A Critique of MMT, Modern Monetary Theory

The following is a critique of Modern Monetary Theory from the view of Monetary Realism.  

Modern Monetary Theory: A Critique from the Monetary Realism Perspective

MR, or Monetary Realism, is occasionally conflated with another heterodox economic school called “Modern Monetary Theory” or Chartalism.   Because of this it is helpful to make some distinctions clear.  This critique is not intended as an attack on MMT, but rather as an informative and constructive critique that will allow readers to better understand the monetary system for their own edification.  Although we find that MMT is incomplete, it is important to note that their description of the monetary system has been influential in forming MR’s understanding and is far superior to the neoclassical models.  So while this review is critical at times, it is important to note that we are critiquing what we view as one of the most complete and quality presentations of the monetary system that is presently available.

While there are some overlapping ideas and conclusions MR and MMT are dramatically different.  MMT is made up of three key components: Wynne Godley’s sectoral balances, GF Knapp’s State Theory of Money and Hyman Minsky’s Employer of Last Resort (the MMT Job Guarantee).   MMT advocates combine these ideas to create one of the most dynamic and well-rounded schools of thought in economics.  Monetary Realism rejects two of these core tenets (in addition to others), specifically the State Theory of Money and the Job Guarantee.  While MR supports much of Wynne Godley’s work we do not believe the idea that the state theory of money accurately describes the market based money system in the USA (in fact, the monetary system of the USA is almost entirely PRIVATIZED by private competitive banks – see section 5 for details).  Nor do we embed specific policy such as the Job Guarantee in our work as we view this as a distraction to better understanding and a conflict of interest in trying to create a purely descriptive approach to the monetary system.  While we do not fault MMT for providing solutions, it is detrimental and confusing to their theory that they describe MMT as being primarily descriptive.

To understand why MMT does not currently apply to the modern monetary system in the USA it is best to understand how they design a government centric view of the money system in much the same way that all other neoclassical economists do.  In this paper, I will show how MMT designs a reserve centric or state centric view of the money system when the reality is that we have an almost purely endogenous or private bank controlled money system.  In doing so, I will reinforce three key facts about the way our system is designed and exists:

• Resources precede taxation – resources must exist, as a simple point of logic, exist before they can ever be taxed and used in the public domain.   
• Inside money precedes outside money – in  a modern money system bank money is created before outside money is created.  That is, inside money is created via the loan process and outside money like cash and reserves facilitate the use of inside money.  
• The private sector precedes the public sector – the organized institution known as “government” or the “public sector” must be preceded by a private sector who organizes and forms the public sector.  This specific design includes legal constraints and institutional constraints that disperse power away from the government and into the hands of the private sector.
  

“a currency-issuer government under flexible exchange rates sits at the top of the hierarchy” – Scott Fullwiler stating that reserves and government money sit atop the hierarchy and are central to the money system.  This is false as reserves facilitate the use of bank money and do not sit atop a hierarchy of money.

“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.” – Randall Wray stating that the entire purpose of the money system is for public purpose (ie, govt spending).  This is false as a money system exists primarily so the private sector can transact in the means of private purpose.  Public purpose is a secondary feature to the majority of transactions that occur on a daily basis in the private sector.

“MMT begins with the government” – Warren Mosler telling us who matters most in the money system according to MMT.  The money system, being a private purpose serving system, should always begin by understanding the private sector’s importance in this system.  Starting with the government is a mistake most neoclassical economists make by building models around bank reserves, the money multiplier or other government centric models.  MMT makes the exact same mistake.

“Under the metallist vision, the state takes a back seat to the market. The chartalist theory, however, places the state on center stage”. Kelton clearly stating that the state is the center of MMT.

In the following sections I will describe how this state centered view of the world is wrong and why MMT does not actually apply to the US system.

1.  Description and Prescription

MMT is often described as having descriptive and prescriptive components, but as a whole MMT is one tightly knit comprehensive macro theory which is “inherently progressive”.  It is an all encompassing theoretical view of the world that offers answers to the macro issues of full employment and price stability.  I’ve asked MMTers on many occasions to clarify this point on descriptive vs prescriptive, but the answers are generally vague and often contradictory.

