Money, Debt, Reserves, Money and Debt II

We are often told money does not grow on trees. So where, then? For grow it most certainly does, and dies, is somehow born, plus all sorts of other organic-like stuff; ‘money talks,’ ‘let your money work for you,’ ‘money never sleeps,’ and so on. What follows is a partial, though lengthy look under the hood of money creation, ably assisted by Warren Mosler’s booklet “Seven Deadly Innocent Frauds of Economic Policy” and the Chicago Fed’s “Modern Money Mechanics”. My own idiosyncratic reactions to those booklets’ contents does the rest. (Thanks to Sigi for putting me firmly on this path!)

For those of you who understand reserve accounting, note that the Fed can’t do what’s called a reserve drain without doing a reserve add. So what does the Fed do on settlement day when Treasury balances increase? It does repos – to add the funds to the banking system that banks then have to buy the Treasury Securities. Otherwise, the funds wouldn’t be there to buy the Treasury securities, and the banks would have overdrafts in their reserve accounts. And what are overdrafts at the Fed? Functionally, an overdraft is a loan from the government. Ergo, one way or another, the funds used to buy the Treasury securities come from the government itself. Because the funds to pay taxes or buy government securities come from government spending, the government is best thought of as spending first, and then collecting taxes or borrowing later.
[Warren Mosler. My emphases.]

A simplification* certainly, nevertheless complicated stuff. Somehow counter-intuitive. A central bank just creates money, from nowhere, because it can. Government sells debt because … more on that below. Money is injected into the system, money with which government debt can be bought so as not to incur the irritation of commercial bank overdrafts of accounts held at the Fed.

Why so complicated? My short answer: banks are profit-making businesses with enormous, centralized power. The commercial bank system is the sole conduit between people and “high powered money” and exists to make money for its owners. Banks are businesses. Banks are therefore usurers ‘corporatized,’ which in effect means institutionalized, which means state-sanctioned. They are also, at some size and in the eyes of the state, too big to fail. They are therefore, ipso facto, part of the state. They are not distinct components of a logically separate ‘private’ sector, somehow at the mercy of government high powered money creation. Indeed, my impression is that central banks exist in part to mask how powerful commercial banks are. Of course economic stability is key, but one can also argue that such stability as is achieved serves commercial banks more than any other sector; it must, after all be stable growth. Economic Growth is systemically yoked to usury and the dynamic of the pyramid scheme, and is the hidden core of our money system.

The Fed can’t drain without first adding: To me, that’s not really a drain. That’s like adding water to a pool in the hope that the pool’s manager will allow you to take it out again in exchange for magically expanding ice cubes with different melting rates.

Repos: adding funds to the banking system, funds which banks then might use to buy government debt—note there are “primary dealers” ‘obliged’ to buy government debt at debt auctions. So why bond auctions at all? Why not just hand over the bonds ‘for free’ and cut out step 1? Because then the money markets would no longer be money markets as we know them. Then the whole thing would be too much of a joke, and a less entertaining one than a game of Monopoly. The following quotes hint at what I mean:

“Efforts to rescue the UK economy were plunged into fresh uncertainty this morning after the government failed to find a buyer for some of its debt, the first such failure in seven years.”
[The Guardian]

“1.923 BTC X 61.59% Primary Dealer bid = 1.18 BTC (PD), greater than 1.0. Or to put it a different way, but for the primary dealers the bid-to-cover was less than one, meaning that some of the issue would have been left on the table.
“Thats a fail; but for the primary dealers the issue would not have subscribed.
“Primary dealers are required to bid. That's the deal in exchange for their being named as "primary dealers." For this reason short of thermonuclear war you will never see an actual (BTC < 1.0) "fail" on a US Treasury Auction - Treasury has rigged the process so as to insure that cannot be reported.”
[Market Ticker]

“China's finance ministry has failed to sell all 28bn yuan ($4.1bn; £2.55bn) of one-year government bonds it offered at an auction.
“It is the first under-subscribed government bond auction since 2003.”
[The BBC]

Quite embarrassing (or at the very least odd) when you ‘give’ the buyers the money with which to buy your product! And I do not believe all of the above is pure, clueless guff from a mainstream media unacquainted with the fine points of MMT. The larger story such stories weave is very important, very powerful, has us in its grip. Ownership of this story, being able to propagate it at will, controlling the paradigm, this is what is at stake here. Who owns the story? The ‘People’ or The ‘Elite’? Does MMT threaten this story, or merely present it from a different angle?

