A Final (?) Look at Modern Money

H. L. Mencken: “For every problem there is a solution which is simple, elegant and wrong.”

We must always be wary of sellers of snake oil, regardless of what form the snake oil takes. Similarly, we must always remember that theories are theories, and that the scientific method is a process of constantly testing falsifiable theories to be sure of their validity. I have been leaping in and out of MMT waters of late, but, unable to set up a nation of my own to run on MMT principles, my testing of its ideas can only be rational and logical, thought-probings to seek out potential weak spots.

At first I felt the “net to zero” pronouncement of private sector credit-based money creation was fallacious, then I looked again and thought it an accurate statement, and now – oh vacillating me! – I think it false again. My efforts to look at money in an economy as a component of a system has led to a new way of seeing debt and wealth (wealth here meaning ‘real’ money).

This post represents somewhat of a negation of my sketches of various, crude monetary systems. The problem of interest those drawings were supposed to address is not accurately presented. The reason is that my starting points were too unrealistic, the systems too crude. Sometimes it helps to simplify, sometimes you lose too much information and your conclusions turn out wrong. However, recognising mistakes is part of learning, so I try to be happy to admit my own.

There has never been an economy that began utterly without money or trade, which was then kicked deliberately into economic life by a government creating fiat money. Likewise, there has never been a situation of zero wealth being turned into wealth by the creating of money. There has always been something there to monetize, some exchange or barter system to simplify. Money emerges in its various forms in stages, from barter to fiat. There is always an economy of some sort in operation, though they do change over time, as governments change, as money changes.

On to my new take. Loans do not net to zero, because they are not paid back symmetrically. In amongst the messy forward momentum of banking and money creation, economic growth and technological developments, loans are made in various forms by various entities to various entities, all in different states of economic health. In that melee some do well and others do not. So, a more realistic scenario than the one I presented a few days ago would be this:

10 banks each issue loans of $100 to ten businesses. Each business owes back $110 to each bank. Of that total $1,000 loan pool the ten businesses compete for as large a share as possible. Maybe four businesses fail, three do badly, two just about OK, and one very well indeed. Perhaps the most successful business accrues from the pool $500, of which it pays pack $110. That business is now the proud owner of $390 that it owes to nobody. That money was initially created as loans, but is now real, owned money. And where is it kept? In one of those banks as a deposit. That deposit gives the lucky bank more leverage to loan new money to the not quite failing businesses. Thus is money created from ‘nothing’, and despite interest owed, and banks having to compete with one another, there is a kind of Baron von Münchhausen ‘pulling oneself up by one’s own hair’ happening here, that ‘netting to zero’ fails to explain. We start with ‘nothing’, create $1,000 in loans, and have, in this crude example, $390 left over, not zero. Banks and businesses may die in the process, but that’s life.

Curiously, what we have is ‘wealth’ creation as a direct consequence of money pooling unevenly throughout the economy. Were this uneven pooling not to happen, there would be no wealth creation. Should, for example, but one business fail in the scrabble to survive, and the nine others do equally well, each of the nine could pay back its owed $110 and have nothing left. There would be $10 unaccounted for, which maybe the issuing bank received as a monthly payment from the failed business. That would be netting to zero, as all debts bar one would be neatly expunged/repaid. An even flow of money has, therefore, the ‘detrimental’ effect of creating no new ‘wealth.’ But this is highly unlikely to happen. Real life is messy and unpredictable. Also note that failure is a precondition for success elsewhere – in this model, if all do equally well, none do well.

But, because money is sticky and coagulates (“being rich is better than being poor” is a logical consequence of scarce money), this ‘successful’ money-creation has long term costs, such as entrenched social divisions. Even longer term it becomes a ponzi-like situation, as more and more non-monetary wealth is monetized into debt in the endless pursuit of eternal growth, and banks, as Corporations in pursuit of profit, seek new customers to fuel the growing debt-pyramid. The amount of debt we are weighed down by today is likely a direct consequence of the scarcity of money (a scarcity which interest/usury necessarily creates), and, more abstractly, of the deeper presumption of scarcity itself, which leads to flawed notions of surplus, deficit, credit and debt which dissonate with what we see occurring in the wider ecosystem.

This unevenness, though, seems to be a vital part of creativity. Smooth-and-featureless is without character, without challenge. It is mistakes, bumps and oddities that call for adaptation, and ‘successfully’ adapting to the unexpected calls for creativity. Furthermore, all problems ‘solved’ generate new problems to be ‘solved.’ That process is probably what progress is, and will make demands of us humans for as long as we are around. Nevertheless, monetary ‘unevenness’ does, in time, lead to gross imbalances, as witnessed in the widening wealth gap. And systems are leaky too, not closed. As we creatively deal with the challenges we face, we set up new challenges down the road. The two key challenges we face today are establishing a sustainable relationship with the planet we live on (part of which is transitioning from fossil fuels), and finding a new way of doing economics, since automation and technological unemployment are going to interfere increasingly disruptively with our current methods of circulating money.