Although MMT certainly has powerful descriptive pieces, without the prescriptive policy approaches such as the MMT Job Guarantee you are simply not describing the world as MMTers envision it because you are no longer offering the comprehensive macro answers that MMT is specifically designed to provide.  Pavlina Tcherneva made this very clear recently:

“Though clearly there is an aspect of MMT that is purely descriptive, I have always considered this division between the descriptive and prescriptive part of MMT to be a fundamentally flawed dichotomy.”

Bill Mitchel has made similar comments in this regard:

“The reality is that the JG is a central aspect of MMT because it is much more than a job creation program. It is an essential aspect of the MMT framework for full employment and price stability.”

There is simply no such thing as being an MMTer without also including the prescriptive component of the theoretical framework.  After all, it is a “theory” of modern money providing solutions to full employment and price stability.  Removing the prescriptive component or the “theory” (how can you remove the “theory” in Modern Monetary THEORY?) leaves you with a basic post-Keynesian framework and not an all encompassing macro theory providing full employment and price stability.  In this regard, MMT is largely prescriptive and progressive as opposed to being purely descriptive as many MMTers often claim.

That said, I do not believe you need to fully understand MMT in order to understand how a modern fiat monetary system with an autonomous currency issuer operates.   MMT can be extremely helpful in aiding one in this process of understanding, but is not necessary in achieving this.   In fact, as described below, MMT might mislead in some aspects of the operational realities of our monetary system.

MMT offers some superb insights into some of the actual workings of the modern monetary system (certainly better than neoclassical models), but given its ”inherently progressive” nature MMT actually requires dramatic changes to the system to be applicable in its entirety.  This is one of many internal inconsistencies that render the foundation of MMT flawed.  They claim that the theory “describes operational realities” (status quo), but that the theory itself is “inherently progressive”.  Clearly, that’s internally inconsistent since you can’t be “describing” status quo (what is) while needing a progressive overhaul for the theory to be entirely applicable.  For instance, in order for MMT’s operational views to become consistent with the institutional framework the Fed and Treasury would need to be combined and the US government would need to halt many of the policies that impose real funding constraints on the Treasury.  MMT often claims that the current constrains are “self imposed”, but these constraints make for a very different world than the one that MMT often envisions.

Further, it’s important to understand that money is not simply endogenous (created inside the private sector) by choice.  Money is inherently endogenous.  Of course, resources must precede taxation and government exists as a mere construct of the private sector.  It can be no other way.  But MMT discusses the monetary system as though the system exists entirely for public purpose (they in fact explicitly state as much).   In discussing their government centric model of the system MMT will often emphasize how government has been “set free” by relinquishing the gold standard in 1971.  But this couldn’t be further from the truth.  There is very little that’s significant about the gold standard since it was just one more self imposed constraint.  Today, we require the government to be a user of bank money through the issuance of bonds and the inability to directly issue money via the Treasury.  This is entirely in keeping with a market based money system and a capitalist economy, but MMT acts as though the world was transformed into some form of exogenous money system in 1971. MMT tries to have it both ways by claiming to be an endogenous money school while also claiming that bank reserves or exogenous money sits atop their hierarchy.  This is not only contradictory, but it is a misrepresentation of the actual monetary system’s design.

Ironically, MMT falls into the same trap here that neoclassicals do by referring to a set of institutional structures as though they have already been changed to adhere to their views even though they clearly have not.  Ironically, post Keynesian Joan Robinson once criticized neoclassicals for this, saying:

[neoclassicals often view the world] “where somehow the future has already happened” (Robinson 1979: xiii)

MMT should clean up this language of “descriptive” and “prescriptive” and describe MMT for what it is – an inherently progressive policy approach that describes a potential policy solution to many of our economic problems.  Instead, they make the mistake Robinson described of describing a “future that has already happened”.

Now, this doesn’t mean MMT makes no important contributions or that the descriptive components are totally void of value.  Quite the contrary.  There are many lessons from the MMT framework that should be more widely embraced.  For instance, an autonomous currency issuer cannot “run out of money” that it can always procure.  Banks are not reserve constrained. Deficit spending is not inherently bad.  These might appear like opinions or concepts that are unique to MMT.   They are simple realities that become obvious once one understands how a modern autonomous fiat currency issuer operates.   MMT expands on these understandings (at times in exaggeration) in order to offer policy prescriptions to fulfill macroeconomic ideas of full employment and price stability.   And in doing so MMT often blurs the lines between our operational reality and their progressive view of the world.  MR does no such thing and instead fully separates the descriptive and prescriptive in order to offer the reader an understanding of the modern monetary system from which THEY can then offer policy ideas.

