Ask Cullen
Since the Q&A’s are so popular I figured I’d add a permanent page on the navigation bar so readers can ask questions any time they want. Feel free to ask anything about anything. And if it’s a great question I’ll make it a post. Please bear in mind that I don’t know everything about everything so reader help in answering questions is encouraged, but please only answer if you’re “in the MR paradigm”! Also, it might take me days to respond some times depending on my time constraints and availability. And remember, this is all about education so if you think I have something wrong then let’s push the discussion in the right direction towards a better answer. I don’t give specific investment advice at the website so please avoid specific investment questions. Lastly, as always, let’s keep it cordial. This is all in the pursuit of better understanding so let’s be constructive even in our criticism. Thanks as always.
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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Cullen,
Is it fair to say that some of the posts on this blog were made at a time prior to the development of MR? If so, what date, approximately did MR develop as a separate school?
-Tom
Tom, I was highly influenced by the MMT teachings and my communications with Warren Mosler. So some of the stories on this site between mid-2010 and through 2011 sound very much like MMT or are straight from MMTers themselves. I was generally onboard with many of their operational ideas (like the money multiplier being wrong, sectoral balances, and the fact that the govt can’t “run out of money”). But I became increasingly uncomfortable with some of their ideas when MMTers started getting upset with me for not also promoting their policy agenda. We had a rather public spat over the MMT job guarantee which I said was based on a misunderstanding of the monetary system. This was in late 2011. Several of us started MR under the same general agreement that MMT creates a false understanding of the monetary system and uses an overly simplistic economic model to make their policy agenda more palatable. So we’ve been developing MR for about 9 months now. It was created with the intention of eliminating a policy agenda and politics in general (the main deterrent in most economic models including MMTs model). We’ve attempted to create a purely descriptive understanding of the way our system is actually designed and how it works. We hope the understanding leads to better policy, but we leave that up to everyone else to decide. We’re only here to inform on the operational side. Not to shove politics on you….
Great response…you are the man!
The split with MMT was the best thing you ever did. I think MR is the best kept secret in economics right now.
Help, I just want to navigate the site to where I want to be…..help
Where are you trying to go? The latest comments are always in the sidebar under the comments widget. The home page can always be reached by hitting the Pragmatic Capitalism logo in the top left of any page….
http://danielamerman.com/articles/2012/FiveC.html
So in the end this is what it’s all about???
thank you…………
Cullen,
I’m taking this scenario straight from Scott Fullwiler in his “Krugman’s Flashing Neon Sign” post (see his Figure 2), but I’ve added some details and some questions to you. Assume the following scenario:
There are two banks, A and B, and one customer (C1), and the Fed. Nobody has any money to start out with (I’m ignoring capital and reserve requirements) and balance sheets are blank. Bank A makes a loan of D dollars to C1 creating an asset/loan and a liability/deposit on its balance sheet. C1 transfers his deposit account to Bank B. The Fed covers the transfer with overdraft protection for Bank A and now Bank B has an asset/reserves liability/deposit on it’s balance sheet and Bank A has an asset/(-reserves) (with nothing on the liabilities side) until it is able to clear this reserve overdraft by the end of the day (and thus clear up it’s balance sheet).
Case 1: Bank A obtains the funds to cover its reserve deficit by borrowing from the Fed discount window.
In this case, is base money created? It seems to me the answer is “yes” since Bank B still ends up with +reserves on its balance sheet, and Bank A’s reserve deficit was cleared. And base money is defined as reserve deposits + paper/coin currency in circulation, correct? Is base money called MB?
Now let’s assume there are more people and banks in the US (but no foreigners! … I’m trying to keep it simple).
Case 2: Bank A obtains the funds by:
1) Attracting paper/coin currency deposits (which are then sent to the Fed to cover the reserve deficit)
2) Attracting transfer deposits from any other bank
3) Selling stock
4) Borrowing reserves from any other private bank (including Bank B)
First of all, have I pretty much covered the ways that Bank A could raise money to cover its reserve deficit with the above list? Secondly, were reserves created? In any of the above cases I would say “no” because the +reserves on bank B’s balance sheet would be offset by destroyed reserves elsewhere (either in the form of currency sent back to the Fed or electronic reserve balances transferred to the Fed)
The same questions could be asked if we add in reserve requirements. Assume now we stop the scenario with C1 getting a loan from Bank A. Bank A raises money to cover its reserve requirements from:
1) The Fed discount window => reserves are created. True?
2) Any other source => reserves are not created. True?
Whoops!! I made a mistake in the scenario. Bank A will not “clear up it’s balance sheet.” … it will continue to have the original loan to C1 as an asset! … but otherwise, the scenario holds (I think!).
Shoot, one more clarification required!… if Bank A borrows funds to cover it’s reserve deficit, then that will show up in its liabilities column. So at the end of the day Bank A will have an asset/loan-to-C1 and a liability/reserve-borrowings. Again, doesn’t change anything else.
Reserve balances are created if a bank borrows from the Fed.
Reserves are necessary to meet reserve requirements and are created primarily by the Fed to meet monetary policy goals. If there are no reserve requirements then it’s possible that the banking system could operate with little reserves at all. See Canada’s system.
Thanks Cullen,
I guess I could have found a shorter way to ask that question. I’d posed pretty much the same question to Scott in an email, and just received a detailed response from him yesterday (after writing the above to you!).
He pointed out to me though that borrowing from the Fed discount window to cover overdrafts or to meet reserve requirements is often penalized by the Fed. To avoid higher penalties, collateral is required for the loans. He also stated that the Fed and other banks (the market in general perhaps) “frowns” on such activities. To the market it indicates “weakness” in a bank’s position.
This prompted my other question to you about whether or not just plain old interest payments to banks (from loans to the private sector) results in greater reserve deposits.
My ultimate question here is can normal banking activity with the private sector result in increases to the base money supply (reserve deposits + paper money/coins)? I think the answer is looking like a qualified “yes.”
I think I have an answer for my own question. For example, assume a closed system, no reserve or capital requirements and a bank makes a loan to a customer for $100 at 100% interest payable in 2 $100 payments, interest first. There’s no money in the system to start out with. The bank balance sheets should look like this:
After Loan:
Assets:
$100 loan
Liabilities and Capital:
$100 deposit:
$0 capital (capital = assets – liabilities)
After 1st payment:
Assets:
$100 loan (only interest paid so far)
Liabilities and Capital:
$0 deposit
$100 capital
After default (the customer only had $100 in his deposit, so can’t make the 2nd payment of $100 principal):
Assets:
$0 defaulted $100 loan, now worthless
Liabilities:
$0 deposit
$0 capital (capital = assets – liabilities)
So there are no reserves here. Reserves would only come into play if the customer could raise some other funds somewhere to make the second payment, in which case reserves somewhere else would probably be eliminated (thus no new net reserves would have been created). So if the customer acquired some money outside this closed system (say he found a $100 on the ground), we’d have for the bank balance sheet:
Assets:
$100 reserves (or vault cash)
$0 loan (paid off)
Liabilities:
$0 deposit
$100 capital
Correct?
Tom
What do you mean by “Theres no money in the system to start out with” ? Do you mean the bank has no deposits or that the customer has no financial assets? This is an ambiguous statement.
If you mean the bank has no deposits well the loan creates a new deposit so no big deal. If you mean the customer has no assets, why on earth would a bank make a loan to someone with no financial assets? How could they ever expect a repayment of that loan?
Greg,
I mean neither the bank or the customer has money. Yes I understand your concern “Why would the bank loan them money to start out with?” I realize that’s a problem! I’m building on a simple example used by Scott Fullwiler in an article he wrote. Here’s the reference:
http://www.nakedcapitalism.com/2012/04/scott-fullwiler-krugmans-flashing-neon-sign.html
See Figure 1. In his simple example the bank doesn’t charge any interest either. If you read the article he hints at how the activity of the private banks and customers in conjunction with the Fed and it’s policy of setting a target interest rate can cause base money to be created. I’ve emailed Scott and asked him some specific questions about this. Basically it comes down to cases where the fed loans reserves… either the purpose of covering overdrafts or for borrowing required reserve deposits.
I was asking a further question about whether or not paying interest could cause reserves to be created… at first I thought they could, but later changed my mind. I needed a simple closed system to work with… so yes, I agree the customer in this case is not a good bet from the bank’s perspective!
It get’s to another fundamental question I had, which is “Is it possible to run an economy with only endogenous money?” Endogenous = bank created = inside = horizontal (MMT speak) from what I understand. I think I’ve found the answer to that too: Dr. Steve Keen proved that a simple economy could function in such a way with a system of differential equations modeling the banking activity. His first assumption was that a bank simply made a loan to a firm that is never repaid, but the interest is paid. He included workers, etc. Google “Steve Keen differential equations.” He’s got a LOT of material on it (slides, downloadable matcad modes, etc). Some of the MMT crowd (Bill Mitchell in particular) got upset with this idea because he ignored the government created money (=”vertical”=outside=exogenous) altogether. I think that MR agrees that the inside money is dominant… and that’s Steve’s position as well. I believe that Steve is actively trying to fold in a model of exogenous money into his system of differential equations. If you look at some of his models, they start off with a bank making a loan to a firm for $100 (which is never repaid), which gets turned over in the economy multiple times per year, and supports wages, interest payments, etc.
Tom,
I too am having trouble with your example since it’s beyond the realm of reality. This is not a chicken and egg story so there’s no point constructing examples where there is “not money” in the system. I think your basic points are generally correct, but not necessarily applicable as you’ve described?
Pertaining to your second question – I think it’s important to understand why outside money exists in the first place. Outside money was created to facilitate private sector needs (primarily its ability to use inside money). For instance, the Federal Reserve system exists in large part to help the settlement of interbank payment settlement. Prior to the Fed system you basically had a bunch of rogue banks who may or may not have settled one another’s payments. The Federal Reserve system streamlined this process and established a payments system that is essentially the same as having one big bank. So they serve as the intermediary in helping different banks settle payments (in addition to other things obviously such as setting monetary policy). Many systems today exist with no reserve requirements and operate with minimal reserves so this facilitating role of bank reserves has been greatly diminished with time. But the point remains that the system of only inside money has been tried and it failed. It evolved into the current system for sake of stability. So I would argue that the answer to your question is no. It’s a little bit like asking “is govt necessary?” Well, I’d say yes, but let’s not confuse the existence of govt as being the whole purpose for our existence….
I think you have to keep things in perspective when discussing these matters and reading the MMT views. MMT does a very strange thing by applying a hierarchy to money and claiming that outside money sits atop inside money in terms of its importance. I don’t necessarily agree with this view. The vast majority of the money in the system (something like 97% or so) is inside money. For every day practical purposes there is only one kind of money that matters to the economy and that’s inside money. Outside money helps facilitate interbank payment settlement (among other roles), but this is a stabilizing mechanism to the far more important kind of money that exists – inside money. So outside money plays a stabilizing role, but is not the driver of the monetary system as MMT implies. Getting things like this backwards leads MMT to often view the world through the lens of “govt first, private sector second” as though the govt can fix all of our problems or steers the monetary ship. Or as Wray says, “After all, that’s what it is all about, right? From inception, the purpose of the monetary system is to move resources to the public sphere.” I think this is a terribly incorrect comment and highlights the narrow view taken on by MMT on many of these matters. Inside money existed well before outside money so the idea that the monetary system exists solely for the purpose of “moving resources to the public sphere” is demonstrably wrong. Monetary systems have existed in some form (often without govt’s) for 10′s of thousands of years. The fact that we created the institution of govt and organized the monetary system under this construct is merely an evolution. But govt money is not the beginning of monetary time as MMT claims. So it’s about balance in my opinion. MMT just veers way too far into the pro government camp and neglects the importance of many other factors in my opinion….
Cullen,
I’m not here on a mission to promote MMT views… I’m just trying to understand the mechanics of banking, the accounting used, and endogenous money creation, etc. You said yourself that Scott Fullwiler was very good on that stuff, and I appreciate his simplified concrete examples. Just checking opinions here to see if I can get some answers to questions I had through concrete SIMPLE examples about interest payments. I don’t claim they represent reality at all! And I agree with you 100% that inside money is dominant!
Hi Tom. My comments about MMT were not geared towards you. They were more geared towards a few MMTers who comment here on occasion who have been very uncivil at times and even personally threatening. This Phil character has been very hostile towards me for a long time now. It’s standard MO for MMTers. They like to think they can just insult their way into winning people over. With me, they’ve attacked me endlessly for not supporting their Job Guarantee and they’ve lied about me, misconstrued my views, and literally threatened me in private emails and in comments. It’s been very frustrating to deal with. I try to keep that nonsense off my site so sorry if my tone came across harsh in my response towards you. I just refuse to have that nonsense polluting my website like it did for a brief bit back earlier this year….Some of these MMTers seem to have reappeared in recent weeks for some reason. I guess they’re bored of attacking who ever it is they’ve moved on to attacking….
OK, no worries. Thanks for your comments.
The problem with a pure inside money system is that since all inside money is pure credit based the only way to pay off old credit is with new credit. Bankruptcies are a feature, not a bug of pure inside money systems. Ponzi dynamics quickly takeover with credit expansions.
Cullens point about the stabilizing nature of outside money reflects, as I see it, the fact that at some point the credit must be paid back and only outside money can do that. Inside money only adds to credit it doesnt reduce it.
One thing Ive started doing is thinking of inside money as credit and outside money as cash. Credit must be repaid, cash doesnt.
Greg,
Inside money doesn’t get paid back any more than govt debt gets paid back. I think MMT is guilty of making the same mistake here that it accuses other people of making with govt debt. If you look at the aggregate debt then it’s impossible for the debt to get paid back. It must always expand so new money can pay off portions of old money and expand the money supply in an elastic fashion with economic needs. Debt only gets paid back in the micro. Not in the aggregate.
Also, inside money does not get paid back in outside money. Inside money gets paid back with inside money (most of the time). Loans create deposits and extinguishing loans with inside money extinguishes deposits (at least on the bank’s balance sheet). MMT creates this strange inside/outside money relationship where MMTers go around thinking that outside money carries these mystical powers making it superior in all ways to inside money. Outside money only exists as a facilitating force for the more important and prevalent form of money – inside money. The settlement idea in MMT is totally confused (of course, with the caveat of “except when settling at the same bank” which totally proves the MMT point wrong to begin with). It’s helpful, in my opinion, to think of the banking system and the Fed System as one bank rather than 1000′s of banks with this intermediary in the Fed and their payment system. But the point is, when you pay back a debt you don’t pay it back in outside money. It gets paid back in inside money and the bank debits accounts and reduces its loan book accordingly. Inside money appears through the stroke of a key (totally independent of outside money). And it disappears in the same exact manner. Although, in the aggregate, inside money cannot disappear….
