“If You Can’t Explain it With Accounting, You Can’t Explain it.”

A big part of Monetary Realism is about explaining things through what I refer to as stylized facts.  And one way to hone in on stylized facts is by focusing on accounting.  We do a lot of that with MR.  Whether it’s the sectoral balances, S=I+(S-I), explaining banking concepts or trying to explain QE.

JKH rightly says “If you can’t explain it with accounting, you can’t explain it.”  And that brings me to a very important blog that a MR reader started earlier this year.  Tom Brown has provided the world with an invaluable resource for understanding money and banking.  He has gone through the accounting in excruciating detail to help better educate people about how banking actually works.  I don’t know of a much better resource on banking.

So, if you haven’t checked it out then go here and check it out.  It’s in the dropdown under education here permanently.  And remember, if someone tries to explain banking to you without the right accounting then tell them they’re not explaining it correctly.  And then point them to Tom Brown’s site so they get it right.

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Cullen Roche

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. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • Rafael

    Tom and Cullen have you guys seen this course yet?

    Economics of Money and Banking, Part One
    by Perry G Mehrling

    https://class.coursera.org/money-001/lecture/index

    Taking it now and it is excellent so far.

  • http://www.conventionalwisdumb.com Conventional Wisdumb

    Cullen,

    I’ll bite. Who is JKH?

    Thanks

  • http://orcamgroup.com Cullen Roche

    Former banker. Knows this stuff cold. Big contributor to MR though I don’t think he’d refer to himself as a “co-founder” (though he really is).

    http://monetaryrealism.com/author/jkh/

  • http://orcamgroup.com Cullen Roche

    I’ll look into it. Thanks!

  • http://www.conventionalwisdumb.com Conventional Wisdumb

    “and JKH (who can’t be named for professional reasons).”

    Very mysterious!

    :)

  • Suvy

    I’m taking the same class. It’s awesome. That stuff is so critical.

  • wh10

    Great find, thanks.

  • jt26

    Congrats Tom. BTW I will be waiting patiently for your accounting description of HPE!

  • http://brown-blog-5.blogspot.com Tom Brown

    Thanks! don’t hold your breath.

  • http://brown-blog-5.blogspot.com Tom Brown

    Wow!! Cullen, thanks for the plug! That’s quite an endorsement! I really appreciate it! Now you’ve really put the pressure on… shoot!

    Everyone, I want to point out that there very well may be errors in my blog. I’m not a professional accountant, banker, or financial person! I started the blog as a place to help teach myself and others what Cullen (and others… especially MR folks) are talking about all the time, especially in regard to banking and balance sheets! I find that looking at things from the perspective of the various balance sheets helps keep me honest and is a great way to visualize what’s happening. Please feel free to make comments or point out where I’ve gone wrong or make suggestions about future posts! I’ve benefits from many helpful comments already, and I’m updating the posts all the time.

    I also try to encapsulate the entire “macro” economy in many of the posts… which is why I include the Tsy and Fed, etc. Think of those as miniature macro worlds. Person x and Bank A can often be seen to be stand-ins for the entire non-bank private sector and commercial banking sectors respectively. Also, I mostly just keep track of financial assets on the balance sheets… which should result in all the consolidated assets and liabilities of all the entities in the example adding to the same number (if you ignore coins). Not all the posts “null-out” in that way though.

    BTW, the blog format was perhaps not the best choice, since the examples tend to follow a progression from simplest to more complex. Not perfectly true, but that’s the general idea. I’ve added links to the three simplest Examples (1, 2, and 3) on the right column at the top (so start there if you’re new to this), but otherwise you need to navigate from oldest to newest in the archive tree if you want to follow the progression. Unfortunately the posts at the very top are the most complex I’ve done (and are also the most likely to include errors!)

    I’m hoping I can get some good feedback from this anyway. :D

    … and I hope you find it useful! -Tom

  • http://orcamgroup.com Cullen Roche

    We’re all works in progress! Just look at me over the years. You’ve built a fantastic foundation that helps greatly. So bravo.

  • Frederick

    No one’s work in the field of finance and economics is flawless. But I am enjoying the development of MR which has really opened my eyes to the way things work. Here’s to hoping it catches on in the years ahead and encourages you all to remain active in helping others understand it.

  • JK

    I’m also taking the class :)

  • http://brown-blog-5.blogspot.com Tom Brown

    No I haven’t. I probably should get further education in all this, especially now that Cullen’s put the pressure on! :D

  • http://brown-blog-5.blogspot.com Tom Brown

    Everybody, I have a special page I keep as a reminder to myself for things I plan to do with the blog:

    http://brown-blog-5.blogspot.com/p/examples-explanations-to-do-list.html

    (you can get there from the nav bar at the top)

    That might be the most logical place to leave suggestions for future posts if you have any. Thanks.

  • http://orcamgroup.com Cullen Roche

    We’re all gonna have to pow wow on this. I am going through the videos tonight and tomorrow. Hope to report back. I hope you guys will provide feedback. Looks like good material so far. Perry’s a great lecturer.

  • Geoff

    A quick perusal reveals that he has some interesting views about money. He uses a hierarchy as opposed to the MR horizontal scale of moneyness. He also makes a clear distinction between money and credit, which I’m not sure would jibe with MR. However, there appears to be a lot there that would be in alignment with MR.