Bond issuance is serious stuff, no matter how ‘effortlessly’ central banks can change numbers in commercial bank accounts. Mosler’s analogy of a football stadium able to display points on a scoreboard without having to borrow them, is misleading; there are very clear rules for the assignment of points dependent on the game of football afoot. As I understand it, the sale of bonds is, from one perspective, a way of measuring the market’s opinion of that country’s growth prospects. From another it is a large, international process which boils down to control of the money system by the owners of money, that is control of the flow of funds generated by usury. Thus if governments were to side-step bond issuance entirely, directly pump the economy with high powered money as they saw fit, that would be printing, pure and simple. That would be government determination of how much money the economy needs, not market. It would be the government ignoring the market. But the market’s opinion must hold, because the Free Market Myth says, ‘Invisible Hand Knows Best!’; that government interference in, or ignoring of the market produces negative outcomes. To be wise, to be in tune with what economics and history have proven time and again, governments should yield to market forces, just as we must all yield to gravity. If we ignore this universal truth, hyperinflation will (eventually) occur (which, by uncanny coincidence, happens to hurt the owners of money more than borrowers).

High powered money is not ‘given’ with the explicit instruction to buy X amount of government debt with it (of course, not only banks buy bonds, but the money to do so does come from their ‘reserves’). Bond auctions must be (more or less) genuine auctions. There is a choice to hold onto the injected cash or exchange it for something less liquid. The stated reason for the injection of high powered money (HPM) is to keep reserves up, to prevent commercial bank overdrafts at the central bank. That annoyance would mean some commercial banks owed the government money, whereas bond ownership means the government owes banks money. Much nicer. What the commercial banks freely decide to do with those freshly injected reserves is their business (unless they happen to be “primary dealers”). As such, “high powered money” hardly has the descriptive ring of truth to it! Its existence and creation is more the legal requirement of a system designed to keep money fruitful and potent, in and of itself, I believe as a centralized tool of control. HPM serves to enable usury, even though usury does not require it (arguments of stability to one side); Canada has a zero reserve system. In the end it is usury which must survive. This system works in the interests of the owners of wealth, who get to make judgments, and profit, on the ever-shifting attractiveness of various currencies, regardless of whether it was cynically designed to do so; regardless, too, of whether the ‘elites’ really are elite and thus ‘deserve’ to protect their positions via such mechanisms.

So, why do governments sell debt? Because of usury generally, because the rich and powerful want to carry on making more money from their money, indefinitely. The system works for them first, for the rest second, and by coincidence. ‘Trickle down’ is a sop. Even the twin responsibilities of ensuring the ‘correct’ quantity of HPM and preventing too high inflation, the main duties of a central bank, at the deepest level, work to protect (stabilize) the interest-based money system. Who in the mainstream talks warmly of zero or negative growth GDP? Social dividend? Demurrage? As such this system is a ponzi scheme for the ‘elites’ and will completely collapse when it becomes apparent to the majority that growth is over. The current system cannot cope with steady state economics. Private sector credit money may not, effectively and in toto, net to zero because its absence would be the destruction of at least 90% of the effective money out there. “Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system.” (From “Modern Money Mechanics” (my emphasis).) Were credit-money-originated claims on HPM ineffective or irrelevant or impotent, somehow not “legal tender”, somehow ‘less’ than HPM, the system simply would not work. “Nets to zero” is neither here nor there, is a red herring. Money promised to function as money must do so. And why do we have money? To assist the economy. Why must the economy be assisted? Because the Perpetual Growth economy, in its current form, sustains elitism.

Commercial bank overdrafts at the Fed: Loans from the government. If a commercial bank is net negative in its reserves, the government is obliged to ride to its rescue. How will a commercial bank repay that money? After all, it can’t create HPM! My guess would be to ‘win’ more reserves from other banks via ‘wise’ extention of credit, but, in truth, I don’t know, and haven’t seen the answer in Mosler’s book. Interest earned on loans does not alter the amount of reserves generally, and is furthermore bank earnings; that is, bank earnings pay bank operating costs, wages, profits to shareholders, etc., so are distributed back out into other accounts in the system as already existing reserves. One bank’s owing of reserves to the Fed is the system ‘bleeding’ HPM generally speaking. Think of all banks as one, as compartments containing the total of HMP in existence. Any reduction of the amount of HPM in the system is potentially dangerous, because credit money is the economy's lifeblood.

