same river for a second time on all this MMT, Fantastic series of 3 blogs these were, Have you hung up yopur pen or is there a book to look forward too. If you want any proof reading done, just holler.

All the best Roger.

https://www.youtube.com/watch?v=195HTzx31So