It’s easy to confuse the operational realities with the meat of MMT (which is the policy agenda). Many who first confront MMT do not fully understand how the state theory, money monopolist and policy prescriptions are all intertwined to form what is known as MMT.  So it should be made abundantly clear that by removing some or all of these elements you are no longer working under the theory known as MMT since you are not providing the comprehensive academic answers to full employment and price stability.    For instance, many famous economists understand that a government that issues debt in a currency it can print can’t default (Alan Greenspan has been saying this for decades), but that doesn’t mean they are all MMTers.  It just means they understand some of the basic operational realities of autonomous fiat currency issuers.   MMTers often act as though some of their conclusions (such as the idea that a government with a printing press can’t run out of money) is unique to their view of the world and undiscovered by the rest of the economics profession.  But the reality is that much of MMT is just rehashed ideas that have been well known for a long time.

What’s unique to MMT is the way they package these ideas to form conclusions about the way we should use the monetary system.  It is the policy agenda that makes MMT a “theory” – it is a set of policy proposals embedded in a macro understanding that all come together to form a comprehensive macro answer to full employment and price stability.   MMTers fail to differentiate clearly between the two and often even create an alternate reality (such as the myth of the money monopolist or the myth that banks serve public purpose) in order to validate the policy agenda.   Like facets of Austrian economics with Crusoe Island, MMT at times blurs the world they want with the world we have.

MR eliminates the policy agenda and focuses instead on the actual system we have in front of us and not the system MMT hopes to create through their admittedly progressive political agenda.   MR also hopes to provide the reader with a broader and more realistic understanding of the monetary system and while we might offer personal opinions on policy we hope to eliminate policy from MR as best we can – or at least separate it from the operational understandings as best we can.  For this reason you’ll never find that an MRist insists that certain policies represent MR.  MR is simply an understanding of the system.  Nothing more.  What we discuss, debate and opine on here regarding policy is purely based on this understanding.

The bottom line is (as you’ll see more clearly below), MMT is an “inherently progressive” theory of the monetary system that requires dramatic overhauls (combining Fed and Treasury, eliminating bond sales, making fiscal policy the primary policy lever, creating a national Job Guarantee, etc) to be a completely accurate description of the actual monetary system we have.  The current monetary construct has very real constraints that make many of MMT’s points void in relation to describing how the current system works.  This explains their recent adoption of two conflicting explanations (the “general” and “specific” cases) of the monetary system.  As Robinson stated (and I alter) [Modern Monetary Theorists often view the world] “where somehow the future has already happened”.  This progressive policy agenda might very well be the best policy prescription for the US monetary system (I am not certain that it is), but it should not be described as a pure description of the current monetary construct.  If MMT is to remain consistent on its “description” it should make it abundantly clear that in order for the theory to be entirely applicable the system must be largely changed.  In this regard MMT is descriptive AND prescriptive.  But it is not merely descriptive of a system we have.  It is descriptive of a system that MMT wants us to have.

2.  MMT Misunderstands Money, Leading to Incorrect Conclusions

In the MMT world, money is chartal money or state money.   In his book, Understanding Modern Money, Wray elaborates:

“Chartal, or modern money is 4000 years old, and it is our proposition that the analysis contained in this book is not merely a special case….but rather it can be applied much more generally to the entire era of chartal, or state money. Instead of trying to locate the origins of money in a supposed primitive market originally based on barter, we find the origins in the rise of the early palace market community, which was able to enforce tax obligation on its subjects.”

To MMT, “modern money” began with the state and the enforcement of obligations.   One cannot understand “modern money” without also understanding how money came to take a “modern” form.  MMT simply ignores the fact that the origin of money was established in human society well before governments.  Because money is a “creature of the state” in MMT the state always plays the most central role in MMT.  But money is merely a social tool and misunderstanding the origin of this tool misunderstands its purpose and proposed uses.  The reality is that money has always existed in some form in human societies.  The organization and structuring of money into fiat through state organizations did not change the essence or nature of money.  It merely changed the way the tool is organized and structured.  But it did not change the fact that money is a social construct and that governments are merely one element of society.   In MMT, one might conclude that money being a creature of the state means that the government is of central importance to our potential prosperity.  And while government has come to play an important role it is even more important to maintain some balance in these understandings.  MMT takes an extremist position in an attempt to bring the state to center stage.