As an aside, this is good place to remind ourselves that interest is redistribution, not creation. But as that redistribution favours the owners of money (over time), shortfalls occur among the poorer portions of society, which generates a need for more HPM. If the economy is not growing sufficiently quickly, there will be falling demand for new loans, credit-money claims on HPM won’t multiply, and defaults (credit-money destruction prior to banks earning a profit) will increase. The amount of (effective) money in the economy shrinks and there is less profit to be earned from interest. If too many people and businesses are too indebted; as, say, oil reserves become increasingly more costly to extract, in energy terms; if also consumerism is faltering, its charisma wearing thin, even new injections of HPM will make no difference. All more HPM can do is increase the ratio of HPM to credit-money, e.g., raise reserves and lower the risk of a bank run (depending on many other factors). But the point is not the amount of HPM (which is almost like dead money), but the rate of growth of the economy as it relates to potential credit-money creation and profits via usury.

Borrowing later: Government creates the money it borrows. It gives the system the money it later borrows at interest. That’s weird and telling, in my opinion.

In brief, government places money as reserves into commercial bank reserve accounts, with which government debt can be ‘purchased.’ “Otherwise, the funds wouldn’t be there to buy the Treasury securities, and the banks would have overdrafts in their reserve accounts.” What a line! Banks with overdrafts mean banks with negative reserves. Counterproductive. Must be immediately rectified by the Fed.

Government sells bonds and other forms of debt as one way of taking HPM back out of those accounts, lowering (for a while) the amount ‘in existence.’ Each debt promises to pay back that amount of HPM to the bearer plus some interest. And then one day government pays out on those bonds, whereupon more HPM enters the system.

The HPM, which must be exchanged for these transactions to occur, is created at need by the government and only by the government. Funny money? What is that money backed by? Whence does its value come? Some say tax and the solvency of the people. I say the value of this money comes from growth of economic activity, or, ongoing sale and purchase of ever increasing amounts of goods and services. Imagine an economy with only taxation. Government gives you money, then taxes it away again. The evidence that growth backs money is the maths of usury (P < P+I), the way the system invariably collapses when it is not growing (recessions and depressions are Not Good), and that inflation drains value or wealth from money.

So, why buy government debt? You ‘exchange’ some of your high powered money for debt because you want the amount you hold of that currency to grow faster (or more securely) than it otherwise could in some savings account. You want more of that currency at some later stage. Why more of that particular currency? The only reason I can think of is because you expect it to be stronger than other currencies, to retain better its purchasing power relative to others. Or some other reason to do with increasing your wealth. You would not buy government debt expecting to lose money (except as a primary dealer, who’d be bailed out at need anyway).


In general

The system is about getting money-richer, money being sticky abstractions of ‘measured’ wealth. Money working for you. Investing so as to maximize profit from money-ownership; a wise mix of risky and stable in your portfolio. Government debt is sound. They can always pay. The only question is, what is the value of this currency relative to others? What does a bond or other government debt offer relative to a commercial bank savings account, or some stock, or gold, or oil? And growth in the economy must be occuring for growth of the money supply not to be inflationary. Growth must also be happening for there to be more and more people wanting to take out loans, earnings from which pay for the interest owed by banks to the owners of money.

The system looks like, as others have said, a government backed counterfeiting cartel. Its centre is the credit money system, for which the central bank acts as a kind of hidden guarantor, a rock of stability. HPM is an enabler of the commercial bank activity. In the end, it does not really matter whether we have 100% reserves or 0%; money means, systemically, that we all need money of some accepted kind to survive. When you need money to survive and there is not enough for everyone ‘out there’ (how could there possibly be enough?), some will have to borrow. Those in a position to ‘help’ financially people in need survive are systemically constrained to abuse that power, because the underlying premise of the entire system is differential advantage, perpetual competition, and success as concentration of wealth and power to increasingly few. (The appendix in Eisenstein’s “Sacred Economics” is very helpful on this point.)

Where does money disappear to? To the Great Nowhere of the Fed via taxes and government ‘debt.’ What about interbank lending; how did it dry up in the second half of 2008? If we are to understand HPM as a pool kinda sorta equally distributed (dynamically) among accounts held by commercial banks at the Fed, and if only the Fed can create/destroy it, how did it disappear to critically low levels? How was there a ‘shortage’ of it? Derivatives and sub-prime. ‘Creative’ forms of debt. The claims on HPM were excessively above ‘required’ reserve ratios and were cratering bank balance sheets. It’s not that HPM disappeared, it’s that there quickly became too little relative to the multiple and exotic claims on it. The HPM/Debt cocktail was way too thin (though HPM is also debt-bound due to government selling debt on the money markets). The bursting of the real estate bubble had an explosive impact on bank balance sheets, such that no bank trusted the other. What to do? The system can’t be allowed to fail! The rest, as the saying goes, is history. And the times are getting interestinger!