Cullen
Im sure Im not using the terms inside money and outside money consistent with JKHs terminology. I think about it as bank money(private) which comes in form of credit and govt money (outside) which comes to me in form of either a transfer payment, a tax credit or a direct purchase of something I produce.
When I get a paycheck it is not a loan, although the initial source of my paycheck may be (and likely is) a loan that my employer has secured to run his business. So indirectly my pay is a function of a private credit money transaction but I am not responsible for that loan repayment. My paycheck is a net gain for me. Although when I go and borrow from a bank I do not have a net gain (in NFAs) because I have an offsetting liability of a loan payment. So yes in aggregate our private money credit system will never be completely paid off but the only way I can ever be at net zero or net positive is for me to pay off all my credit money. And I cannot do that with ONLY inside (my terminology) or credit money of my own because I will always have an offsetting liability. I must have a net increase in my outside money position so that my net worth is positive. That, as I understand it, is how the govt deficit meets my “net” savings desires. We all want to be out of debt at some time and that will only happen if we have some portion of the federal deficit or national debt on our balance sheet that more than offsets our liabilities to private banks.
Greg,
This isn’t JKH’s terminology. These terms have been around for decades. And it was actually Brett who started MR on the use of these terms so he deserves the credit there….Outside money is simply money with no corresponding private sector liability (cash, notes, coins, etc). Inside money is bank money netting to zero.
I think it’s important to note that inside money is the dominant form of money in our economy. There is no such thing as being completely paid off or everyone “being out of debt”. Money is not an institution that allows such a thing because the fact is, most of society has not earned the position where they are free of being indebted to the rest of society. Money is borrowed when it is unearned. The govt does not exist as a charitable service designed to hand out money to everyone before it has been earned. This is why private banks compete for loans and you must prove your personal credit worthiness in obtaining money that you have not yet earned yet desire to use in the now. I fear that MMT has this entire relationship backwards and somehow envisions a world where everyone has access to money without having proven themselves worthy of deserving it (obviously, there is an element of public purpose and using govt to provide for those who can’t provide for themselves, but I am speaking from a more general sense here). In fact, this could very well be the essence of a capitalism vs socialism debate which is clearly a slippery slope.
But I’m off track here. The bottom line is that most of the money in our society is inside money and while NFA is a very important facet of the monetary system it is impossible for the system as a whole to be “paid off”. In the micro sense you can “pay off” your debts by acquiring someone else’s inside money, but for the system as a whole this is impossible. The system remains in debt because most people want money before they have earned money. The private banking system exists to provide this for people. The alternate is a govt run system that essentially fires money out to people more for charitable purposes than for competitive purposes. I can’t imagine that system lasting very long as it would be remarkably unstable….
I think you mean debt must be repaid to a creditor.
Cullen,
What are the pros and cons of a “convertible currency” system like the gold standard vs the system we have (fiat money system). Do you think one is superior to the other? Why? Do you know historically why Nixon “closed the gold window?” I’ve watched his speech about it on youtube, and he made a vague reference to “speculators” causing trouble, but do you know what the essential reasons were?
What are your views on a banking system like we have vs a system that required “100% reserve requirements.” I understand that in the system we have a bank’s ability to loan is not restricted by reserve requirements, and I understand that reserve requirements only apply to SOME types of deposit accounts (checking accounts) and don’t put restrictions on loans directly. I get all that… and I’m not really sure what is meant by “100% reserve requirements” … but I know that’s a popular concept with Ron Paul types and Murray Rothbard and some other “Austrians.” I think what they mean is that for ALL deposit accounts (except perhaps some types of time deposits like CDs) the bank must keep 100% reserves on hand. this really doesn’t make much sense from the bank’s point of view unless it charged for that service (instead of paid a tiny interest rate). I assume also that in this kind of system there’s no central bank from which the banks can borrow their reserve requirements…. so they’re basically stuck warehousing people’s money (on their spreadsheets!) unless they can borrow excess reserves from another bank (or other business?).
-Tom
An elastic currency means it can expand and contract with the economy. Non-convertible currency systems constrain its users in numerous ways. The Euro is essentially a non-convertible system like the gold standard. This leads to inherent trade imbalances and solvency crises since no entity can create the currency necessary the eliminate the solvency crisis. These systems are not sustainable.
100% reserve banking doesn’t fix anything. Banks aren’t reserve constrained. Do we not want an elastic money supply? Should borrowers be constrained ONLY by how much money already exists in the system? Or should we have an elastic money supply that can expand as money demands expand? I think we’re better off with an elastic money supply rather than a fixed amount of money that hopes for lower prices when the reality is that wages and prices are sticky….
The IMF has recently released a white paper on this topic. I have not read it yet but apparently it is based on Irving Fishers work from the nineteen thirty’s
I linked to it a few days ago.
I was looking at Fishers info and came across a report that said he lobbied for this from introduction to his actual death bed. He had meetings with the president and wrote numerous letters. He said that FDR? was interested but scared of the bankers so I don’think much has changed.
Apparently Keynes charisma won the popular opinion.
With regards to fixed money supply, I think the growth rate was not fixed but to be controlled by the usual smart people at the appropriate rate to avoid the booms and busts.
Here’s the link:
http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf
The IMF was surprised that their model surpassed even Fisher’s optimism. I wonder what that means for the future, since the IMF has a lot of sway.
I couldn’t tease out of the model how Fisher and the other economists of the day controlled for supply volumes as Cullen mentions. I agree with Cullen that you need some sort of knob to keep the supply linked to demand.
To my mind, as small component of Government credit would be the tail that wags the dog, thus controlling the supply. Then fully reserved money, which is high quality, would follow along.
OK, the Chicago plan did anticipate using some credit: Here’s a quote:
Second, steady state inflation can drop to zero without posing problems for the conduct of monetary policy. The reason is that the separation of the money and credit functions of the banking system allows the government to effectively control multiple policy instruments, including a nominal money growth rule that regulates the money supply
The cons are we would end up like the Eurozone, whose countries have a fixed exchange rate of 1 to 1 and the amount of credit in a society would be arbitrarily tied to the amount of a yellow precious metal we dug up from the ground. The pros, there would be no government funded bailouts.
I can’t see an advantages of having a 100% RR, although I understand what the Austrians are trying to do. I think what would happen is traditional lending will become more unprofitable, which will only increase the number of shadow banks who won’t have to deal with such onerous regulations.
A current article on Forbes claims that “……IOR is the reason for the unresponsiveness of the economy to the Fed’s massive increases in M0. IOR disrupted the money multiplier effect within our fractional reserve banking system. This, in turn, destroyed the causal relationship between M0 and NGDP……..” He also claims that eliminating IOR would be extremely inflationary.
http://www.forbes.com/sites/louiswoodhill/2012/07/24/in-response-to-sen-chuck-schumer-whats-a-fed-chairman-to-do/3/
What would happen if the Fed eliminated IOR tomorrow?
Nothing. The economy is weak because there is no demand for credit. This is because the private sector, particularly households, have too much debt and are deleveraging their balance sheets. Their is no such thing as a money multiplier or a fractional reserve banking system and inflation is much more of a fiscal phenomena, how much credit the private and public sector are creating combined, than a monetary phenomena. Furthermore how much lower can the Fed funds rate go? It’s already at .25%. Will lowering it an extra .25% really be that much more inflationary?
You wrote:
“The economy is weak because there is no demand for credit.”
Since we’re still at a historically high private debt to GDP ratio (it’s now at ~260%… although I understand that it was as high as 301% within the past 3 years) do you think that means that we’ve got a LOT more deleveraging to do before the economy improves? (As I understand it, a much healthier place to be is around 100% of GDP. At the end of WWII we were at about 45% I think.)
That’s part of Steve Keen’s argument for why we need a “debt jubilee” to get the economy restarted. I believe that Michael Hudson shares this view… at least he refers favorably to similar events in the ancient world.
Government spending could also do it I guess.
If demand for credit were to increase right now, at our current private debt to GDP levels, wouldn’t that amount to just re-inflating the bubble and thus setting us up for an even harder crash again in a short time?
(Of course in all this I’m assuming the denominator of this measure, GDP, doesn’t change much, but perhaps that’s a huge mistake!)
IOR is in place to create a floor under the FFR. If they eliminated IOR the FFR would likely fall to 0%. The Fed is trying to sustain a corridor rate between 0-.25%. In addition, if the Fed ever wants to raise rates in the future they will not merely change the FFR. It’s the IOR they will use to change the rate. With so many reserves in the system there is inherent downward pressure on the FFR. So the IOR rate serves as a de facto FFR and an emergency valve in case of higher inflation and the necessity of a rate hike. Cutting IOR would do nothing. The Market monetarists just have this all wrong. Sumner, by his own admission, doesn’t even understand banking.
Hey Cullen,
In my limited understanding, I hit a bit of a road block when people ask me “Well, what happens if the rest of the world doesn’t want to buy our Treasuries (our National Debt). I think you make the case that this situation is highly unlikely, but suppose it became somewhat true.
Suppose China etc. began to sell off all of their Treasuries, and move their dollars… 1) “where” can China move those dollars, i.e. what are the main options? … 2) what happens to the U.S. bond market? [I'm thinking the price of bonds go down / the rates-of-return along the yeild curve go up]
and 3) when the demand for Treasuries decreases (thereby decreased their price and increasing their rates-of-retutn), how does the U.S. government accomodate this? Does the Fed ever absorb more Treasuries onto it’s balance sheet (a.k.a. monetize the debt)?
It’s a a point of confusion for me: does government finance change at all when demand for Treasuries decreases?
Hi JK,
The best response is “who cares”. China gets pieces of paper with old dead white guys on them. If they don’t want to hold onto these pieces of paper then they can exchange them for bonds. But no one is twisting their arm to hold US t-bonds. If you study bond auction data you’ll notice that the PD’s can ALWAYS take down 2X the auction. Foreign bidders are insignificant in this process. They could not even show up and the auction would go off just fine. Yes, the value of these bonds matters as they represent the underlying viability of the currency to some degree, but again, that gets us back to the inflation constraint. That’s a totally separate issue though. “Enough buyers” is not a problem unless inflation were to really spiral out of control. And that gets us back to the hyperinflation debate….
Hope that helps.
Cullen,
When a bank receives interest payments, do those payments generally get deposited in its reserve account? I realize that the bank must still pay its expenses such as payroll, overhead and dividends, but presumably there’s some left over after all that.
In other words, is some fraction of the interest payments a bank receives used to increase the base money supply?
-Tom
Banks receive what is essentially a subsidy for doing business with the Fed. In this case, the IOR offsets what is essentially a tax for holding excess reserves. So they earn an income from being in business with them. This is pure profit for the banks.
By “IOR” I take it you mean “interest on reserves.” I wasn’t talking about that actually… I just meant normal old interest payments from the public, like I make on my mortgage.
Cullen,
I’m very interested in the mechanics of how our private banking system works and how it interacts with the Fed. That’s why I enjoyed Scott’s article so much… it gave brief, super simple, but specific examples of that.
Do you know of a good reference (text book, website, whatever) that really focuses on the mechanics of banking in our system?
Thanks,
Tom
Lavoie’s primer on endogenous money is pretty good.
http://aix1.uottawa.ca/~robinson/Lavoie/Courses/2007_ECO6183/childguide4.pdf
Thanks Cullen!
As to my question below… if by interest, I don’t mean interest on reserves…
-Brad
A quote from your “Why QE is not Working” article appeared in ZH today.
http://danielamerman.com/articles/2012/FiveC.html
So is this how it all ends up?
Hi Cullen. I liked Warren Molser’s recent article “Is the Ryan Budget the next Bachman Budget?” because it illustrated in simple terms what I believe most elected officials in Washington DC don’t seem to grasp. Did you read the article? Does it basically agree with how Monetary Realism sees (describes) the choices faced?
http://www.huffingtonpost.com/warren-mosler/ryan-budget_b_1784137.html
Warren’s obviously far better than most neoclassicals, but this is a case of MMT going to an extreme again. He says:
I don’t know why MMT tries to state the currency is a public monopoly (well, actually I know exactly why, because the endgame in MMT is an academic rationale for the Job Guarantee). It’s not necessary and it doesn’t help anyone understand the monetary system. Worst of all, it’s not even necessary to make a rational argument for the JG, but they’ve dug their heels in on this “money monopoly” idea so I guess they’re going down with that ship.
Banks issue inside money and they do so independent of the govt or reserve positions, etc. Warren doesn’t even seem familiar with the term “inside money” as its meaning in economics is that it’s not “outside money” or govt money – money with no liability. In MMT all money should be “outside money” or govt money if Warren’s right, but that wouldn’t even make sense either. The terms are confused and can’t be applied to MMT. So it’s all incoherent to begin with. They do this on a lot of terminology like the use of vertical and horizontal which totally contradicts Basil Moore’s use of the terms.
More importantly, banks are an oligopoly in this country. Not part of a public monopoly as MMT states. So all money doesn’t come from the govt. Most of the money in our system comes from private banks who exist as private entities serving private purpose (their shareholders for profit). MMT often complains about private banking (almost daily) and then when it’s convenient they say banks are public servants (WHAT?).
I also don’t agree that the country needs a perpetual budget deficit to grow (it does RIGHT NOW, but in general). Sure, in a de-leveraging like right now we need it. But Warren’s comment that govt spending = public savings is a bit misleading and implies that the private sector can’t grow without govt spending. It might be true RIGHT now, but there are clear cases where that’s not true. He doesn’t even mention the trade deficit and there are obviously nations in the world who run trade surpluses with budget surpluses who do just fine….So it reads like another case of MMT always bringing everything back to the govt. I like Warren’s conclusion in the current de-leveraging context, but the commentary is too general and vague for me….
But yeah, the same conclusions apply regarding Ryan. He has no idea what he’s talking about regarding the budget and the monetary system….
Whew! Thanks for such a prompt and thorough response.
I need to re-read your paper on the differences between MMT and MR.
Just for clarity: according to the sectoral balance model, MMT doesn’t say that government budget deficits are necessary. It says that one of the three sectors must be in deficit if the other two are in surplus. So technically MMT agrees with you that the domestic private sector can be sustainably in a deficit with a government surplus, SO LONG AS there is a sufficient trade surplus, right? Or am I misundetstanding something here?
No, Wray has been explicit about his belief that govt should always be in deficit (and the notion that MMT might be in favor of trade surpluses and even budget surpluses as a result is, quite frankly, a bowl of laughs). The whole point of MMT is to promote a fiscalist approach and the Job Guarantee. That’s MMT in a nutshell. The idea that MMT might be in favor of current account surpluses or budget surpluses is hilarious and would contradict MMT’s core policy proposal. I know some MMTers are trying to move the goalposts on this realizing that the CAD is a huge hot mess for them (I even see some now using the MR description of the way spending and taxing works), but I have years of quotes to back up these ideas proving that MMT has been wrong for decades on big ticket items. I am not merely “misrepresenting” MMT as so many often claim. I am not going to have MMTers filling this section with their commentary.