You’ll often find that MMT focuses very little on private sector growth, innovation and the role of production.  This is because MMT begins with the state (the state theory) and ends with the state (the Job Guarantee is MMT’s endgame).  Hence, it’s not surprising that most of the political ideas in MMT are state centered and seek to emphasize the power of the government.  Wray even explicitly states that the purpose of the monetary system is to move resources into the public sphere:

“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. “

Warren Mosler, the founder of MMT, says:

“MMT begins with the government”

These two sentences by Mosler and Wray summarizes MMT succinctly.  MMTers believe the monetary system exists primarily for public purpose.  It’s true that public purpose is an important piece of our economy and prosperity as a whole, but this is an extremist view that conflates the true reason for the state’s existence and the evolution of money into fiat money.   A monetary system exists primarily for private purpose.  Public purpose is entirely secondary here.  The sheer number of private versus public transactions within the monetary system makes this abundantly clear.   The monetary system exists so that private producers and consumers can transact business.  The fact that we also use the monetary system for public purpose is completely secondary to this primary purpose.

MMT would likely respond to this criticism saying that I’ve misconstrued Wray’s point and that currency is created to establish national sovereignty, which is what Wray really meant.  But this point is obviously wrong also.  A brief historical review proves this.

In the USA The Coinage Act of 1792 established the dollar under sovereign federal control. There were many forms of money used in the colonies before this. The various colonies issued their own forms of paper currency to more easily facilitate exchange (not to establish sovereignty). Also widely distributed were coins. Primarily foreign coins. In fact, the dollar is called a dollar and not a pound because of the wide distribution of spanish dollars in the colonies. The Coinage Act was established after the first central bank of the USA was established in 1791. Of course, the USA became independent in 1776 so the argument about sovereignty is obviously wrong. Hamilton argued for a national bank and a single currency because of the inefficiencies. Not because of a lack of sovereignty. Creating a single currency under control of the govt created efficiencies (one of which was procuring funds from the public) that made money more efficient.

I’d also add that the Euro is a good example that also proves the sovereignty argument wrong. The Euro obviously reduces sovereignty. That’s why MMTers dislike the Euro. But it increases exchange efficiencies and that’s been the primary reason for its creation.  The USA did much the same thing.  They created a national central bank, Treasury and one currency for increased efficiency of exchange.  Not to establish sovereignty.

Government is a tool created by societies to further public purpose.  The monetary system is an organized institution largely regulated and overseen by government.  But government is not the engine of economic prosperity (though it can help) or the purpose of the monetary system.  Government is merely one of many tools we create to help further prosperity within this system.  Government, however, is not synonymous with prosperity nor should we believe that just because the monetary system is largely a creature of law, that this means the monetary system exists for the sole purpose of moving resources from the private to public sphere.  To do so ignores the fact that prosperity and increases in living standards are primarily the result of private sector innovation, ingenuity and production – not government policy (which serve as a facilitator).

In understanding these points it’s important to note that monetary systems (of some sort) have existed long before government’s existed.  But in the MMT world monetary time started 4,000 years ago when the state began to formally organize money as an institution.  This ignores the history of money and the very essence of money as a social construct that exists not only to move resources to the public sphere, but as a social construct serving much more than some government institution.  Further, it’s important to understand that outside money (government money) was created to facilitate the use of inside money (bank money).  We know this because inside money existed long before outside money.  Outside money came into creation in large part to help stabilize inside money (such as the Federal Reserve System) or help move inside money into the public sphere (such as the creation of the Treasury Tax and Loan program).

As I will elaborate below, money (and monetary systems of various sorts) has existed long before governments.  The fact that it has become an organized institution with government oversight does not mean that the purpose of money or the monetary system is only to organize mobilization of resources from the private sphere to the public sphere.  That might be a partial reason for its existence, but it is certainly not the only one or even the most important one.   As you’ll consistently find, MMT is very unbalanced when it comes to this view and always brings everything back to the power of the state over the people.