Some graphics inspired by Modern Money Mechanics







* “Currency held in bank vaults may be counted as legal reserves as well as deposits (reserve balances) at the Federal Reserve Banks. Both are equally acceptable in satisfaction of reserve requirements.” And: “Part of an individual bank’s reserve account may represent its reserve balance used to meet its reserve requirements while another part may be its required clearing balance on which earnings credits are generated to pay for Federal Reserve Bank services.” (From “Modern Money Mechanics”.) There are fine grades of difference in the role played by high powered money as it resides in different places, as well as what reserves really are, and not all of it is customer owned, even though there are—by virtue of the nature of fractional reserve banking itself—multiple valid claims on that ‘real’ money. As to ‘real’, in the end, the validity of any money, whether high powered or otherwise, rests on faith: “What, then, makes these instruments – checks, paper money, and coins – acceptable at face value in payment of all debts and for other monetary uses? Mainly, it is the confidence people have that they will be able to exchange such money for other financial assets and for real goods and services whenever they choose to do so.” (“Modern Money Mechanics”) I can only conclude that this complexity serves to generate a powerful and unconscious sense of wow! in the observer, to foster trust in the competence of the experts who designed and remain in tight control of such an amazing system. Seriously. This is an amazing system. The smarts involved in building and maintaining it are not to be underestimated. And, perhaps most importantly of all, it is a pseudo-solid chimera that can take almost any shape yet still be exactly what it is; wealth-mining machinery of exquisite design. After centuries in existence, we are still debating how it 'really' works. That says something.

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.

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?

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.

Modern Monetary Theory: shiny, new and good? Part II

I’ve been digging deeper into MMT at Bill Mitchell’s blog, and finding the effort both stimulating and rewarding. My studies thus far have yet to answer all questions I have, and neither have my concerns been completely allayed, but I become friendlier with the idea the better I get to know it (with caveats of course). This post represents Stage 2 of my Modern Monetary Theory Journey.

One point I raised in my first post on MMT was about private-sector credit transactions netting to zero. The claim struck me as fallacious, as interest accrues to lenders, representing, from their point of view, a net positive. If this were not so, they would not lend money in the first place. Further study has updated my position. “Netting to zero” actually means “no new net wealth is created,” which is true. Only the loan is created, which is expunged either upon the last repayment or upon default. The interest must be fished out of the existing pool of money and handed over to the lender. Credit extension is therefore not a net wealth creating process, it is a shuffling-money-to-the-banks process. In a pure debt-money system, in which no money at all is created by government spending, we have a ponzi-like situation that can only fail. In such a system existing wealth in the economy is slowly transformed into debt obligations as private banks extend the credit economic activity requires. At some point over-indebtedness crashes the system, and all that apparent wealth disappears. (This short analysis equates wealth with money — an equation I don’t usually make.) Money spent into existence by the sovereign on the other hand, assuming it finds goods and services to buy, is, in contradistinction to credit, wealth creation.

So strictly speaking, and when seeing wealth as money — which is a legitimate assumption in this exercise of understanding how money works in a fiat economy — extending credit creates no new wealth, or “nets to zero.” My bad. However, that it nets to zero may be largely unimportant, because the public can be too heavily indebted regardless, but I’ll get to that in a moment. For know I want to go over how MMT views a monetary system.

Below is a graphic I’m borrowing from Bill Mitchell (please refer to his site for details):



A short time pondering this chart gives the viewer the impression of a system of flow, with injections, transactions, and removals taking place both vertically and horizontally. Rather wonderfully, tax is seen as taking out the trash. If there’s too much money in the system, tax it out and trash it. There’s no need for government to save if it can simply spend what the economy needs, in particular circumstances, into existence. (This is of course quite a trick to get right, but the idea is sweet.) We don’t need to think of money like we used to think of gold, as having magical intrinsic value, or as representing deserved reward for hard work and so on. It’s merely the lubricant the system needs in the correct quantities (which change over time) to hum along. Let’s not get all romantic and religious about it. This newer perception empowers us to get rid of the rather presbyterian idea of saving up for a rainy day (at the level of the sovereign — thrift and saving are still handy values for the private sector), and treat deficits and surpluses as necessary positions of balance that arise dynamically as the economy moves through time.

Two quotes from Bill Mitchell capture the essence of this nicely:

“Accordingly, the concept of fiscal sustainability should never make any financing link between debt issuance and net government spending. There is no inevitability for debt to rise as deficits rise. Voluntary decisions by the government to make such a link have no basis in the fundamentals of the fiat monetary system.”