I don’t know why there has been an influx of MMTers coming here in recent days voicing their opinions on matters, but the attacks (I am not accusing you of this) and blatant attempts to mislead or claim that I am “misinterpreting” MMT is getting really old. I do not care what MMT has to say about the monetary system. This is not the “Ask an MMTer” section. Nor is it a section to provide an understanding of MMT. Nor is it a section for MMTers to fill space and clarify their ideological positions so they can try to promote their views. I know you’re sympathetic to MMT so if you can’t come here without trying to promote MMT then please don’t comment. This is not an MMT website and I have zero desire to be associated with such a strong politically motivated group. If I thought MMT was right then I’d happily describe the system as MMT describes it. But it’s not right and it should not be taught as a purely descriptive idea. If an Austrian came here misrepresenting views I would slap them on the wrist in the same manner so don’t take it personally, but is not a place for MMTers to promote their views. Frankly, MMTers should hold themselves to a higher standard, get consistent on the message, admit it’s a policy driven view of the world (“inherehtly progressive” as Wray says) and then promote the hell out of it. There’s nothing wrong with doing that. What’s dishonest is saying MMT is just a set of understandings when anyone who knows MMT knows that the policy agenda (the prescriptive piece) is the key piece of the entire theory (it is in fact what makes it a THEORY in the first place). The obfuscation on matters like this really hurts your cause and discredits your views as trying to be something you’re not….My two cents on the matter.
I understand your frustration, but I think you sometimes misunderstand me. I don’t comment here to advance MMT ideas. I read here, and I comment here, to further my own understanding. While I am admittedly symathetic to MMT, that does not mean I endorse everything it stands for. At this point, with my limited yet expanding understanding, I prefer to refer to myself is supporting ‘ModernMoney’ in general.
So, my comment above about the sectoral balances was not a defense of MMT or an advancement of it, but rather my expression of my understanding coupled with asking you to clarify the issue if I’m mistaken.
It’s not worth your time to check, but I think if you were to review my comments you’d see that while I’ve challenged you at times from a MMT-perpsective, I’ve never beraded Monetary Realism. Not even once. In fact, I’ve defended you and your positions on MMT websites. Just recently I’ve been using your explanation of the Treasury, Primary Dealers, Private Sector, and Fed in the money creation process, to challenge MMTers to clarify their position and explain why your explanation is incorrect. And i’ve not been satisfied with their responses so far.
Please don’t take my devils-advocate position, sometimes which comes from an MMT perspective, as me trying to push that theory. Again, it is simply me trying to ‘figure it all out’
You’re right. I am not sure why you’re “guilty by association”, but in the last 24 hours about 5 different well known MMTers swarmed the site to criticize various points. You’ve been reading and have been very cordial for much longer than that so it was purely coincidence that your comment coincided with theirs.
Sorry.
Cullen – I may be wrong, but maybe the increase in MMT questions is because you’re getting through to some of them and winning some to your side. Early on it seemed to me the diff btwn MR and MMT was semantics – so I ignored much of the back and forth…. but lately either you’ve been clearer, or the concepts have gotten deeper and clearer. So in essence I’m a former MMTer (admitedly a white belt one) and am only recently inspired to really dig into what’s different.
Unfortunately, for me to learn MR I need to unlearn some MMT things. And right now I’m still mostly unsure what I need to unlearn. For that reason I’ve found a lot of the recent MMT comments and your replies quite helpful. So hopefully you’ll entertain the MMTers who seem sincere in their search for answers because I’ve got some of the same questions and yet am 100% loyal to whatever direction you take it because a) i learned it here, and b) i trust your motives
hangemhi,
thanks for this comment, but I need to be very clear about something. I don’t want you to be loyal to me. I want you to be loyal to what you believe is right. That’s what this has always been about for me. To me, the MMT description was very close to the truth. But as I delved into the details it became clear that MMT, like many other econ schools, contained errors. The deeper I’ve gotten into this the more concise and precise I’ve gotten in explaining these issues. So what you’re seeing is really an evolution of ideas. I know it hasn’t been easy to follow at times and it appears like my position has totally changed, but I prefer to think of it as an evolution of ideas. What JKH and the other guys have come up with is in large part entirely unique, but also built on the shoulders of other people (many of whom are MMTers).
As for better understanding all of this I would reread my understanding paper and then the MR vs MMT paper. That should do it for you. After that you might conquer JKH’s CIA.
http://pragcap.com/mr-recommended-reading
http://pragcap.com/mr-different-from-mmt
Thanks, Cullen
“I don’t know why MMT tries to state the currency is a public monopoly (well, actually I know exactly why, because the endgame in MMT is an academic rationale for the Job Guarantee).”
You have never properly engaged with or addressed the MMT arguments on this subject. Perhaps that is why you “don’t know”. Instead you have simply opted to misrepresent those arguments.
Calling the currency a public monopoly in no way provides a greater ‘rationale’ for the JG. Your argument here is completely nonsensical.
Please stop saying that MMT is simply an attempt to make an ‘academic rationale for the JG’. You are implying that MMT economists lack academic integrity. This is highly offensive, and totally false.
“Warren doesn’t even seem familiar with the term “inside money”
Yes, I’m sure Warren Mosler isn’t familiar with the term ‘inside money’. Please stop being so pointlessly offensive.
“They do this on a lot of terminology like the use of vertical and horizontal”
No, MMT economists are very clear about how they use the terms ‘vertical’ and ‘horizontal’.
“MMT often complains about private banking (almost daily) and then when it’s convenient they say banks are public servants (WHAT?).”
Again you are completely misrepresenting MMT arguments. You do this repeatedly.
“Warren’s comment that govt spending = public savings is a bit misleading and implies that the private sector can’t grow without govt spending.”
No, it is not misleading. No, it does not imply that the private sector can’t grow without government spending.
“it reads like another case of MMT always bringing everything back to the govt.”
This reads like another case of you misrepresenting MMT.
With all due respect, your comment is counterproductive and just blatantly wrong on several counts. But first, I am not going to have MMTers come here and fill up space with this nonsense. We’ve had these debates before. You guys insist on using the “money monopolist” to promote the idea that the monopoly supplier of currency is the only entity that can provide full employment since a lack of currency supply results in unemployment according to you all. I am perfectly familiar with your line of reasoning and frankly, it’s 100% BS that MMTers keep saying I don’t understand MMT. I actually understand MMT better than most MMTers do. And it’s clear from your comments that you don’t even understand it all that well. Of course, we both know that you largely learned MMT from reading my site so it’s quite humorous that you now come here pretending to know this theory better than me.
If Warren understood what inside money is (the precise definition as most economists use it) then he wouldn’t have used it the way he did. He’s using it completely wrong. Maybe he made a mistake. Fine, but it’s not hard to understand that “all money” is NOT inside money. More likely, he’s changing the definition just like MMT changes the definition of “full employment” or “vertical money”. Inside money, by definition is money with a liability. Anyone who actually understands MMT knows that outside money is the center of the MMT universe. So no, he’s obviously using the term wrong. You clearly don’t even understand the context here either or you wouldn’t have defended that point in the first place. It’s blatantly wrong. These terms have specific meanings for a specific reason and they’ve been used in a traditional sense to sustain clarity. He’s mutilating terms that have specific meanings in economics and in doing so he’s creating confusion. If MMT wants to reinvent the wheel and use different terms than fine, but this manipulation of existing terminology is counterproductive. MMT does this with many terms. If they’re going to change definitions then why not just use different words and remain consistent with the rest of the field of econ???? You’re obviously not familiar with the terminological mess with verticalist & horizontalist so I’ll just let that fly even though you’ve come here with an insulting comment claiming I “don’t understand” when it’s very clear that you have no idea what you’re talking about in the first place….
Frankly, I don’t care if you think I am misrepresenting MMT. We’ve had these debates and we’ve moved on (at least I have – maybe you guys are still obsessing over the break-up???). MMT’s description of the monetary system is wrong. Verifiably wrong. I am sorry to break it to you and I am sorry that mistakes were made in promoting the theory. And I am extremely sorry I ever supported some of those views. But I am not here to protect your ideological and purely political views. I am here to offer people a better understanding on how the monetary system works and if someone learns something from an Austrian, an MMTer, a Monetarist or anyone else whose views are clearly wrong then I will correct them and put that person on a course towards better understanding. But there’s no point in you filling up space here defending what is obviously nothing more than an ideology designed around promoting the Job Guarantee and a fiscalist approach. If you want to promote that view elsewhere then be my guest (you guys have plenty of outlets for that), but I will not have you confuse people here and devolve the conversation into the standard MMT argument which is nothing more than petty “you don’t understand” and other childish/pointless/empty retorts. You all have a well known history of insulting others and engaging in crude debate tactics. It’s why no one engages with you and I have zero desire to jump in the mud with you again. I made that mistake once before and I will always regret it. I can assure you this site will never again become a place where MMTers just rampage over me or other readers with their nasty approach to debate.
I get your views. You all think I am some horrible person because I won’t promote your JG and have corrected some of the errors MMT made in operational aspects of the way the monetary system works. And so I’ve become some big evil doer because I am making an earnest effort to JUST get the operational stuff correct. You all have threatened me with physical harm, you’ve attacked me endlessly (like you all do with everyone you confront), you’ve sent me dozens of vicious/nasty emails and you’ve proven that you’re not just trying to educate, but you’re trying to promote an agenda (and that you’ll attack people endlessly to promote that agenda). I respectfully want nothing to do with your agenda and refuse to be associated with a group who is notorious for lashing out at everyone who disagrees with them. I have always wanted only to help people better understand the monetary system. I am sorry if my views impede on the progress made by MMT, monetarists, austrians or any other group. I’m critical of the views of many different groups. If you think that makes me a horrible person then so be it. But please don’t engage me in this forum protecting these views. MMT has nothing to do with this forum and it’s not the place for that conversation. Thanks for respecting the environment of education (not argumentative conversation) that is being cultivated here.
In the spirit of education then, it is only fair that you allow me to respond to some of your points. I’ll try to be brief, and will just focus on the substantive issues. Just to clarify, the following is simply my own understanding of these matters.
“a lack of currency supply results in unemployment according to you all”
MMTers argue that involuntary unemployment occurs when spending in aggregate is insufficient to maintain full employment. If aggregate spending is currently insufficient to maintain FE, either “non-government” spending has to increase, or government spending has to increase (or some combination of the two) to a level at which FE is attained (assuming that is indeed the goal). For non-govt spending to increase (in the absence of govt spending), the non-govt must save less/spend more of its income or/and take on more debt. If involuntary unemployment exists at any given time, this indicates an unwillingness of the non-govt sector to do either of these things to a great enough degree to maintain full employment. Given that the govt faces “no solvency constraint”, it can increase its spending to accommodate the non-govt’s desire to save (or not take on additional debt), and thereby deliver a sufficient level of aggregate spending to maintain full employment at all times. If non-govt spending subsequently increases, govt spending can reduce and vice versa. Again, given the absence of a “solvency constraint”, the govt can choose to hire all those that are currently unemployed at a fixed wage, letting the quantity employed at that wage ‘float’ whilst keeping the wage fixed.
“MMT changes the definition of “full employment”
MMTers argue that mainstream economics has changed the definition of “full employment” to mean a level of unemployment that corresponds with the NAIRU (at best). Keynes and Tobin, among others, always maintained that full employment means full employment, as do the MMT economists.
“Inside money, by definition is money with a liability.”
The term “inside money” is typically used to mean money that is created in and exists “inside” the private sector. It is credit extended by one private sector entity against the debt of some other private sector entity, and is a liability to the issuer and an asset to the holder. In aggregate, “inside money” is a “closed system” in which all financial liabilities and assets net to zero. I’m sure Mosler is well aware of this.
“The dollar” taken as a whole includes “inside money” (private) and “outside money” (state). In aggregate, however, “the dollar” is also a “closed system” in which all dollar financial liabilities and assets net to zero. As such, it is possible to think of the dollar (on the macro level) as “a case of inside money” – i.e. a “closed system”, with non-dollar assets (including, I presume foreign currencies) being on the “outside” in relation to the dollar.
But perhaps you should ask Mosler about what he meant rather than assuming that he doesn’t know what he’s talking about.
As I said, MMT economists are clear about how they use the terms “vertical” and “horizontal”.
“Your ideological and purely political views… obviously nothing more than an ideology designed around promoting the Job Guarantee and a fiscalist approach.”
This is precisely the sort of comment which MMTers find so insulting. You are essentially accusing them of acting in bad faith and of having no intellectual or academic integrity.
“I corrected some of the errors made in operational aspects of the way the monetary system works.”
Personally I think that the MMT description is actually more accurate. For example, I have yet to see anywhere on your sites an explanation of the fact that Fed liabilities are also US government liabilities. This is an important point, as it means that when the Treasury has a positive balance in its Fed account, the US government is effectively holding its own liability.
Mosler has changed the meaning of the term for his own convenience. Under the MMT model all money comes from the govt because banks have magically become public purpose entities who are out doing some great charitable service for humanity. Out here in the real world banks are competitive profit seeking entities who are regulated by the govt but issue money independent of the govt who serve their shareholders, not the public. They are not public purpose entities. I think Wray called them “vampire squids” or something like that which isn’t exactly what Mosler claims. You guys contradict yourselves on this on an almost daily basis by complaining about modern banking without admitting that the current design structure is totally at odds with the MMT description. It’s a blatant contradiction and you have to be very biased to read Bill Black ranting on a daily basis and at the same time reading Mosler who calls banks agents of public purpose. This point alone renders MMT’s description of reality largely void as it totally misconstrues what private banking really is and just mischaracterizes the fact that banks issue money independent of the govt. I’ve talked to Warren about this at length and I think he’s wrong about it so there’s no need to “ask Mosler”. Besides, he’s not the end all be all when it comes to understanding modern money. He’s a genius, but even geniuses make mistakes at times. Inside money is bank money. So “all” money is not “inside” money. This distinction exists for clarity sake so just shrugging it off and claiming that “all” money is “inside money” defeats the point of the term’s very existence. It’s wrong to misconstrue words like this.
On FE – the industry has come to agree on certain meanings for the term. I am well aware that a few economists don’t agree with this terminology. But that doesn’t mean it’s okay to just change the meaning as it’s understood by 95% of the profession. But you do this with many terms so there’s nothing inconsistent about MMT’s inconstistency on terms here….
You are acting in bad faith. You are obscuring your political biases in many cases by claiming that MMT has no policy agenda embedded in it. I see MMTers constantly claiming that they are apolitical or just “describing operational realities”. Then you have Wray saying MMT is “inherently progressive” while also claiming MMT works for “any size govt”. No, the MMT as MMT envisions brings the “state back to center stage” as Kelton said. Why the doublespeak? Why is your message so mangled? Maybe you’re not being intentionally dishonest, but it comes across like that. I’ve repeatedly recommended that MMT get consistent on this because it undermines your overall message. The bottom line is, for MMT to be applicable, the system requires some pretty dramatic changes. It is inherently progressive and not just a mere description of our operational realities. MMT is a potential option for the way our monetary system could work. It is not a description of the way it currently works.