The state exists not as an entity that can or should impose its will and powers on the people.  It exists as an entity by the people and for the people.  It is not an exogenous entity whose powers should always be taken to an extreme just because it might have the capability of achieving certain things.  The fact that government’s CAN do something does not always mean it SHOULD.  But MMT often takes these views to an extreme when it’s convenient to their policy agenda saying the government CAN therefore it SHOULD.  This position has also been criticized by post-Keynesian Perry Mehrling:

“Wray recounts some of this history (pp. 61-69, 98-102) but misses its significance. The significant point is that our government is our creation. It is only able to tax us to the extent that we allow it to do so. Its taxing authority arises not from its raw power but from its legitimate authority. Further, our state arises out of a thriving private civil society, not the reverse, as the colonial parable would have it. Our state is not a king demanding bounty, and consequently the argument that the power to tax is the source of money’s value does not seem very compelling.”

This conflated MMT view can be seen in their many conflicting statements on the subject.  Some MMTers say the theory is “inherently progressive”, but others try to claim it has nothing to do with politics.   Fullwiler says that MMT is not a theory of the state entering the realm of politics:

“It’s a state theory of money, not a theory of the state (that would be the realm of politics and political theory, by the way).”

But MMT is based on the “state theory of money”.  As Wray makes very clear (contradicting Fullwiler), MMT is “inherently progressive”.  In fact, as you’ll see below, MMT is theoretical entirely because it is a set of policy proposals based ENTIRELY around the realm of politics, political theory and their inherently progressive agenda.  The very fact that some MMTers think they have differentiated between normative and positive economics (descriptive and prescriptive) is a clear sign that MMTers don’t even agree that their work is a theory with origins in a theory of the state while also being “inherently progressive”.

More recently, MMTers have started using two conflicting descriptions of monetary operations.  They now use a “general case” and a “specific” case to explain why the government “spends first” in their general case and actually procures funds first in the specific case.  This is an evolution in MMT ideas that obscures and hides the fact that MMT’s long-held positions on “operational realities” are in fact shifting, misleading and largely designed around one policy agenda.  Fullwiler says:

“[Modern money theorists understand that there are legal constraints on the Treasury]—the key is to understand what “deficits or Fed lending logically precede tax payments and bond sales” does and does not mean. That is, when MMT’ers say the latter, they are effectively saying “deficits or Fed loans logically precede taxation and bond sales as an operational reality of the monetary system” (the general case), and this and the statement “the Treasury must have positive balances in its account prior to spending under current law” (the specific case) are in fact not mutually exclusive. Both can be and are true—the government can and does require itself through its own self-imposed constraint to obtain credits to its own account at the Fed that were created via previous deficits or Fed lending before it spends again.”

It’s completely incoherent and illogical to argue that the two views are “not mutually exclusive”.  One is a description of our reality (the way things actually are) while the other is a description of an alternate reality (the MMT government self funding view).  It is like arguing that the US government has the power to drop nuclear bombs on every country in the world (the general case), but is constrained by international self-imposed laws (the specific case).  Of course there is a reason why the specific case exists and while the “general” case might be an operational option, the specific case exists for specific real rational reasons.  The “general case” by no means makes the “specific case” void.

To be more specific, in the actual specific case in the USA the government’s money creation abilities are dispersed away from the government to the private banking system into private hands because the system was designed in such a manner so as to disperse money creation powers out of the hands of government and into the hands of the private sector.  MMT would state that the government has a natural monopoly on money because it establishes what money is and who can distribute it.  This might be true, but it does not change the fact that the US government has legislated its monopoly away to private banks.  Any monetary presentation which misconstrues the fact that banks dominate the money system as it is presently designed is woefully lacking in accuracy and relevance.

Furthermore, it’s helpful to understand why the specific case even exists.  Why isn’t the government the distributor of all money as the general case posits?  One of the primary reasons why the “specific case” exists is because the USA is built around a market system where money is controlled by the private sector and not an authoritarian government monopolist.  Saying that the “specific case” is consistent with the “general case” is completely incoherent.  Like saying that murder is illegal, but is consistent with the view that that murder is a legal construct “self imposed” by the government and therefore doesn’t apply to government in some “general case”.  That’s a vast misrepresentation of our reality.