“The real cost of any program is the extra real resources that the program requires for implementation. So the real cost of a Job Guarantee is the extra consunmption [sic] that the formerly unemployed workers can entertain and the extra capital etc that is required to provide equipment for the workers to use in their productive pursuits.”

However, as one of the stated aims of MMT is full employment, we must be careful not to set up a system characterized by moral hazard. If we deploy MMT within a GDP-growth obsessed paradigm, with conspicuous consumption the economy’s locomoting force, a citizenry confident there will always be work might be easier than ever to goad into buying more than it can afford. That innocuous looking rectangle in the middle of the graphic is therefore a weak spot as far as I can tell, unless we wean ourselves off our addiction to consumption and shopping. Until we have a more mature attitude to material acquisition at the cultural level, I fear MMT would be like letting children into the candy store, a candy store with finite resources.

In terms of the money, how would this play out? A population up to their eyeballs in debt after a multi-year shopping binge suddenly stops consuming at the rate they have been. Demand falls, business suffers, unemployment rises, and people have to pay off their debts. In steps the government and employs the cast-offs, but the money thereby injected into the economy is used to pay off debts. Government therefore has to employ/spend until those debts are down again, and the party can start over. This would be a smoothed out boom-bust cycle with less suffering, but may stoke consumption even further beyond current unsustainable levels. Keeping our eyes on the ecosystem and how wasteful our production/consumption processes are is of course essential.

I can envisage too that private industry, aware that displaced workers will find work in the government sector, might more aggressively pursue automation, not having to fear a consequent collapse in purchasing power. A weird world in which say 80% are perpetually employed (doing what?) by a State spending money into existence, effectively to fund a private sector which hardly need employ anyone, all to keep the system ticking over. Without intending the worst aspects of communism, MMT might deliver them. It would all depend on other elements of how we change the way we do business, e.g. how we educate our young, other money-types we introduce (see Bernard Lietaer), lowering the working week while changing the nature of waged-labour, and whether MMT can be effective alongside a drive to consume more sensibly and sustainably.

The money controlled by MMT, namely the fiat currency of the sovereign, would still be a scarcity-based tool, so having more would be better than having less. Consequently, it would pool to the rich over time, and the rich, via lobbyists and other techniques, would of course attempt to bring their influence to bear on government to favour their chances of staying rich. But, in a situation where the government is skilled at spending money into existence, the rich have no real leverage. Money creation is owned by the sovereign, which no longer has to borrow from the rich and powerful. Therefore, redistributive taxes aimed at inhibiting the process of social stratification that so bedevils countries like the US and UK, would be far easier to deploy. This is a Good Thing. This element of MMT alone (freeing the sovereign from the money lenders) may be enough to reshape our attitudes to monetary wealth culturally, and this change may be sufficient to make government a better shepherd of the economy, and more resistant to money-based corruption.

However, could we lurch from a Market run world to a State run world? I fear this is a possibility, though of course I cannot prove it one way or the other. The current paradigm asserts that Markets, via the Invisible Hand and arbitrary, almost blind money-processes, do what’s best for us in the end. This paradigm is under severe attack on many fronts. Books are available aplenty which pick apart this idea and expose it for the empty, though manipulated platitude it is. Those who call for less regulation/intervention need to address the underlying assumptions of how markets work (perfect knowledge and rational market participants) in order to appreciate what it means to rely entirely on the blind wisdom of The Market. However, government is also incapable of perfection, though it is foolish to demand perfection of any system.

In the final analysis we need to guard against over-dependence on any one component of society, and develop instead a far less centralized, networked and redundantly laid out set of interdependent, competing (though complementary) components. I recommend Bernard Lietaer’s talk for more on this. Right now my initial basket of components looks like this:

1: One global currency which must be used for international trade and has a demurrage of maybe 5%.

2: National fiat currencies deployed by sovereigns along MMT lines, for taxation and general economic activity; money as economic lubricant.

3: Many local currencies, or alternative currencies to compete with the sovereign’s currency, but supported by the sovereign.

4: Technological unemployment must be embraced as part of the 100% employment push (unintuitive as that sounds at first hearing), while things like education, societal health, beating crime, and living within the limits of the ecosystem must be prioritized.

MMT is but one component of many, but a very important first step out of our current self-imposed dilemma. A path away from material acquisition as society’s primary locomotion must, I feel, be pursued in conjunction with MMT’s deployment, alongside that of the competing/complementary monies touched upon above.

All in all I would characterize MMT as a very welcome breath of fresh air to economics, one which has the potential to pull us out of our self-imposed, debt-based dilemma and off in a far different, far healthier direction. Spread the word!

Modern Monetary Theory: shiny, new and good?