We’re perfectly aware of the fact that Fed liabilities are US govt liabilities. We just don’t think it matters as much as MMT likes to claim. But then again, you could misconstrue an argument like this to claim that Citibank’s liabilities are the liabilities of the US govt because Citi is too big to fail (if, as Mosler claims, “all” money is inside money then we should have no problem bailing out these great public purpose serving entities – especially since the money to “fund” that bailout doesn’t “come” from taxpayers “per se” – gotta throw the per se in just in case someone challenges the specifics, you know? Do you see what a convoluted mess that is? Taxes don’t fund spending, banks are for public purpose, banks are good, banks are bad, all money is inside money, contradiction, contradiction). We just think you guys way overstate your case on the importance of outside money with the whole “taxes drive money” and settlement in reserves. We’re not saying outside money is not important (and we’re not anti-govt by any means), but it’s not the “center of the universe”.
But we’ve been down these roads before so what’s the point really? My recommendation to you all would be to get some clarity not only on terminology as it pertains to the rest of the field, but to get consistent on the fact that MMT is “inherently progressive” and not merely descriptive. In the long run, you’ll gain a lot more traction. I am a pretty reasonable guy, but when I see this sort of doublespeak I immediately know there is intentional obfuscation occurring. It’s not necessary. You don’t need to hide the fact that MMT is a pro-govt, very left wing approach to economics. Sadly, you don’t even need to mangle the operational realities with strange metaphors about money “bring destroyed” or things like that to understand why the govt is not constrained. MR has described why the govt is not constrained, but we’ve done so by describing how the system actually works because we understand the intricate institutional relationships unlike MMT which just makes up a total myth about how it all works. It’s totally contrary to this weird “taxes destroy money” and “spending creates money” which is just totally wrong and not how the accounting works at all.
Anyhow, I think you all try to hide the political motivations behind all of this because you know it would render the theory dead in the USA. You shouldn’t be so fearful of the political right. You should fight back and own your progressive agenda and prove them wrong, not only on economic grounds, but on moral grounds. You have the firepower, but you undermine it with what appears (at least to me) like intentional deception (and now a changing storyline with this “general” and “specific” case)….I was a supporter of MMT under the thinking that you could support MMT without being in support of the policies. But then it became clear that wasn’t the case. But then Mosler said it was the case. Then Mitchell said it wasn’t. Then Wray said it was. Then Pavlina said it wasn’t. And the amazing thing is, you guys still aren’t consistent on this incredibly important point. What a mess….How is anyone supposed to know what MMT is when it’s most important proponents don’t even know….Do you see what the Austrians do and why they have such a huge following? Because they own their politics and they shove it right in your face. MMT obscures the message and irritates centrists like me (who would normally be quite sympathetic to MMT) because your message is totally inconsistent. If you can’t win over people like me with your message then it’s a lost cause.
I know that highlighting issues in MMT makes me a very bad person (according to MMT), but I guess that applies to my criticisms of Austrian econ, market monetarists, Keynesians and many other schools. We should be in search of the truth here and the sad thing is that you don’t need all these myths and false metaphors to understand why a Job Guarantee might be a good idea. But MMT has dug this very deep hole based on the state theory of money that is intended to rationalize the policy agenda, but actually sets it back substantially because the operational description just ends up getting mutilated by contradicting points, differing versions of the theory (general and specific) and blatant political biases that are hidden for some reason.
You should check out Wray’s latest….He calls the banks “miscreants”, calls them “frauds”, bankers are “psychopaths”, admits that banking is not even necessarily in-line with public purpose (“This could be consistent with the public purpose, although that is not at all guaranteed.”) and we’re supposed to believe in the MMT idea of banks being “established for the public purpose”?? WHAT? How can MMT so blatantly contradict itself? By Wray’s own admission the banks don’t even serve public purpose and he’s not sure they can even if we implement the fixes he calls for. It’s these sorts of blatant contradictions that render MMT’s conclusions questionable. MMT requires massive structural changes to be applicable today. It really is progressive. I’m not even saying that the progressive agenda is wrong or bad, but the world MMT “describes” (like in banks serving public purpose) is not at all the world we actually live in…..
Greg,
Check out lectures 9, 10, and 11:
http://www.debtdeflation.com/blogs/lectures/
He goes over how he structures a double-entry type balance sheet to make it amenable to modeling with differential equations. I’m an engineer, and I use Matlab and Simulink myself (not Mathcad or Mathematica), so I’d like to translate some of his models into an environment I’m more familiar with… should be relatively straight forward, but I haven’t tried it yet.
Greg,
Check out lectures 9, 10, and 11:
http://www.debtdeflation.com/blogs/lectures/
He goes over how he structures his models, in some cases starting things off with an initial loan to the firm for $100 (completely endogenous money case). He also describes how he uses a double-entry balance sheet like table to create the parameters for his differential equation based models.
Cullen,
Hypothetically, leaving aside the devasting economic impact, if the U.S. government were to extinguish all net financial assets by taxing people and distributing that money to all holders of T-bonds, and then no longer issuing T-bongs, could the private banking system still function?
I’m trying to imagine an economy where deficit spending never occurred… where the U.S. government only ever spent what it collected in taxes.
JK,
That’s a good question. I am not really sure. T-bonds play a really crucial role in today’s banking system, but I am not certain that changing t-bonds into short-term notes or cash would necessarily destabilize the system. Don’t get me wrong here – I think the extra NFA is a good thing. I am not saying govt spending is bad. I actually support the expansion of NFA as it liquifies the system. The problem with a zero t-bond world, in my opinion, is that the banking system would have to totally avoid booms and busts in order to run smoothly. And booms and busts are an inherent feature of the business cycle so there’s no getting around it. So I guess my answer is probably no?
Cullen
Hi Cullen,
I’m surrounded by great people in TN, but very very conservative in their gold standard logic. I tell everyone to be very careful what they wish for with the Paul Ryan addition. People here are open to listening to MMR and even open to heavy deficit spending over the next few years (as long as the deleveraging is seen as ending in the private sector in 2015ish). But, no one believes that the deficit spending will decrease at that point.
After reading a few books by some retired CBO guys (Clash of Generations by Kotlikoff) and a demographics pro (Diane Macunovich?) I get worried not about our recent debt of 16T, but how do we manage a debt of 100-200T without seeing inflation… assuming we are printing all of these massive interest payments?
I know that in the near term we need to worry about staying the course and getting through this mess and get the population working again.
What do I tell people about longer term? In 2025 will we be able to raise interest rates so my retiree clients earn more than .1% on their savings accounts? Or does the debt interest payment (perception and money creation) prevent the FED?
I know your site is dedicated to explaining our monetary system and you haven’t made a huge push on entitlements/public policy… but I want to connect the dots when discussing MMR with folks. Otherwise I get the response “well then we can just continue to deficit spend until the baby boomers are dead and all will be fine” .
Given demographics and your thoughts on deleveraging, what do things look like 15 years from now? Maybe 50T in debt is manageable and my brain just can’t grasp it yet. It just seems if 50T is the debt (or also private sector savings), then there is a large potential for inflation if the private sector is deleveraged by 2015.
Sorry Cullen… give me a few more years and I’ll get it… maybe a simple line of thought will help clarify. Ha…like there is anything simple here! I’ll go back to reading the “Understanding the MMS” now. Thanks so much again for opening my mind.
It’s not easy TH. I’m pretty fiscally conservative as well so I am not here to tell you that govt spending has no downsides. But I think the key point here is that we need to start thinking about govt debt differently. The govt has no solvency constraint. It can always procure funds from the private sector or via its central bank in a worst case scenario. So we need to stop thinking about the debt as being something that’s “unaffordable”. We can always “afford” it. The more important question is understanding how this spending impacts the economy and how it can potentially induce inflation, which could potentially erode our living standards. I don’t know if you read my piece on the economy, the human body and the system of flows the other day, but that’s a good way to think about all of this. The govt plays a facilitating role in helping keep the system flowing. Some of that flow can lead to unproductive outcomes, but for the most part govt spending is just a way to keep the flow going when the private sector isn’t spending enough of its income (like right now). How that flow ultimately leads to productive output is really up to us, not our govt (though admittedly, the govt doesn’t spend very efficiently on what it spends on). The USA has an enormously productive base. So we need to stop worrying about default and start worrying about inflation, what inflation really is and how we can use the tools at our disposal to improve our living standards. There was a time in this country when we used to envision using govt to build magnificent things, put men on the moon and things like that. For some reason, the govt in the last 30 years, has become nothing but an enemy. I think that’s an extreme view. We need to use govt effectively and efficiently. But we must first realize that govt was not created by us to destroy us. It is a powerful tool that can help dramatically improve our living standards if we use it correctly. Getting over the solvency issue is a good first step there….
You didn’t answer his questions:
What happens when the federal debt is $50 trillion?
Will the interest payments on the debt be borrowed?
Must interest rates remain low so as to keep borrowing costs low? After all, can interest rates return to 5 percent if that would mean $2.5 trillion in interest? Wouldn’t that be half of federal spending?
What if we grow our economy like Japan over the past 20 years, or just as bad, Italy?
In your ‘worst case’ scenario in which the Treasury must procure funds directly from the Fed — well, isn’t that bad?
I am willing to accept that federal debt never has to be paid back but can be rolled over permanantly, but how much can we carry?
It’s easy to say that we can print — but other than vague concerns about inflation, you never address the potential consequnces of going down that road.
You would hope that an increase in net financial assets like that would induce some spending and that this would lead to some growth and that living standards would increase as a result. But no one can claim that printing more money will necessarily achieve that. What we know right now is that spending is too low because private balance sheets are a mess. So we’re hoping that some govt spending can rectify this. But it’s not a guarantee. What we know for certain is that we’d likely be in a depression right now had we not spent any money at the Federal level.
The govt can always control the cost of its debt unless inflation rages. So we’re back to the inflation constraint again.
Yes, hyperinflation would be bad, but that would primarily be the result of a decline in production. That’s my guess at least given my study of history and what generally causes hyperinflation. We could do some silly policy things (like taking on foreign debt) or lose a war but I doubt that will happen.
You want precise answers for imprecise subjects. I could flip the table and ask you what level of debt will ruin the US economy? There’s no clear answer there either.
‘What level of debt would ruin the US economy?’
…
Well, I think we’re about to find that out. … What’s the conventional wisdom on that? 100 percent of GDP? Interest costs at 25 pct of your budget?
The primary concern, imo, is that once you are carrying so much debt you must keep interest rates low, which takes away your ability to fight inflation by raising rates.
…
YOu talk about a time when we used government spending to put a man on the moon or built a highway system. Since those days, we made a fiscal policy decision to use our resources on entitlement programs (indeed, to borrow money to do those things) and that has choked off our ability to do those more productive spending.
How does an accountant say he’s going to kill you? He says he’s going to credit your life asset.
“We’re perfectly aware of the fact that Fed liabilities are US govt liabilities. We just don’t think it matters as much as MMT likes to claim”
I think it matters, because if the Treasury has a positive balance in its account at the Fed, the US government is holding its own liability. You can’t hold your own liability as an asset.
The following is my own understanding and interpretation of this issue:
Money is a liability to the issuer and an asset to the holder. When the holder of the asset returns it to the issuer, the liability is cancelled and the asset is cancelled. When the liability/asset relationship that represents “money” is cancelled in this way, “money” itself is cancelled, or destroyed.
If you hold your own liability you have “net zero”.
Banks create money by issuing a liability. This bank liability is called ‘credit’, or a ‘deposit’, and is held by the depositor (account holder) as an asset. When the holder of the bank’s liability pays it back to the bank, their assset is cancelled and the bank’s liability is cancelled. The bank can’t hold its own liability as an asset. It nets to zero.
As such, money is created when a bank issues a liability, and destroyed when the liability is returned (paid back) to the bank.
Simple example:
Bank A credits Mr B’s account with $1.
That $1 credit is a liability to bank A and an asset to Mr B. Thus we can say that bank A has “-1” and Mr B has “+1”. Money has been created.
Let’s now say that bank A charges Mr B $1 for a service. Bank A thus debits Mr B’s account by $1.
Mr B now has “0” (1–1= 0), and bank A also has “0” (-1+1=0). Money has been destroyed.
It’s the same thing with the US government, just a bit more complicated.
One part of the US government (Treasury) can hold the liability of another part (Fed) as a nominal asset (i.e. a positive balance in its account at the Fed). For the US government however, this nets to zero. As such the balance in the Treasury’s account does not represent additional “funds” for the US government. Instead the balance in the Treasury’s account is a US government liability, as you said.
Simple example:
The Fed credits bank A’s reserve account with $1.
That $1 credit is a Fed liability. As such it is a US government liability. It is an asset to bank A. Thus we can say that bank A has “+1” and the Fed has “-1”. We can also say that the US government has “-1”. Money has been created.
Let’s now say that the US government imposes a $1 tax on bank A. The Fed thus debits bank A’s reserve account by $1 and credits the Treasury’s account with $1.
Bank A now has “0” (1-1=0). The Fed still has “-1”, and the Treasury now has “+1”. The US government has a liability (-1) and an asset (+1). Its liability is its asset and vice versa. Thus the US government also has “0” (-1+1=0). Money has been destroyed.
Now it seems strange to say that money has been “destroyed” in this case, given that the Treasury still has a positive balance and the Fed still has a liability…
…The simple answer is that the Treasury’s balance isn’t really “money” at all! Rather it is simply a record of tax that has been collected, or money that has been “destroyed”.
(As such it makes sense that the Treasury’ balance is not actually counted as part of the money supply).
Of course the Treasury doesn’t look at it this way. The Treasury typically sees itself as having additional “funds” in this case (which it nominally does, let’s say). But the US government does not!
Another way of looking at this is to imagine that bank A pays the $1 tax with a $1 Federal Reserve note. When the Treasury holds that $1 note, it counts it as an asset. However, for the US government it is just a piece of paper with pictures on it – not “money” or “funds”.