  • Geoff

    He also has a neat insight that the definition of “money” depends on one’s POV. For example, to the average person on the street, the main form of money is deposits (check!) whereas to banks, money is currency/reserves.

  • http://orcamgroup.com Cullen Roche

    The hierarchy could be a problem as it pertains to what money is. I think money should be defined by its utility as a medium of exchange and not by some govt centric hierarchy. Building a world view around govt money is misleading for reasons that are well documented in MR. It’s incredibly important to understand central bank powers and the fact that Tsy can tax and sell risk free securities, but I don’t know about building a world view around these things. I view those components as facilitating parts of the monetary system and not along some hierarchy.

    One could also debunk the hierarchy concept by pointing out that the govt money only has value because there is pvt output backing it. So that brings us back to the private sector again which is why I think you have to start with the private sector and build out from there when understanding money. The hierarchy tries to imply that money maintains value because of some govt specialness when I think the govt derives its powers by being backed by pvt output. Ie, in the aggregate, there’s nothing that really makes deposit money all that less special than govt money because once the pvt output is gone no money is valuable. In fact, in a hyperinflation, one of the few things that maintains its value is common stock of viable corporations so if one really wanted to debunk a hierarchy view they’d go to that extreme and point out that pvt money issued by corproations in the form of common stock actually outlives govt money in a hyperinflation. And pointing out individual bank fragility or even a crisis where many banks fail is a fallacy of composition.

    As for reserves as money, yes, I would agree. Deposit money is money for the avg joe and non-bank corporations while reserves are money for banks. That’s consistent with MR.

  • Geoff

    Yeah, I’m not sure if his govt centric hierarchy is going to work. He did talk about outside and inside money in the part I saw. We shall see if he brings it home with outside money as facilitator. I doubt it but shall “reserve” judgment until the end. :)

  • Rafael

    He uses the hierarchy in the context of a gold standard monetary system to begin his lectures as a way to provide a starting point.

    That said, in lecture three he starts describing a monetary system dominated by private money as deposits.

    In one lecture he makes the statement that neither the state centric nor the private centric money view have it quite right because it depends on the design of the monetary system being described.

    He also alludes to how the IS/LM model is not the best way of learning about money where his lectures are primarily done by going through balance sheet operations. I found this funny given JKH’s quote having to do with accounting.

  • LVG

    I just finished the 2-5 lecture. Here are some initial thoughts:

    1) I don’t like how he uses gold as the top of his hierarchy. Gold is just a commodity today. You can’t even use it as money.

    2) He doesn’t think credit is money.

    3) He says reserves are inside money, which they can’t be because they are a Fed liability even by his own definition.

    It seems like this Mehrling guy is close to getting a lot right, but not quite there.

  • brad voracek

    Taking the same class! Really interesting reading by Allen Young, and awesome lectures so far.

    Have you guys heard of this movie coming out about the Fed?

    http://www.bloomberg.com/video/a-new-documentary-takes-on-the-federal-reserve-uMxMx7i9THCUL9QZFu6acA.html

  • Rafael

    See his Week 1 discussion under Weekly updates.

    He is using the gold standard as a starting point, but admits it is not the state of the world today.

    Throughout the lectures plus in this Week 1 discussion video he states the all forms of money are forms of credit.

    His use of the language “inside” vs “outside” money a bit differently than how MR uses it. He uses the terms flexibly by taking into account different points of view and within the context of the monetary system being described. He deems reserves and bank deposits as forms of “inside” money when describing the gold standard. His definition of “outside” money is an asset that is no ones liability.

    More importantly the way he describes whose liabilities are whose and what that means in the context of the monetary system he is describing is far more fundamental.

    In one of his lectures he even describes the monetary system as it once was before the Fed existed as well as the state of the world where governments did not issue money at all and borrowed from the private sector (Civil War period).

    Therefore, I don’t think it would be correct to suggest that he is a proponent of the gold standard or suggests its like the world we live in today. As he states, you really need look at what the institutional arrangement is.

  • Rafael

    Also, in think about the flow of his lectures, I do think they need to be watched in order as they are a progression. After viewing one randomly, I can see why there is some confusion.

  • Suvy

    In our most recent set of lectures, he talks about the money system being a hybrid system between the private sector and the government. And yes, he’s an awesome lecturer.

    It’s interesting that you differentiate money for banks in the form of reserves vs money for non-banks in the form of deposits. I never thought about that; it’s a very interesting point of view.

  • Suvy

    I do think sectoral balances are important, but we can’t ignore the supply chain of an economy. We can ignore shifts in production costs, shifts in input costs, shifts in worldwide demand, and other things of that sort. The capital structure of an economy is just as important as looking at the sectoral balances to make sure everything makes sense. A simple would be the impact of a drop in worldwide industrial commodity prices and its impact to commodity exporters vs commodity importers.

    Understanding feedback loops is just as important, if not more important, than understanding the sectoral balances approach. These are complex systems with all sorts of very funky behavior. To think that everything can actually be boiled down to a few equations is just not the case, especially if you’re ignoring feedback loops and all sorts of other shocks.