Modern Monetary Theory, or neo-Chartalism, proposes debt-free money creation by fiat. Money is created by the state at no interest, then spent (not lent) into the economy for the funding of projects, with the aim of achieving full employment and maximizing money-demand. Taxation controls inflation.

“Modern chartalism theory states that under a fiat money system, money is created by government deficit spending. Because money is not tied to or backed by a commodity, money can only be created when the government spends money. Government may, or may not, ask for that money back in taxes. The demand to hold and acquire [this] money is driven by taxes levied by the state, taxes that can only be paid in the state issued fiat currency.” Wiki

 
This blog entry is my initial thoughts on and criticisms of MMT, as well as a consideration of its possible usefulness in transitioning to a resource-based economy. (Thank you Martin for posing the question!)

Positives

On the positive side Modern Monetary Theory (hereafter ‘MMT’) treats money as a necessary chimera to be controlled by us for the enabling of economic activity, and not as some Act of God or Nature equipped with magical intrinsic value and oh so handy for controlling wayward, lazy us. There has of course been MMT precedent, at least in nascent form, during the days of Jefferson and Colonial Scrip, and a little later during the revolution when The Continental (the name given the currency) did the impossible and funded US armies against the sovereign. The brave, new, revolutionary recognition was that governments could both lend and spend fiat currency into the economy. The success enjoyed by Pennsylvania with their variant of the colonial scrip system was particularly eye-catching:

“The model that earned the admiration of all was the loan office established in Pennsylvania in 1723. The Pennsylvania plan showed that it was quite possible for the government to issue new money in place of taxes without inflating prices. From 1723 until the French and Indian war in the 1750s, the provincial government collected no taxes at all. [ ... snip ... ] The currency depreciated by 21 percent against English sterling, but Rabushka shows that this was due to external trade relations rather than to changes in the quantity of currency in circulation.” Ellen Brown, Web of Debt, p39

More on currency depreciation later...

MMT focuses on full employment, which, especially in the light of recent research published in “The Spirit Level” by Wilkinson and Pickett, is certainly a noble intention, one in tune with homo sapiens sapiens’ base needs for respect and dignity, though this is a positive fraught with difficulty in my view. But perhaps MMT’s biggest positive is it differs from the current program only a little, which means switching over to MMT would not be very difficult technically. Only the argument need be won, albeit in a world highly suspicious of anything remotely resembling ‘just printing money.’ Perhaps we need only be cooly scientific when appraising the US Fed and other central banks monetizing sovereign debt through quantitive easing to demythologize money a little.

Negatives
 
On the negative side are all of the problems money always brings with it. MMT money is, as are all other monies as far as I can tell, logically bound to scarcity, competition, profit maximization, perpetual GDP growth and ever increasing consumption, and most crime. Indeed, MMT is perhaps more attached to increasing consumption than are the more austere gold-backed or commodity/intrinsic-value money theories. And then there’s corruption, which is necessarily engendered by the systemic pressure of success being ‘Having More Money Than The Other Guy.’ No laws in history have ever prevented corruption, so the already very tricky task of printing the correct amounts of debt-free money in relation to money created by private banks, is yet further complicated (how often do government funded projects go over budget, and how water-tight is taxation?). Also, MMT sees debt-money as being self-destroying (see quote directly below) – either the debtor defaults, or the principal is expunged upon final repayment. But as we all know, the interest accrues to the creditor, and that is indeed ‘real’ money. (This is so obvious I wonder if I’m missing something.) As before, money-lenders accrue a larger and larger share of the available pool of money via the sucking up action of interest, once called usury. An MMT government would have to tax lending institutions down to size to prevent this distortion from becoming permanent, while at the same time printing money for the economy and taxing the correct amounts back out to prevent serious inflation/deflation problems from arising. Considering the ever-present power of lobbyists and the imperfection of politicians/humans generally, it is hard to imagine this being durably successful.
 

“All transactions between agents in the non-government sector net to zero. For every asset [debt-money] created in the non-government sector there is a corresponding liability created $-for-$. No net wealth can be created. It is only through transactions between the government and the non-government sector create [sic] (destroy) net financial assets in the non-government sector.” Bill Mitchell, emphasis added.