I made a simple diagram to explain my thinking on this:
http://www.flickr.com/photos/84792170@N03/7765255644/
You’re creating a false world where the Fed and Tsy’s balance sheets are suddenly the same thing. And your example is totally void of value because most of the money in our economy is inside money, not outside money. But you start with outside money even though most money creation starts with inside money. You’re misconstruing the whole process. Why does MMT state that banks aren’t reserve constrained, but “leverage” reserves? That makes no sense. Why do you understand that most money creation starts with inside money and that outside money facilitates transfer of inside money? But then you like to start with outside money in your examples even though this gets everything totally backwards. Or you create examples where money settles in outside money (except of course when it’s at the same bank because that would ruin your whole theory). The whole settlement idea is wrong and misleading. Kelton had an example of this using a credit card that was just horribly wrong. Why do you misconstrue all of this? It’s totally unnecessary. You’ve created an example that is void of value. You guys do the same thing with the banking system claiming that banks are essentially a part of the govt (and then ranting on a daily basis about how banks don’t serve the govt’s needs!?!?!?!?!). You’re just creating a myth. You can’t consolidate the Fed and Tsy’s balance sheets just because you want to. You can’t claim the Fed is part of the govt just because you want to. They’re separate entities. They might have a “symbiotic relationship” as I’ve stated on many occasions, but that doesn’t mean their balance sheets are the same things. They have separate balance sheets. Separate arrangements as specific entities. It’s true, in some mythical world where the CB and Tsy are the same entity, you would be right. But that’s not the world we live in. These arrangements exist for a purpose by design. The Fed can’t buy from the Tsy for a reason. You also can’t create these silly chicken and egg examples starting only with outside money. That’s pointless and doesn’t at all relate to how our actual monetary system works wherein private banks create most of the money and the govt borrows it and recycles it (DOES NOT DESTROY IT).
You guys are just making an extremist example here to promote your policy agenda which all leads back to the money monopolist and the justification for the JG. I think MMT made errors in developing the theory and is now stuck with this metaphorical rhetoric that is just totally wrong, but must be defended because 20 years of research are written using this storyline. I know some of you are changing that story (the specific case), but that’s just moving the goalposts. Sorry, but the MMT world is not the world we live in and it’s not necessary to distort reality to promote your policy ideas. I don’t know why you guys insist on doing it. Well, actually I know exactly why….The sad thing is that if you described the world for what it is (as we do) you could still support the JG on the same grounds. And you wouldn’t have to create these silly myths around the state theory of money….Unfortunately, you’d have to admit that the general case is just totally wrong and that 20 years of research was based on a false understanding of the way things work and that MMT has contradicted itself time and time again…..
I love this Joan Robinson quote which applies to MMT perfectly.
Ironically, MMT does the exact same thing. You create this world where somehow the future has already happened. You’ve consolidated the Fed and nationalized the banking system before it’s even happened! I’m not even saying your ideas are totally wrong because the world MMT envisions might well be a better and more sensible one than the one we have. But your description is not the world we have. It is a world in some mythical alternate reality….If you want to promote that view as a progressive agenda then fine. But you shouldn’t try to sell it as “operational reality” because it’s absolutely not.
I didn’t “start with outside money”. I began by describing in simple terms how commercial bank money is “created” and “destroyed”. Then I moved on to explain in simple terms why I think tax “destroys money”.
I didn’t consolidate the Treasury and Fed.
Fed liabilities are US govt liabilities. To the Treasury, Fed liabilities are assets. But to the US govt (Congress to be more specific), Fed liabilities are liabilities, not assets.
As such, a positive balance in the Treasury’s account at the Fed is a US govt liability.
The Federal Reserve is “an independent agency of the US federal government”, and part of the executive branch.
I’m not saying the Fed and US govt are the same thing. I’m saying that Fed liabilities are liabilities of the US govt.
Your own liabilities do not represent “funds” to you.
Say you issue an IOU on a piece of paper. That IOU is your liability and an asset to the person you give it to.
When that IOU is returned to you (paid back), your liability is extinguished.
Your IOU on a piece of paper becomes “money” when it is issued by you and held by someone else (it is their asset and your liability), but when it is returned to you it ceases to be “money” (as both asset and liability are extinguished). Then it returns to being just a piece of paper.
Phil,
It’s impossible to debate any of this when we’re using conflicting definitions of words/ideas. You’re bringing everything back to the idea of the state as the money issuer. So of course, from your perspective, money is an IOU of the government. But not everyone agrees with this terminology.
More importantly though, I can see that Trixie has moved onto just outright slandering me on the MNE website. This is really crossing the line. First, I never said I managed a huge fund or that I had millions of clients. Anyone who knows me knows that I never attempted to increase clientele beyond the initial clients I had and that the fund was always created to remain a “small investment partnership”. Nevertheless, I grew the fund at a CAGR of 17% per year with no negative years in a very turbulent environment primarily in my late 20′s. How many people do you know who managed any level of assets through the 2005-2011 period with those results? Not many I presume. I have the audited results to prove it. If starting a small company and generating 17% per year (even on a small asset base by industry standards) doesn’t make me “entrepreneurial” then fine.
Further, hedge funds are pooled as “one account” so she has no idea what she’s referring to there. And the initial investment was my personal investment in 2005 (when I was 25 years old). That’s why it’s listed as “majority personal assets”. And “revoked” is the standard term the SEC uses when an RIA is closed, as in, I sent in a form saying “no longer doing business as”.
I am done with MMTers. This has crossed a line that is really unreasonable.
I am going to have to ask you to stop commenting here any further. I hope you understand that this has reached a very personal (even legal) level where it is no longer conducive to anything positive. I will be distancing myself from all MMT conversations because of the extremely negative direction this all seems to be headed. It’s crazy how a disagreement on the internet has turned into personal threats and slanderous comments about me in so many ways. This was never personal for me, but many on your side have crossed a line that is unhealthy. I am sorry we see the world differently, but I think it’s just best if we don’t discuss eachother’s views and instead recognize that we need to co-exist without criticizing or demeaning each other. MMT is not my enemy and I will be cognizant of this in the future when responding to questions. Thanks for understanding…
Ok then. Peace.
One last point though,
“You’re bringing everything back to the idea of the state as the money issuer. So of course, from your perspective, money is an IOU of the government”
I’m saying that central bank money is an “IOU” (liability) of the government as well as a liability of the central bank. This includes notes, reserve balances, and the treasury’s central bank balance.
Commercial bank money is an “IOU” (liability) of a commercial bank.
Are you saying this is incorrect?
I agree that all the personal stuff should stop. But I don’t think people should stop discussing each other’s ideas. Debate just needs to be carried out in a fair and accurate way on both sides.
Phil,
We’ve said the govt is an operational currency issuer. But we’ve also noted that the govt is a currency user in some capacity (as the Tsy is). It’s designed that way. Like a car maker who sells his blueprint to other car makers by choice so they can build, distribute and profit from the car and then decides they would prefer not to build the cars themself, but use the other automakers car. The US govt is no different. Yes, in a mythical world they could be the only issuer or the monopoly issuer, but they’ve chosen not to. I am not here to say it’s right or wrong or that it even makes sense. I am just saying it is.
I agree the personal stuff should stop, but some on your side have really crossed an uncomfortable line. They’re now attacking my line of work and misconstruing what I do, what I’ve done, implying that the SEC “revoked” my license (which is absolute nonsense), etc. The commenter clearly has no idea that a hedge fund is pooled as “one account” or that “revoked” is the standard term for termination of an RIA (it doesn’t mean the RIA was stripped of its license). They haven’t just misconstrued these points. They’ve almost certainly broken the law as these comments definitely border on defamation of character. I know you guys are still seeking clarity on much of this debate, but I cannot continue it. Your side has proven that they’re willing to do anything to make their message heard (threatening emails, comments with threats of personal harm, attacking/misconstruing my background/work, logging my every comment for later use, stalking, etc). None of this is okay, some of it is downright creepy and I won’t be involved in it. I’ve tried to distance myself from MMT because of this crude behavior, but now it’s time to pull the rip cord. I hope you understand.
Cullen
I don’t know anything about those emails. Such behaviour is totally unacceptable.
“in a mythical world they could be the only issuer or the monopoly issuer”
I never said the government is or should be the only issuer or “monopoly issuer”. I clearly stated before that commercial banks issue their own type of money.
I’ll try to summarise my point:
You issue an IOU to someone. That IOU is later given back to you. Do you now have additional funds? No. Your liability has simply been extinguished.
When the govt spends it issues IOUs. When those IOUs are paid back to the govt, does the govt then have additional funds? No. Its liability has simply been extinguished.
The govt has a self imposed rule that it will only issue as many of its IOUs (liabilities) as it has received from taxes and bond sales.
Hi Phil. The problem with your comment (in my opinion) is that the govt doesn’t issue most of these “IOUs”. Private banks do that and then the govt borrows them or recycles them through taxation. I know MMT says you can’t or shouldn’t borrow your own IOU, but that’s really what the govt does. They borrow and reuse their own IOUs. It might not make a lick of sense, but it is what it is.
It’s like this. Say GM builds a totally awesome and unique car. But they decide they’re not going to make it, distribute it or profit from it. So they outsource these actions to other car makers. So these other car makers get the blue prints from GM, sign the forms to use the patents, etc, and then start producing, distributing and profiting from the production of this car. Then for some odd reason GM comes back to them and decides they need cars to perform various actions. But rather than produce their own cars they go to these other car makers and BORROW their cars.
That’s how the current design of the system works. The banks make the cars and the US govt CHOOSES to use the cars made by the banks. Yes, the govt could (in theory – modern monetary theory!) just create its own cars and use them, but it doesn’t do that (at least not very often). I am not saying it makes a bit of sense, but it is what it is. You’re just saying that GM makes its own cars, but the reality is that it doesn’t really do that in any great capacity at all (aside from notes, coins and reserves which are relatively minor in the grand scheme of things). See what I mean? This is why MMT’s description isn’t very accurate. It’s just not what really happens. In order for the MMT description to apply the system needs to be overhauled and changed. It really is “inherently progressive”. And who knows – maybe if MMT has its way the world will be a better place? But its description is not “operational reality” of the current system.
I am sorry to be critical of MMT and I know it’s a very touchy subject, but I really don’t think the MMT description of GM issuing all the cars is correct….And for me, it’s all about getting the operational realities right. It’s not personal, it’s not about me being hateful or anything like that. It’s all in the interest of finding the truth.
Cullen
Really didnt want to get into this discussion with you (I try to avoid MMT/MR piss fests because I REALLY like yours, Mikes and Beos contributions to the discussions in general) but you made a very interesting analogy and I want to expand and think about that more.
One of the weaknesses of your analogy is that in fact GM would no longer own the production, they gave that or sold that. The others could rightfully say. “Hey, we got the factories and blue prints…. go piss off” That doesnt seem true AT ALL with our monetary system. The Fed is the one that truly is there because of Congress and if Treasury (at the request of Congress) took back all spending responsibilities the Fed would have ZERO standing to resist. They cant say “Hey, we got the blueprints now and the factories..nah nah nah ne nah nah”
But even a further point, you seem to recognize the silliness or unNECESSARY nature of this whole charade as well. The Treasury has never nor will they likely ever be denied “funding” by our current arrangment. I think part of the responsibilities of those analyzing this system… those in MR, MMT and the other quacks is to look for answers to our quagmire and the answers dont come from continuing a charade. By saying this, it doesnt mean I want to eliminate banks, or strangle private money out of existence (totally impossible btw I know) but people do need to explain, VERY CLEARLY, to the masses that in reality it is NOT necessary for a country of 300 million with the level of influence we have, to borrow anything from anyone. Especially a $US from a Central Bank we’ve only had in existence less than half our time as a country. This is where I think MR has lost its way a little bit (not citing MMT as the “perfect” alternative either). I’m not convinced we can move forward under the current institutions without a lot more lying (like moving certain spending off budget so it doesnt affect the deficit). So lets call an end to charades. CBs can serve very valuable roles in modern capitalist economies, ours is currently serving only the desires of people who are absolutely in denial about some realities of economics. As a person who has only looked at econ/finance seriously for almost 4 years I feel like I could sit down with almost any of these fed bankers and within a 30minute discussion I could ask a question of them that would have them bumbling blabbering and calling security. And I have you, Warren, Mike and many others to thank for that. You have done some very illuminating work for me. Thanks
Greg,
I’ll have to respectfully disagree. There are too many “ifs” in your response. “If” we did this. “If” we did that. That’s where MMT comes in. “If” we change this then that is true….I am really trying to get away from this whole MMT vs MR debate because it’s counterproductive in many ways and people seem to be getting very emotional about it, but the banks just spent the last 30 years saying “Hey, we got the factories and blue prints…. go piss off”. We can’t even put them in jail. They’re too big to fail. Too big to control. Too intertwined and too important to cut loose. And now they run the town. That’s just how it is. They’re telling us to piss off every single day because they know who is in the driver’s seat. They issue all the money and they know it. Money is power. They know it. We sold the blueprints and refuse to take them back. I don’t know why, but we did. As I said, I am not here to say it makes a lick of sense. But it is what it is. MMTers seem to know this in their heart of hearts (which is why you guys spend a lot of energy attacking banks in my opinion), but refuse to admit it openly. I don’t know why. I wish you guys would point it out and make the case that it doesn’t make any sense and is a crucial flaw in the system that needs to be fixed. You have the evidence and the firepower to make the argument. So why not do it? Hell, use MR’s analogies and work if you want.
Pragcap has always been about teaching and explaining. Not an agenda or politics. That’s just how it is. And it will always be like that. It was like this even when I was MMT. I never talked about the MMT policy ideas. Never. I 100% get the MMT perspective and I really do sincerely respect and appreciate the progressive approach. I really do. It’s just not my thing. It never has been. I very rarely do policy and politics here. I don’t enjoy it. People get too emotional, too involved, too personal. Just look at the MMT response to me (and mine back). It’s not a positive development. So I prefer to stick to explaining the machine. Not fixing it. There are a million MMTers running around doing that. And if my work and analogy helps then USE IT! I have zero issues with a progressive agenda, deficit spending, or govt. NO ISSUES. I just don’t want to see the description of our reality mangled. That’s really all I care about. Getting the truth out about how the machine CURRENTLY works. I think MMT twists reality to create a future that has already happened. Maybe I am wrong, but that’s how I see it. I’m not malicious or motivated by hate towards MMT. In fact, I am purely trying to teach. That’s it.
Lastly, I realize that it’s silly to borrow back your own IOU. But I am not certain that having competitive banking is not a superior route. As I said with the JG stuff, state banking is not well proven over long periods in an economy like ours so it’s hard to make a recommendation on where we should go.
Cullen
Cullen debunked MMT and they can’t stand it. He’s highlighted the great big statist flaw in the theory and they hate him for it. And now he’s being attacked and threatend left and right.
Greg, you seem like a pretty reasonable guy most of the time. Why don’t you straighten these people out and show them how Cullen is right. Show them that the government has chosen to be a user of its own currency. Show them why MMT is wrong so they can begin to explain to their followers how the view is progressive and nothing more. You’d be doing yourselves a big favor and you’d stop looking totally insane for threatening and attacking the most pragmatic guy on the internet.
LVG, don’t stoke the fire please. We’re trying to reduce the MMT/MR tension. Not increase it. Thanks.
@ Greg,
This is a simple but important point. In MMT the state creates all the money and doesn’t HAVE to USE money. But in MR the banks issue the money and the state HAS to USE it. The MR version is closer to reality. It might be designed by choice, but once you understand that the banks are in control then the MMT griping about banks starts to make sense because their existence as private money issuers means the MMT model is wrong.