 
To my mind this is flawed reasoning arising (tangentially, though with clear connecting lines) from the terrible difficulties economists have — from Smith through Ricardo and Marx, into the neoclassical school, and now even post-Keynesians — defining value. By my lights, wealth (a form of value) cannot be created by any type of money creation on its own. New ‘wealth’ is assisted/facilitated by many different types of funding, in conjunction with technology. Technological developments are of course the source of all increases of living standards through the ages, bar none. If we travelled back in time and dumped 10 trillion dollars on primitive hunter gatherers, then left them alone with that cash but no know-how, their standard of living would not improve by one bit. Increases in ‘wealth’ (improving living standards) happen on the heels of technological advances (from farming to silicon chips). How new technology comes into being, that is, how it is funded and distributed, is a separate question. Money does not equal wealth. It is confused for wealth because it is such a good technology for enabling economic activity. MMT seems not to see this important distinction, though it is almost there, breathing on the window that looks out on this perspective.
 
The problem with pure debt-money systems is the ponzi debt-wall eventually encountered. There can never be enough money in the system to pay back the interest, except by extending yet more credit to cover existing obligations. If government issues debt free money that problem is somewhat assuaged, but the jobs, technology and other factors have to be in place in order for this created money to have something positive to do. That is key. Otherwise new money does nothing except inflate prices.
 
On to full employment. I am a big believer in the Keynesian observation of technological unemployment (MMT being, somewhat ironically in this case, a post-Keynesian baby), so worry that unless coupled with a major effort (very difficult to pull off I’m sure) to reduce the work week, the MMT push for full employment will end up looking something like communism, with increasing numbers employed by the State to do any old thing, so long as they are receiving a wage (which is also happening right now). Even with reductions in the work week, the nature of work is changing so rapidly, the highly skilled might have to pull 120, while the less skilled only work 20 hour weeks. I haven’t seen this issue addressed in MMT debates and writings, and am myself at something of a loss as to how to square this circle. Education will certainly be key, but that takes a lot of time and is also very difficult to get right. It takes almost a generation to equip the young for the future, but things are changing so fast, what we teach today is often useless information a decade later.
 

“The only sensible reason for accepting the authority of a national government and ceding currency control to such an entity is that it can work for all of us to advance public purpose. In this context, one of the most important elements of public purpose that the state has to maximise is employment. [… snip …] So then the national government has a choice – maintain full employment by ensuring there is no spending gap which means that the necessary deficit is defined by this political goal.” Bill Mitchell, emphasis added.

 
Fairness is always a priority consideration, no matter the model pedaled. Even the fiercest ‘free’ market liberal would argue that fairness is best served by his model, indeed justifies it, that minimal state intervention is the only guarantee of a fair and efficient distribution of goods and services. The road to hell is paved with good intentions, best to let the market work its magic via competition and equilibrium, and not touch, with well intentioned fingers, the running system. The more we interfere, the further away from efficient equilibrium the market, that beautiful state of nature, lurches. If unemployment rises, it is for good, internal reasons, and the market will adjust back to maximum employment in its own good time. MMT has the type of good intentions that so nettle ‘free’ marketeers, and though I am not a ‘free’ market liberal, good intentions of the full-employment kind worry me. We need in my view, going forward, a new way of earning our sense of self-worth, one that is not related to material success, nor to our wage, nor to our contribution to the economy. As I have pointed out before, economics values air at zero, ditto for important social qualities like trust, compassion, friendship, and a sense of belonging. Economics is, in my opinion, worse than useless at assessing value; its efforts in this area have had a net negative effect on society. We should therefore stop looking to economics’ pained struggle to define value via price and money, and search elsewhere. (The Venus Project would be a good place to start.) Full employment, though well-intentioned, is a dodo. We need a new model.
 
This full employment/technological unemployment blindspot shows how very mainstream MMT actually is, despite the knee-jerk abhorrence of ‘just printing money’ that still exists in spades in the public imagination. The standard dismissal of the problem of technological development rendering human labour less and less necessary, is that more work is created by the economy as efficiencies increase. This is the ‘lump of labour’ fallacy so often cited in discussions of technological unemployment, but as I have argued before, the real fallacy lies in assuming that the shrinking pool of available human-only work can power the entire economy indefinitely. It is our cultural sense that labour is a yucky effort to be rewarded/motivated by wages, that without labour we become lazy good-for-nothings, that there is no such thing as a free lunch, which taken together prevent us from recognizing labour as merely one manifestation of work itself, and that work can be fun, indeed should be. There will always be work. Exchanging labour for a wage, on the other hand, is a quite recent invention, and hardly a genetic necessity. We’ve been around for a couple of hundred thousand years. For only a fraction of that time have we exchanged our labour for money to survive. Accomplishment, as we all know deep down, is its own reward, as is success. Both phenomena were known to us before we invented money. Strictly speaking we do not therefore need a wage to make this so, or to prove that we have accomplished something, or succeeded at something, or even to get unwanted things done (so many of which can be automated). Society has many ways of bestowing praise and reward aside from remuneration.

In “Debunking Economics”, Steve Keen (who describes himself as almost being a post-Keynesian) points out that the post-Keynesian school has no theory of value. Since MMT is a post-Keynesian creation, and since it intrinsically requires maximum employment, I would say that the labour theory of value is as close to its heart as any other. For the sovereign to print debt-free money into the economy, and thereafter to avoid inflation, there must be corresponding economic activity, aka buying and selling, plenty of goods and services, and people earning money they can spend. If inflation is currency devaluation, and if inflation is in MMT combatted with full employment, then currency value comes from labour. We are back with Karl Marx (and Karl Denninger too, strangely enough — the people one finds in bed together!); ultimately money derives its value from labour, from people doing work which provides them with purchasing power. Of course in this case this is also akin to utility value, since money has to flow to all market participants to keep goods and services moving. Nevertheless labour is an unavoidable component in this system of money flow.

I have saved perhaps the most complicated issue for last. It lies in the area of currency exchange and international trade, hinted at above. Currency depreciation leads of course to price inflation of imported goods. For countries with few natural resources MMT might prove something of a time bomb. If oil were to be priced in a non-dollar currency (not a wild impossibility in the foreseeable future), MMT would be problematic even for the US should the dollar devalue relative to whichever currency, or basket of currencies, oil is to be priced in. And when we transition away from oil, those countries surviving from exporting it will also be in dire straights. I’m not sure if MMT can help here, at least not on the world stage. Saudi Arabia would have to import large amounts of resources, but would have next to nothing to export. I imagine this sort of problem affects many other nations besides. As Colonial Scrip experienced some 300 years ago, funding national projects by printing money to buy the imports necessary for their completion has a negative effect on your currency’s international standing.

The complexities arising from money as commodity and currency fluctuations generally are very difficult for all sovereigns to deal with, no matter how dominant they are on the global stage. For MMT to be worth its salt in practice, wouldn't near-global implementation of it be necessary? Some nations have to be losers in the balance of trade wars, have to be net importers. If they print off their own currency to settle their external trade bill, I cannot see how this would not devalue that currency. It is this aspect of MMT I find most vague and naively hopeful in the theory. Internally, within the domain of the sovereign, MMT seems elegant enough (forgetting problems of corruption and competence for one moment). Worldwide it would be a whole other kettle of fish. Dreams of elegant control and finesse almost always shatter when they meet the hard rocks of an uncaring reality. Nations are not separate systems equipped naturally with everything they need. The fact of widely and randomly scattered resources across the planet we inhabit demands of us international solutions to problems of scarcity and wealth distribution. It is at this international level I expect MMT to experience its greatest difficulties.
 
An open question: how are pensions managed in MMT?
 
Preliminary conclusion

MMT recognizes that, crudely speaking, all money is, in the end, somewhat like the money that comes delivered with the board game Monopoly. It’s there to make the game possible. In the beginning the amounts among the participants are equal, but over time the majority become poor, while one becomes rich. Luck, some skill, and the rules of the game, make this happen. In life this happens too, but in the real world, more money can be created, somehow, to cope with more players coming to the board, economic growth, and other variables. Taxation circulates money too, keeping the economy going via government spending and welfare. There is no state in the board game fulfilling this function, keeping the game going, which is how there can be a sole victor. The ultimate question is whether MMT can tune the state’s activities to get the best out of money’s role in society, or if money, as I believe, is in fact a flawed technology in light of other technologies rendering human labour and scarcity slowly redundant.

Will money creation along MMT lines be part of a transition to a resource-based economy. I think so, but in an as yet unseen form — a money fully automated on the supply side, with no interest anywhere, that cannot be treated as a commodity, and that is global.

The current system is an implicit variant of MMT anyway (fiat is a major part of it, and the Fed and Bank of England are bidding, via quantitive easing, at their own auctions). We are also, in my view, already transitioning implicitly, away from scarcity and towards abundance. For me the big question is whether monetary collapse must occur before wide, open recognition of the validity of a post-scarcity, non-monetary society can begin. With peak-oil making the news again, and the usual attendant  reaction of doom and gloom, our cultural inability to contemplate seriously radical alternatives like a RBE, in the face of radical challenges, is the main issue. While we continue to believe there’s only one game in town, we flirt with unnecessary disaster. Hopefully, the good sense inherent in MMT will win the day, and lead to a softening of attitudes to money generally, as part of the softening of cultural loyalty to old platitudes and received wisdoms about value and human nature. To want a system in which we are money’s masters, not its servants, would be quite a victory. The far harder part though would be sustaining an MMT system globally.