@SS
This is my last comment in this thread because I respect Cullens desire to keep this place free from MR/MMT battles but you brought something up I wish to address.
” In MMT the state creates all the money and doesn’t HAVE to USE money. But in MR the banks issue the money and the state HAS to USE it.”
Its State money, the US$, which EVERY bank liability is denominated in in this country, and ask them if they want to go back to having their own liabilities and simply fight amongst them selves when crises arise. This happens to be a very valuable construct as I see it as a US citizen. I think its better that all banks deal in the same currency within our borders.
The one issue I have with describing the Treasury as a user is then who is the issuer? Who “cannot ever run out of money”? The CB?
Is there any entity on this planet that cannot run out of money?
There must be, within our institutional designs, someone who creates money ex nihilo, spends it into existence and then does something to make it necessary/desirable for the rest of us to want to use it. Money doesnt come from the gorund or trees. We invented it out of social relationships and it has evolved almost everywhere to be relative to different geographic/culturally related areas all using the same piece of paper or numeraire in a computer…. but something somewhere CANNOT run out of it. It might have to change names every 200 years.
To me, saying that its banks that are THE issuer leads to a couple problems. 1) Banks are profit making institutions, they can only survive where people already have some money. Deposits get made loans get paid back etc etc. Banks dont go set up in a un charted piece of territory and then commerce springs up around them. Banks come after some degree of commerce already exists. They come along later. 2) What banks issue must be paid back. If they issue 1000 they expect 1100 in return over some period of time. Which is why #1 above is true. But even if a bank issues 1000 and only expects 1000 back you are not net better off, nominally. MAYBE in real terms but not for sure.
So as I see it there must be an entity that can issue “spending power” without it all needing to be paid back, if we are going to organize as we do into large groups in adjacent geographic areas and agree to all use the same “spending power ticket”…… and that cannot be a private bank. They will go bankrupt in that scenario.
We must create something that cant go bankrupt
Hi Greg,
Thanks for always keeping it so civil. A few things. MR doesn’t disagree that the govt is a good thing or that govt spending and NFA is a good thing. But the way I’d describe it is that the govt exists to facilitate private sector existence. The monetary system doesn’t exist purely for the purpose of moving resources to the public domain as Wray has explicitly stated. The monetary system primarily exists to coordinate the exchange of goods and services in the means of private production. The creation of private banks was a step in this process. But as you noted, this wasn’t a very efficient process. So the Federal Reserve system, a central bank and a Tsy that is all interconnected is a vast improvement over the system of private banks. But it’s important to note that this institutional design is still just a facilitating feature to private banking. Ie, it is still inside money that steers the ship. Outside money is the stabilizing force. But make no mistake, if inside money goes worthless (let’s say in a hyperinflation) there is nothing the govt can do with outside money that will fix this. This brings us back to the point that it’s production and ultimately the private sector that the monetary system exists around. This is why I think it’s important to make the distinction between govt money and bank money. Intermingling the two mangles the real relationship that exists here. The govt is not the lead horse here as MMT would claim. Govt is in fact a user of the social construct created by the private banking system. It’s designed like that for several reasons – to disperse the power of money creation away from govt and to give the power of $ allocation to competitive markets. I am not saying it’s right, that it works great or that it makes perfect sense, but this is the system we have. The govt is a user of its own money. It’s only an issuer in that it has vast legal powers and tight relationships with the private sector that allows it to always procure funding.
The other point is that there’s no such thing as private debt being paid back in the aggregate. In fact, it must grow elastically as the economy grows. Like govt debt, it cannot and will not ever be paid back in the aggregate. Inside money is less stable than outside money because private entities don’t have taxing power, but that’s just a feature of competitive markets and the business cycle – it’s inherently unstable.
I hope that helps clarify my thinking on all of this.
Best,
CR
Cullen
Its never really been hard to be civil with you or Mike. From the first time I visited your sites I always liked the confidence mixed with the right dose of humility you guys displayed. Ive certainly made some comments on the internet Im not proud of now but I am trying to comment less but comment clearer and smarter.
This comment section is approaching record length so I would like to take it to my site and come up with a post for you to comment on if you wish. I havent posted anything in a while but Im feeling the stirrings from my “brain gizzard”. The place where thoughts, opinions and emotions sit for a while and stir, ruminate, ferment and age til they are ready to be regurgitated.
My site is here http://gbgasser.blogspot.com/
Give me a little while to post (Im a slow typist and it might be long) and if you come I dont mind if you laugh but dont laugh and point at me.
Hi Cullen,
I have a question regarding an old post of yours, “Does China Fund Our Spending?” and I apologize if you’ve answered this ad nauseam. I’ve been following you for a long time, so I’m a little embarrassed this still doesn’t make sense to me.
One of the lines in the Warren Mosler quote is “China gets its dollars by selling goods and services in the United States”. Does that mean when China sells goods and services to the US Govt, or to anybody in the US? My confusion stems from some of the comments (in particular Michael Cullen) who seems to argue (based on experience) that whenever a boatload of stuff from China hits our shores, the Chinese are paid. Does the US Govt intercept their payment and require them to hold it in a reserve account, or is it different when they’re selling merchandise to US households or firms?
Thanks,
Troy
I think you have to be careful reading the MMT description as Mosler and others describe it. MMT will literally say the USA is not revenue constrained in any fashion. I don’t agree with this idea. Unfortunately, I wrote that piece shortly after I had just come across MMT and was in support of their more general ideas (like the fact that the US govt can’t run out of money) so I fell into the trap of making some of the same loose metaphorical descriptions that MMTers do because I wasn’t entirely versed in MMT’s totally theoretical framework well enough to see where it was also wrong on parts. I’ve since seen the light and that’s why we started Monetary Realism. Because of these specific detailed disagreements on operational realities.
The main thing to understand here is that China receives US dollars by virtue of running a large trade surplus with the USA. So they get dollars, we get pieces of plastic and those dollars basically sit with a Chinese bank account until they’re used to buy US assets. If the Chinese let them sit around they aren’t much good to the Chinese. So they buy US Tsy’s and support their currency peg and things like that. But if you study US bond auction data you’ll notice that the auctions are never constrained by how much foreign buyers actually buy. The Primary Dealers are always able to take down 2X the entire auction. So there’s no need to worry about foreign funding of the Tsy. It’s just never a problem. The US govt uses its domestic banking system to procure funds and finance its spending. So don’t worry about China. They’re not a player in the funding process.
See here for more:
http://pragcap.com/mr-recommended-reading
http://pragcap.com/understanding-modern-monetary-system
Cullen,
Could you be more specific on a point of this question…
Let’s say you own a business and for simplicity let’s say that you don’t sell any product in the United States, but you are a U.S. business located here. All that you do is make stuff here and sell it to Chinese consumers.
1) Do you personally have an account at the Fed (or at the bank of china?) where you accumulate Yuan? And then you personally decided when and how much of your Yuan to exchange into Dollars?
or
2) Is there some kind of automatic conversion where whatever you sell to Chinese people, that they pay for with Yuan, your income stream get automatically converted to Dollars? If so, how does this process happen?
thanks.
Cullen, new comments at MNE about you:
http://mikenormaneconomics.blogspot.com/2012/08/randy-wray-why-is-obama-administration.html
I’m pretty sure that commenter Trixie is the source of the MMT attacks that are now filtering over here. You might want to consider banning all the readers who have started commenting about MMT in recent days since they’re probably coming over from MNE and have nothing of substance to add.
1. This section is not intended to be used for issues like this so let’s try our best to keep this section a questions only section with the primary purpose of helping to educate.
2. Trixie is a long-time reader of this website and once praised my work. But as soon as I rejected the MMT Job Guarantee and facets of MMT she turned on me and has turned into a harsh critic. Like many MMTers, she seems to think I am an evil person because I want to get the operational dynamics right. I know they’re mad that I criticize them, but I criticize lots of people. It’s not personal. It’s been in the interest of obtaining a better understanding. That’s all. I’m not here to torpedo austrian economics, monetarism, MMT or any of the other schools I some times criticize….I am here to explain why a certain view of the monetary system is accurate from a descriptive perspective. MMT gets a lot of stuff right (a lot more than most other schools), but I think it also has some issues….
3. She’s misconstrued my comments and she should know better than to do that because she’s been reading here for a very long time and she knows my gripe with the state theory very well. It has little to do with the name calling. It has everything to do with the idea that the state is the “monopoly supplier” of money. This is where this whole debate started and I made it very clear that I disagreed with the JG, not on political grounds, but based on MMT’s faulty evidence proving their thesis. The key component of this is this idea that the state is a money monopolist and the false idea that banks are essentially a part of the govt. They like to claim that banks are essentially parts of the govt because they have to obtain charters and are regulated. Well, I had to obtain a charter for my company and I am regulated by the govt. Does that mean the govt owns my company or that I am suddenly an agent of public purpose? Of course not. Granted, banks are more highly regulated than my company, but it’s largely the same structure. Companies are regulated by the state, obtain state licenses to operate and are privately owned and funded. That’s how being a corporation works in this country. Banks are not much different than any other corporation in this regard. It doesn’t mean they are owned by the govt or part of the govt. Our banking system is an oligopoly run by privately owned banks. It’s similar to GM creating a car and then giving away the blueprints for the car and allowing other automakers to build and profit from the new car. Is GM the “monopoly supplier” of that car? Of course not. But MMT misconstrues this reality to claim that banks are in the business of serving the govt and public purpose as part of this monopoly. It’s just false. And it’s not hard to understand why it’s false. MMT contradicts this argument in their daily criticisms of banks. But they still don’t admit that this is a contradiction and that govt is not the monopoly supplier of money because that would hurt their entire theory and make a lot of old research look very bad….It’s unfortunate because you don’t even need this false descriptive component to support the JG….
4. I am not interested in monitoring MMT comments. If you have a comment about MMT please leave it at a MMT website. This is not the section for it. Thanks.
I’m very familiar with your views on this and I totally agree. I just thought you might be interested in the criticism since it might have been the source of the recent influx of MMT commentary here. Sorry to fill the space with unwanted material!
Cullen,
Here’s some interesting recent slides from Keen:
http://www.debtdeflation.com/blogs/wp-content/uploads/2012/08/UWSPresentation.pdf
Some of them deal with recent efforts at incorporating government spending and policy into his mathematical models.
Thanks Tom! Does he have audio for that talk? I’d love to hear it.
Well, there’s this:
http://www.youtube.com/watch?feature=player_embedded&v=OgGritTEDB8
Plus a paper by some of the Canadian mathematicians that were evaluating the models:
http://www.debtdeflation.com/blogs/wp-content/uploads/2012/08/GrasselliCostaLimaMAFEonline.pdf
Cullen, I am getting confused with all this MR VS MMT Talk, I feel that the site is suffering an identity crises and think perhaps a simple chart could be posted to explain the differences.
I am grateful for the conversions everyone has shared on this site but also see where there is some left over room for improvement.
My suggestion/Question is can there be a Chart that has X amount of questions and have the Answers posted as to how MMT, MR, view them.
Example:
Govt Seek To Provide Full Employment: MMT MR
YES NO
Inflation controlled by Fiscal Policy Yes No
Etc……….
No need to get confused. The core pieces are really simple.
MMT is progressive. MR is purely descriptive.
MMT believes that the state is the issuer of money or the money monopolist. MR says money is issued primarily in the form of an oligopoly controlled by the private banking system (though the govt does issue other less important forms of money such as notes, reserves, coins).
MMT says money is a creature of the state. MR says money is a social construct that has existed long before the state and the state’s involvement in money is merely an evolved institutionalization of money.
MMT believes the state has the responsibility to hire all the unemployed. MR makes no claims on policy and rejects the Job Guarantee as a core component of monetary theory.
See below for more:
http://pragcap.com/mr-different-from-mmt
Cullen, a blogger for the Akron Beacon who goes by DA_King posted this response when I suggested that federal debt was not only a good thing but a necessary thing:
“There is no real private sector surplus with a deficit and debt driven economy. It’s an unsustainable illusion. We’ve sustained it to the point of a $16 trillion federal debt, and a far larger real debt if you add it all together, but it cannot last. It’s impossible. We are sending hundreds of billions of dollars in taxpayer revenue into an economic black hole already to pay interest on the debt. Those are wasted resources, and things are about to get much worse with our current irresponsible deficit policies and coming entitlements explosion. We are in the process of committing national economic suicide, and neither Keynes nor the Austrians would approve of it.”
How would you have responded to him? Thanks.
I would explain to him how we procure funding by harnessing our banks and guaranteeing payment with the central banks backing. This makes it impossible for the US govt to ever “run out of money”. So the only thing that’s “unsustainable” is not the amount of debt we take on, but the inflation it might cause. That’s a very different phenomenon than insolvency as in “running out of money”.
So you might ask him, what’s “unsustainable” about 1.7% inflation in a world where the sovereign currency issuer can’t “run out of money”? Better yet, what will cause inflation if he is worried about it? Because a “low growth” thesis would generally contradict this view….
Cullen,
Given that the private sector is typically seeking to maximise yield on excess reserves/cash with the highest safety, why would a bank buy or hold any U.S. Treasury Bill (3-month Tbill yields 0.10%)when they can get 0.25% holding reserves at the Fed? Who is the buyer of all these Tbills below what the Fed is offering on reseves?
thx.
Hi Dis,
Banks actually on-sell most of their inventory so to them, it’s about hedging exposure, managing risks and earning fees here. Who is seeking anything over 0%? The rest of us poor schmucks whose bank accounts are earning nothing….
Hi Cullen,
Do you think it would be fair to say that one of the big differences between MR and MMT is that MR attributes (correctly in my opinion) the legitmacy of money to the FIAT issuer, but the valuation to the users, where as MMT assumes that the value is defined by the issuer. This is why in MMT increasing the money is not seen as inflationary.
Personally I also think that just because the valuation of a currency is not tied to gold does not mean that it is not tied to any asset/commodity. Indeed, the fact that we measure price and wage inflation in dollars/pounds/yen instead of gold just shows we have taken the equation “35$ = 1oz Gold = variable qty basket of goods” and converted it to “variable qty $ = 1 basket of goods” Same equation, same relationship between $ and goods. The gold bit was alway irrelevant in terms of the real value of money, which is and always will be its convertability from one asset class to another, aka its purchasing power.
Hi Andy,
I think you’d have to ask this same question on an MMT website for their opinion. I don’t speak for them nor should I. From the MR perspective, I think we’ve designed an approach where the value of the currency is not just up to the state so you have quantity and acceptance value. Acceptance value is largely controlled by the state. It’s all about laws, regulations, enforcement, etc. Quantity value really comes down to production and quantity of the currency (output, production, CPI, FX, etc). The key piece in this is production. Inflation can occur in a very high production environment (like full employment), but also in a very low production environment (generally consistent with hyperinflation). MR says both values are important, but that quantity value is ultimately more important because production is the backbone of a monetary system. Without it, there’s no need for the system. So yes, you could say we focus more on quantity value. I hope that helps.
Cullen
Can someone tell me if there is a way to sort the comments by chronological order (i.e. “oldest first”) as they were prior to the site redesign? I can imagine viewing newest first is easier for Cullen to keep up with, but I find it unintuitive and sometimes a little challenging from a flow perspective.
If it’s not an option, but could be added with relatively little trouble, consider this my vote for that feature.
I switched it back. It was annoying me also.
Cullen, I am trying to pkg monetary function in a way that my 17 YO H.S. Junior can understand as he takes a college economics class (I am sure there will be heated discussions (professors) proxy my son. My question is sort of abstract and more will be asked in the future, But based on what you have seen and experienced with your work thus far, what percentage of the populace/readership/human encounters would you say hear and receive the MR/MMT Message?
Thanks for your work
Honestly, I’d guess less than 1% of the population understands this view….
The Republican campaign is again calling for a commission to “study” our going back to the “Gold Standard”. (I guess this idea works since only about 1% of the population understands where our money comes from.) My question is, isn’t the value of our fiat currency vs other fiat currencies mostly controlled by the currency traders short term and their speculation on the value of the various currencies going forward? So would talk about the gold standard actually help our currency to increase in value over the short term and thus make us less competitive in the short term (e.g. something Republican campaigners like for now)? Are currency traders in the 1%, or do they just look at technical charts?
I’ll let Cullen or somebody else who knows answer your questions, but something you wrote (“1% of the population understands where our money comes from”) made me think of a book I heard about recently:
http://www.amazon.com/Debt-The-First-000-Years/dp/1933633867
The author was criticized for his views over at the von Mises institute (an “Austrian” group) in a book review… which led to a fascinating back and forth between the author of the book (David Graeber) and the von Mises readers… David responded to the original criticism with 5 or 6 very long and detailed posts! I feel like I’ve read a significant section of the book in just reading those! He followed those up with responses to many of the readers. He didn’t get one response from the original article author (Robert Murphy). David is an anthropologist and looked at the question of where did our money come from. The evidence does not suggest barter, as the neo-classicists, Austrians, and classicists (Adam Smith, etc.) suggest. Instead it looks like a gift/credit based beginning to money (like I’ve heard Michael Hudson and Steve Keen suggest). Anyway I thought David’s posts were well worth reading… and probably his book is too!
http://mises.org/daily/5598/Have-Anthropologists-Overturned-Menger
(check out the “Comments” tab at the top).
Oops, I’m wrong… Robert Murphy did write something:
http://archive.mises.org/18301/david-graebers-response-to-my-article/
Hi Dennis,
pegging the currency to the price of gold would almost certainly “stabilize” the value of the dollar. But it would create many more problems than anything else. Maybe see the recent article on gold on the front page. The problems regarding a lack of floating exchange rates is the most problematic. So you increase currency stability at the threat of destabilizing the domestic economy. Like Europe’s arrangement, it makes no sense.
Cullen
Cullen,
“The problem with your comment (in my opinion) is that the govt doesn’t issue most of these “IOUs”. Private banks do that and then the govt borrows them or recycles them through taxation.”
My understanding is as follows:
All money raised by taxes or bond sales eventually goes into the Treasury’s accounts at the Fed, and all spending by the Treasury comes out of these accounts. This means the Treasury ultimately always receives payment in government-issued “IOUs”, and spends by issuing government “IOUs”.
The Treasury also uses Tax & Loan accounts in commercial banks to hold deposits temporarily before they are “called in”. These accounts are similar to other bank accounts in that the deposits are liabilities of the bank at which they are held. The main purpose of T&L accounts is to manage flows to the Treasury’s account at the Fed so as to minimise disruption to the Fed Funds market.
Banks have to post collateral against T&L deposits above a certain sum, and pay interest to the Treasury on T&L deposits that are kept by them for longer periods of time. Most T&L accounts, however, hold deposits for less than a day before they are called in by the Treasury.
When T&L deposits are called in, the bank debits the T&L account, the Fed debits the bank’s reserve account, and credits the Treasury’s account at the Fed. The Treasury then spends out of this account.
When the Treasury spends, the Fed debits its account and credits a bank’s reserve account. The bank then credits customer accounts accordingly.
Banks can initially pay for government bonds by crediting the Treasury’s T&L account, if the Treasury agrees. Similarly, when non-bank individuals or institutions buy government bonds, their bank can carry out the transaction by debiting their customer’s account and crediting the T&L account. At some point however, the Treasury will call in these deposits, at which point the T&L account is debited, the bank’s reserve account is debited, and the Treasury’s account at the Fed is credited.
The Treasury’s balance in its account at the Fed is an asset to the Treasury and a liability to the Fed. To the US government, the balance is both an asset and a liability, given that Treasury assets are US government assets and Fed liabilities are US government liabilities. So for the government, it nets to zero. The US government holds its own “IOU”.
As discussed, when you hold your own “IOU” you do not have additional funds. Your liability has simply been extinguished. As such, when the Fed credits the Treasury’s account a US government liability is extinguished, and when the Treasury spends (and its account is debited), a US government liability is created, or issued.
As mentioned, the government has a self-imposed rule that the Treasury will only spend as much as comes in from taxes, debt auctions and other sources (leaving aside coins and other money that the Treasury has the option of issuing). This doesn’t change the fact that government liabilities are extinguished in payment to the government and created when the government spends.
This is quite a good explanation I think:
“The U.S. Treasury receipts from taxes and the sale of securities now total well over $2,500 billion a year. Almost all of that comes out of the bank deposits of taxpayers. Banks must cover those payments with their own reserves on deposit at the Fed, but bank balances at the Fed total less than $25 billion. How can banks manage such a large flow of funds on so little reserves?
The answer is that the Treasury spends on average as much as it receives. Its spending replenishes banking system reserves about as fast as they are used. However there can be significant short-term imbalances between inflows and outflows. Banks would be in trouble if the Treasury made no provision for those imbalances. That is the principal purpose of the Treasury Tax and Loan (TT&L) program.
All tax payments by individuals and businesses go into Treasury accounts at depository institutions called TT&L accounts. Government spending, however, is paid out of the Treasury account at the Federal Reserve. The Treasury must therefore replenish its Fed account with frequent transfers from its TT&L accounts.
Payments deposited in TT&L accounts cause a transfer of reserves within the banking system but do not change the total. However when TT&L deposits are moved to the Treasury’s account at the Fed, banking system, reserves decrease accordingly. By targeting a constant balance in its Fed account, nominally $6 billion, the Treasury helps to maintain the reserves of the banking system at a nearly constant level. This is key to enabling the Fed to maintain control of the Fed funds rate, its primary monetary policy tool.”
http://wfhummel.cnchost.com/treasuryflows.html
Also: http://www.ny.frb.org/aboutthefed/fedpoint/fed21.html
Hi Phil. Thanks for the detailed comment. Allow me to clarify my point.
I am not really concerned with “self imposed” constraints. I am always referring to the way things are, not the way they could be. We impose constraints on whether the govt can drop nukes on other nations. But that doesn’t mean we should build a “general case” arguing in favor of dropping nukes everywhere just because the rules are self imposed. Human beings impose lots of self constraints. They generally exist for good reason. This is no different in the monetary system.
Now, why does this self imposed constraint exist? Why, as the FRBNY states, does “the Tsy receives most of its funds from commercial banks”? Why does the private sector fund govt spending? Why is the govt a user of the money it could create on its own? Because the system is designed in a manner so as to disperse the power of money creation away from the govt. The social construct is not merely a construct of the govt. The private sector creates most of the money and the rest of us use it. That’s just how it is. So the govt is a user of its own currency by choice. The settlement in reserves is a sideshow that just smooths certain processes. It doesn’t change the fact that the govt needs to procure funds as the system is designed. I do not care that there exists this world where the govt could be its own issuer. It does not matter in my opinion. Analyzing this other world is great for mental exercises and understanding (I know you’re 100% right if the rules are changed), but it doesn’t matter in the here and now.
The fact is, we have a two tiered money system. We have inside money and outside money. And inside money is the money we all use for all practical economic purposes. The creation of the T&L accounts and the reserve system is entirely for facilitating a smooth process whereby the Tsy can procure funds without disrupting the payments system and the reserve balances. It doesn’t at all change the fact that the govt has to procure funds from the private sector before it can spend (as the system is designed). I am not saying it makes the most sense or that it’s a good thing necessarily, but this is the system we have. We both know the govt cannot “run out of money”, but I disagree with your notion that the govt doesn’t have to use the same money we all use. That it is somehow unconstrained in what it can spend. I think the govt is very much constrained by how much money it can procure from the pvt sector. Govt’s always find this out in a hyperinflation. The inability to procure funds in a hyperinflation is precisely what leads to collapse. So I think it’s terribly wrong to make this claim that the govt doesn’t have any revenue constraint. It does, the system has been designed to ensure this, and history has borne this out time and time again. Hyperinflation ALWAYS proves there is a revenue constraint because the tax system always collapses in a hyperinflation.
See my point now? It’s about the social construct being a product not only of the govt, but of the private sector. In addition, it’s about dispersement of money creation. And lastly, it’s about understanding the currency viability is not merely about govt enforcement of taxes, but is more importantly, a construct of whether the private sector is willing to transact in the currency (and as a result, whether the govt can procure funds from the pvt sector).
Cullen, interesting argument.
My point is:
“when you hold your own “IOU” you do not have additional funds. Your liability has simply been extinguished.”
So its not possible for the US government’s own “IOUs” to serve as US government “funds”. The government can’t “procure funds” by getting back its own “IOUs”. That simply extinguishes previously existing liabilities. When it spends, it issues (creates) liabilities.
Money isn’t really like a car, because a car is an asset to the company that builds it and sells it. Money, in contrast (credit and fiat money), is a liability to the institution that issues it. This is why I think the IOU analogy is useful, because it doesn’t mix up assets and liabilities.
Hi Phil,
I understand the point you’re making. First, I don’t really like the idea of an IOU. IOUs get paid back eventually. In the aggregate, money in a fiat monetary system does not ever get paid back. Not at the private or public level. It can’t. The money MUST expand elastically to meet the growing needs of the public. I think you’re starting from a definition of money that satisfies your argument as opposed to looking at what money really is – primarily a medium of exchange. But that’s a separate point really.
More important is the point that the govt is a user of the social construct in a manner that is similar to the private sector (though not exactly analogous). Money existed long before govts. The organization of money under govts did not suddenly make govts immune to all the laws of money. But the govt has powers that are different. For instance, you and I both know that the govt can’t “run out of money”. But that doesn’t mean the govt doesn’t have to procure funds from the private sector. The govt is very much a user of its own currency in some aspect even though you might not want it to be. As I previously mentioned, in a hyperinflation tax receipts collapse. This is an inability to procure funds. Saying that the govt can just create its own money at this point is a pointless rebuttal. Of course it can always create more money. It can’t “run out of money”. But that doesn’t mean it is unconstrained by revenues because many hyperinflations have proven that a currency issuer is indeed constrained by how much revenue it can pull in. In other words, it is constrained by what Monetary Realism refers to as quantity value. Saying that the govt doesn’t have a funding constraint is a useless concept if it’s not put into context. If the govt can’t procure funds then its currency is useless. It doesn’t matter if they can print more. I think the system has been designed precisely for this reason. To ensure that the govt must be able to procure funds from the private sector because if it cannot then something has gone seriously wrong. Yes, in theory, we could release the govt of this constraint, but I think the constraint was implemented for a reason. To disperse money creation away from govt and ensure that govt is not immune to using money in much the same way that the rest of us are. MMT basically says “release the govt of these chains!”. I think we can understand that the govt can’t run out of money, but keep this in perspective at the same time so as to understand there this doesn’t just mean govt is unconstrained by the necessity to procure funds.
MR explains how the govt uses private sector inside money and procures funds. It explains that the govt is not immune from have to deal with the social construct WITH the private sector. It explains that the govt cannot run out of money, but is still constrained by its ability to procure funds from the private sector. There’s no need for the MMT myth that govt spending creates money (fiscal policy actually doesn’t create any money at all – it recycles existing money) or this nonsense about taxes destroying money. You can support deficit spending and job guarantees and budget deficits and eliminate all these concepts that don’t apply. That’s my thinking here. I am sorry to be critical of MMT. But I really do believe the “taxes destroy money” and “spending creates money” is factually wrong. It’s not necessary for understanding how the monetary system works.
Your arguments regarding the “social construct” and hyperinflations are interesting and worth pursuing, but not strictly relevant to the argument I presented, which is quite simple:
Money is a liability to the entity that issues it.
Commercial bank money is the liability of a commercial bank. When a bank issues/creates money, it issues a liability. The two are the same in this case.
When the bank’s liability (money) is returned (paid back) to the bank, the bank’s liability is extinguished (“destroyed”), and as such money is destroyed.
It’s the same with the US government. When the US government’s liability (money) is returned (paid back) to the government, the government’s liability is extinguished (“destroyed”), and as such money is destroyed.
When the US government spends, it issues/creates a liability (money).
when the bank hat liability is extinguished (“destroyed”) when the issuer gets it back, then when the government gets its own liabilities back, money is “destroyed”.
yeah you can probably ignore that weird bit at the end! (or delete it!)
Phil,
I think you’re obscuring the process. The govt does not just print its own money when it spends. Most of the money in our system is created by private banks and is then used by the govt. The T&L/reserves shenanigans doesn’t change what really happens which is the debiting of a private deposit (taxes) and the crediting of a private deposit (spending). This doesn’t destroy or create money. In fact, fiscal policy doesn’t create money at all. It redistributes money. The whole reserve system was created to facilitate the transfer of inside money more smoothly (for varying purposes). But it doesn’t change what happens which is the govt using inside money for public purpose.
On the hyperinflation ideas – if you agree that hyperinflation is often caused by a collapse in tax receipts (which it is) and the govt’s inability to raise funds then you must agree with my thinking that the govt is indeed very much constrained by its ability to procure funds. To me, this is an irrefutable point. History has borne it out time and time again.
I hope that helps clarify my thinking here.
Cullen
MR is a refreshing change of pace around here. I’ve been trying to explain to people for years that hyperinflation is a collapse in tax receipts and therefore constitutes the equivalent of a government not being able to obtain money from the private sector. The MMT idea of government not being revenue constrained is wrong and their idea that taxes destroy money is a terrible misrepresentation of what actually happens. I agree with you that MMT is way better than most mainstream econ, but it still has huge gaps in it.
“the system is designed in a manner so as to disperse the power of money creation away from the govt.”
“Money existed long before govts.”
Cullen,
Do you have any proof, and in the second case, concrete examples for these two assertions?
In the first case, I question whether “the system was designed” for the stated purpose. As I understand it, the funding constraint on the Treasury dates from the gold standard era, when it had the function of preventing an unsustainable drain on the US’s gold reserves.
Moreover, since Nixon took the country completely off the gold standard, few in Congress or even at the Fed or Treasury have manifested the clear understanding of the nature of a true fiat currency that MMT and MR share – which makes it hard to support that they had such clear purpose in mind in allowing the operating constraints to continue without modification for the new reality.
The second assertion may depend on one’s definition of ‘money’ but, again as I understand it, anthropological and historical evidence supports that anything with the characteristics of ‘currency’ – acting as a standardized unit of account and medium of exchange – has entailed deliberate institution by governments, and does not predate them. On the other hand, if, taking the basis of ‘money’ to be ‘faith/credit’, one traces its origin to a totally informal arrangement where if you do something for me, I feel obliged to reciprocate in some unspecified way and later time, it is hard to see where ‘money’ enters in to such transactions.
“The social construct is not merely a construct of the govt.”, the sentence following the first quote raises a broader point. In addition to money, government and the ‘private sector’ – including corporations and even small businesses – as well, are all ‘social constructs’.
This issue relates to another discussion that included comments by ‘Marx Reloaded’ (and to me, reveals a blind spot in Marxist thinking as well), but would require a lengthy discourse to fully explore.
For now, what I would say is that the distinction between ‘public’ and ‘private’ is not an absolute one, and of little use as a basis for any analysis approaching the level of scientific rigor. That and semantics (eg what ‘money’ means), in my view accountsfor much of what may appear to be irreconcilable differences that have arisen in recent discussions (which have, however, constituted a serious discourse on profoundly significant issues).
Hi Colin.
Forms of money are found in primitive animals. Money is primarily a social construct and medium of exchange. Forms of money have been found in primitive animals like monkeys. One monkey grooms another in exchange for sex. It’s an unspoken medium of exchange, but it’s an exchange. They might as well write a note to one another that says “this note is worth one grooming in exchange for sex”. It’s the same exact thing as a monetary exchange. All governments do is organize this social construct. They literally create the notes that say “this note is equal to __________”. So to me, money has evolved just like we have.
Regarding money and the separation of money creation from the govt – the entire Federal Reserve Act is based on this idea. The Federal Reserve system is designed to be separate from the govt and works through the private banking system. It might not be the perfect system, but it is the system we have. So the whole FR act is designed to keep the creation of money separate from the govt.
Hope that helps.
Cullen
In the ‘monkey’ example, I am still not seeing where ‘money’ comes in – even if there is a clear sense of ‘obligation’ to reciprocate grooming (and there are simpler explanations for mutual grooming behavior – such as that it is intrinsically pleasurable for both parties), that sense would be a totally intangible mental proclivity – how is that a ‘medium of exchange’ even between two monkeys, let alone transferable to a third party?
I also understand the general purpose of the Fed, but not clear on any specific connection of the FRA to the constraint that the Treasury must sell bonds to make up any fiscal deficit – especially once the USD became a true fiat currency.
If the government were to remove that ‘self imposed’ constraint (which both JKH and Brett Fiebiger have suggested, might be a reasonable measure to take), would that change your view of the relative significance of ‘inside’ vs ‘outside’ money (given that the Fed could continue to provide reserves to ‘backstop’ commercial bank lending/’inside money’)?
You’re thinking of money as a tangible thing (at least I think you are). We should just stick to thinking of money as a social construct (primarily) for exchange. Money doesn’t take a physical form in most cases any more. It’s now just numbers in computer systems that track promises or various tools that facilitate the use of these promises. In the monkey economy these promises are not organized. In the human economy they are organized by govts.
I didn’t say the Tsy MUST sell bonds. I said they must procure funds. The govt must also use private sector money. That’s how our system and all money is designed. Govt is not immune from the rules involving these obligations. We see this in the case of a hyperinflation where the public sector is no longer able to obtain the social construct through taxation. And the system collapses. Hyperinflation is an inability for the govt to procure funds (the tax system always collapses in a hyperinflation). Our system is designed to make the govt a user of the currency in some capacity. It does not matter if govt organized the currency under laws and rules. In the USA, private sector banks issue the money and the govt uses it. The govt could choose not to issue bonds, but it would still have to tax in order to be able to use the social construct. That’s just how it works. No one in a monetary society is immune from having to obtain the social construct to be able to make good on promises they claim they can make. Govt’s are a little different, but the equivalent of them not being able to make good on payments is hyperinflation. And they end up not being able to make good on payments (in what MR calls quantity value) by virtue of not being able to obtain money from the private sector.
Actually, I am thinking that ‘money’ ought to entail a symbolic aspect (one of the hallmarks of human intelligence – although trained apes have demonstrated a limited capacity). Even ones and zeros existing as electromagnetic patterns in a computer derive their meaning and utility as symbols for something else.
It also seems like even a measure such as combining the Treasury and Fed into a single entity would not alter your sense of the primacy of ‘inside money’ over ‘outside money’. My own sense is that they play different roles, and deciding which ‘comes first’ or is ‘primary’. may be more of a political than a substantive issue.
To me it’s rather simple. The way our system is designed the banks issue the overwhelming amount of the money that results in any sort of economic growth and the rest of us use it. Including the govt which really just recycles inside money through the economy and accommodates inside money through the issuance of notes, coins and reserves (outside money). So it is inside money, overwhelmingly, that matters to the economy. The entire existence of outside money is to facilitate the existence of inside money. Unless you created a state owned banking system I don’t see how this view could be changed. Only then would all money become state money and blur the distinction between inside and outside money to the point where it didn’t matter.
‘Outside money’ is deceptive. Trillions of dollars (all taxes, all govt debt purchases and all govt spending) “flow through” ‘outside money’ at some point, but it is managed in such a way (by the Fed, Treasury and commercial banks) that it appears to be quantitatively insignificant.
Also, the smallest single part on a pyramid is the capstone, don’t forget.
http://firstlegend.info/3rivers/capstone_edited.jpg
It doesn’t matter that it flows through outside money (rather, it matters less than you think). Once you understand how the monetary system works you know that outside money simply facilitates inside money. Cash allows a balance of inside money to be drawn down. Reserves allow inside money to be settled and influenced through govt policy in a more efficient manner. NFA supports the balance sheets made up of inside money. Outside money’s entire existence is a facilitating/supporting role. It is inside money that matters most here in all instances. And govt uses inside money regardless of the sideshow that occurs in reserve settlement. I know this view is highly problematic for MMT, but it is our reality in my view. The thing I don’t understand is that you seem to understand much of this but still support the “capstone view” no matter what. You can have your job guarantee, fisclist view and pro govt view with the MR understandings. So why support the mythical “taxes destroy money” view? MR explains how an autonomous currency issuer can’t run out of money, how govt is good for the monetary system, etc etc. But we’ve eliminated all these strange state money views and metaphorical myths that don’t help anyone understand how the monetary system actually works….
Taxes do “destroy money” as far as I can see, at least in the way that I tried to describe earlier. Obviously I haven’t convinced you of that yet.
You use the term “funds”, which for me is somewhat inaccurate.
I agree that the whole “outside money” construct plays an “accomodative” role in the day to day. But you’re focusing too much on relative quantitities and ignoring to overall structure. You’re looking at the base of the pyramid and assuming that it is superior because it is bigger than the top. But even then you’re not actually seeing the true scale of “outside money”, because it is managed in way that effectively disguises its significance.
If a bank pays $5 billion to the treasury and the treasury immediately spends it, from the outside it looks like nothing has happened to the quantity of “outside money”. This is precisely how the Treasury, Fed and commercial banks conduct their business in this domain.
You’re skewing the process though. The govt obtains inside money, an IOU in the private sector. This credits the govt account which then makes it possible to debit this account and credit someone else’s account. This all involves the redistribution of inside money regardless of the reserve settlement process. The result is always the same – debiting inside money to redistribute inside money. Like Mosler, you’re just claiming that all money is the same (no outside or inside money). As Mosler said, all money is inside money in MMT (which makes no sense to begin with). The reality is that banks issue money independent of the govt and all the rest of us use it (including the govt). The govt does not just credit its own accounts (even if you claim it could do this, it doesn’t actually do this). So no, taxes do not destroy money. Taxes allow the govt to redistribute money. That’s how our system is designed. Bank money is very different from outside money. When the govt cannot obtain private credits to its account it’s always consistent with hyperinflation or death of its currency. A govt that cannot tax to procure funds is dead. This has been borne out hundreds of times in history. The fact that the govt could just credit its own account is meaningless. The inability to procure funds is death.
Regarding outside money – again, you’re just skewing what really happens. All the action happens in inside money. All the pertinent economic activity occurs in inside money. The reserve system exists to smooth the interbank system. The interbank system is not the economy. It’s strange, in a weird way, you’re basically saying that the interbank market is more important than the actual economy. Of course, payments at the same bank do not even alter this market so that clearly proves your point wrong. It’s all facilitating infrastructure designed to smooth the payments system and make the banking system work as though it’s one cohesive unit.
Regarding pyramids – you can knock the top off a pyramid and it’s still an impressive structure. Leave just the capstone and you don’t have much of anything other than a cool looking rock. Much like the real economy – it’s the inside money and the transactions in inside money that matter most. Take those away and all you have left is some silly interbank market in outside money with nothing to facilitate.
not to mention that in “normal” times (when there isn’t a massive quantity of “excess” reserves), small changes in the size of the monetary base are enough to change interest rates across the whole economy.
Right, it’s a tool to influence the cost of inside money. The fact that you can control the cost of inside money by changing the balance of outside money does not mean outside money is somehow more important than inside money. After all, it is the inside money you’re trying to have the end effect on. Not the outside money. Obviously, the govt wants to influence the cost of inside money because that’s the money that matters. Outside money is just a tool to influence the cost of the money that really matters to the economy….Your point is like saying that you can alleviate a head ache by taking advil and that that means the advil matters more to your body than the blood it is thinning/impacting. Take the blood out and you’re dead. Leave the advil in and you have a dead guy with some advil in his veins.
I agree that taxes are essential. If the government is unable to collect an adequate level of taxes relative to its spending then inflation can occur, and if the government completely loses the ability to collect taxes then hyperinflation can result.
I’m not saying that all money is the same, nor am I trying to say that ‘inside money’ is unimportant.
Also, interbank settlement is important but it is primarily the need to transact with the government sector in ‘outside money’ which creates the basic demand for it.
When a tax is levied, it may in the first instance be paid in ‘inside money’, but at some point subsequent to that it has to be paid in full in ‘outside money’ (a debit to a bank’s reserve account). The government does not settle with banks in the way that banks settle amongst themselves. Full payment in ‘outside money’ has to reach the treasury’s accounts at the Fed, given that all treasury spending comes out of these accounts.
We’re just having a circular discussion now. You’re starting with the idea that money is in demand because of taxes. I would say money is in demand for reasons that go well beyond taxes though taxes and laws play a clear role. For instance, I would contend that people don’t much care what the medium of exchange is so long as it’s widely accepted, convenient and somewhat stable. I could care less if my money is denominated in Yen, RMB or USD really. The important point is that they’re all stable and give me access to the output I want. Output really drives money. Not taxes. If you can buy things using a medium of exchange that is relatively stable with a great deal of convenience then the idea that taxes drive money is secondary. People don’t use money so they can pay taxes. They use money so they can own output. The tax is of secondary importance here. One coordinated social construct makes all of this more convenient, but it doesn’t change the basic idea that output drives money.
Also, the whole TTL system was created to smooth the govt’s procurement of inside money. Inside money existed before outside money. All the govt did was create infrastructure around inside money to make its various uses more efficient. That is, we have a money system dominated by a private banking system and a govt that helps to facilitate its uses. The monetary system does not exist so govt can move resources as Wray says. The monetary system exists to help the private sector exchange goods and services. You have the entire order of importance backwards.
Phil,
Even if you were right it wouldn’t matter. The way the system is designed today the government must obtain money credits before it can debit its own account and credit a private bank account. If you want to claim this is “self imposed” then fine. But it doesn’t matter. The way the system is designed today the government uses bank money and must always obtain bank money before it can then spend. If it didn’t do this then the government would just spend the money without first obtaining the credits. Obviously, it doesn’t do that so the MMT description that taxes destroy money is wrong.
Right LVG. Although money is denominated in the unit of account designated by the govt there are two distinct money issuers in the current design. One is the banks and the other is the government. You could basically call the USA’s design a market based design. That is, the banks lead and the govt follows/facilitates. Misunderstanding the two forms of money will result in misunderstanding the money system.
At the risk of muddying the waters further, I think my reference to the ‘symbolic aspect’ of ‘money’ applies here. What is symbolized is real wealth, generated primarily by the productivity of the ‘private sector’ in a free market economy (cf the ‘goldbug’s’ desire to have ‘money’ embody wealth in and of itself). However, government plays the primary role in establishing, and maintaining the efficacy of, that symbolic connection.
Cullen, would it be possible for you to list at least ten words (based on level of importance) that should have relevance in any monetary discussion?
Example: Social Construct, Inside money, Out Side Money, Inflation, Floating Exchange. TAX…etc.. Reason is, It helps me to compartmentalize and valuate/ weight these concepts.
Thanks MR Roche for all your work..
Yes, I will make a glossary. Thanks.
I would think that by now the workings of the monetary system (MR) would be well enough understood by Congress and the executive branch that they would have put aside all their fear-mongering and finger pointing over the spurious federal debt and Social Security/Medicare insolvency crises. They are bound to be aware that US has no solvency constraint. So why do they continue to make it an election issue? Can they really be that dishonest – or that ill-informed? And doggone it, as much as I like Ron Paul’s other positions, why is it that he just doesn’t get it when it comes to national finance?
Jim,
This is not easy stuff to understand. Most economists and monetary theorists do not understand why the govt can’t run out of money. Or they are too dishonest to make the distinction between inflation and solvency which are two totally different things. Honestly, I don’t know why the rhetoric doesn’t change. I just keep concluding that most politicians just really don’t understand it.
Cullen
The politicos are saying what every banker wants people to hear. God forbid that somebody will understand where our fiat currency comes from. I’ve talked with two highly successful semi-retired brokers from big companies (now on their own in Maui), both were positive that bank loans were from deposits. I tried to explain that loans are created “ex nihilo” by the banks, and that loans actually create an asset that is often sold to others for cold hard cash. Of course these two were republicans that were so worried about the national debt I thought they were going to cry about the lack of a good future for their children. I think part of my problem explaining this stuff was that they don’t understand latin e.g. “ex nihilo” (see your MR write up page 5). Question, are you sure that there isn’t an english word that captures this process? The idea is so fantastic! There isn’t even a word for it in American english, or Hawaiian Pidgin!
The literal translation: ‘out of nothing’, seems clear enough. However, ‘out of thin air’ packs more of the same punch as the Latin.