Additionally, this design mechanism (or self imposed constraint as MMT describes it) is embedded to emphasize the fact that the government “deals” in the social construct that the people allow to exist. To argue that the government does not procure funds to spend is a semantic debate because the government must always procure funds to ensure that the private sector allows the government to deal in the social construct (money) of the people (government of course being a construct of the people inherently making money a creature of the people and not just the state as MMT says).   The government does not impose its will on the people through their powers (as you’ll see below, taxes don’t “drive” money).  The people allow the government and the government’s money to exist.  This “general” and “specific” case only confuse the way the system actually works and conflates operational realities in what appears like an attempt to explain away the fact that MMT does not explain the actual workings of our monetary system and instead explains some alternate reality.

Another conflated aspect here is with regards to the idea of “money” itself.  MMTers will avoid use of the term “money” as best they can because they don’t really have a clear definition of money at all (though they claim to be experts at defining precisely what it is).  This becomes particularly confusing when they include government bonds as net financial assets to be the same thing as reserves or deposits.  In an effort to show that the US government is already a self financing entity (which it is most certainly not) they will blur the line between issuing bonds and issuing straight bank deposits as a self funding entity in their counterfactuals.  But banks deposits and bonds serve totally different purposes under the current design.  One is the “real” money while the other is a claim on the “real” money.  Like all securities issued by public or private entities, bonds are merely a claim on a cash flow generated by the underlying entity.  But MMT distorts this reality to claim that government bonds are somehow the same as deposits or cash.  This is just one of the many ways MMT distorts definitions to make their alternate reality somehow closely resemble our actual reality.

Lastly, this shows that MMT has no sense of balance in this relationship between government and the people despite claiming to “understand modern money”.  Of course, if one views the history of money as being just 4,000 years old (as MMT does) then it’s understandable how one might come to believe that money is nothing more than a “creature of the state”.  But the reality is that the essence and history of money goes much deeper than governments, legal mandates and taxes.  Money, as a social construct, has always existed in social creatures.  It’s widely acknowledged that various primitive apes utilize money in their social interactions exchanging various things in advancement of the group’s well-being.  Government is simply one organized tool that represents the evolution of money.  But money did not originate with the state.  It merely evolved and became institutionalized with the state.  But the state did not alter its essence or role in society.  Government’s merely streamlined the process by which this tool can help society achieve its goals (and at times have even impeded on this process).

One of the more bizarre contradictions in MMT is Warren Mosler’s thinking behind the outstanding stock of private sector financial assets.  Mosler calls these investment vehicles a “demand leakage”.  He says:

“The massive pools of funds (created by this deadly innocent fraud #6, that savings are needed for investment) also need to be managed for the further purpose of compounding the monetary savings for the beneficiaries of the future. The problem is that, in addition to requiring higher federal deficits, the trillions of dollars compounding in these funds are the support base of the dreaded financial sector. They employ thousands of pension fund managers whipping around vast sums of dollars, which are largely subject to government regulation. For the most part, that means investing in publicly-traded stocks, rated bonds and some diversification to other strategies such as hedge funds and passive commodity strategies. And, feeding on these “bloated whales,” are the inevitable sharks – the thousands of financial professionals in the brokerage, banking and financial management industries who owe their existence to this 6th deadly innocent fraud.”

This is odd for many reasons.  First of all, Mosler accumulated his wealth running a hedge fund and acting as one of the “sharks” who fed off this system.  So it’s a strangely hypocritical position for him to take.  But more alarming is the basic misunderstanding behind this concept.  Mosler is essentially falling for the “cash on the sidelines” myth.  Anyone who understands financial markets knows that all securities issued must be held by someone.  The issuer cannot just issue new securities unless there is demand for those securities.  In a primary market this issuance helps to fund investment.  But the sense that Mosler discusses has to do with secondary markets where securities are merely exchanged by various buyers and sellers on exchanges.  These are not demand leakages because they are money that has “already been put to work”.  The savers have accumulated income in excess of their desired spending and have willingly decided to allocate those funds to some vehicle that generates a return.  Mosler’s comments imply not only that saving is bad, but that there would be less saving if there were fewer outstanding vehicles in which to invest.  That is entirely false as these securities would not even have been issued were there no demand for them in the first place!

This is also contradictory in the way MMT presents government deficits.  MMT often uses the sectoral balances to show how the government’s deficit is the non-government’s savings.  Of course, the deficit is funded via t-bonds which are securities which must always be held by someone at some point.  But MMT does not present these securities as a “demand leakage”, but instead as some sort of net benefit to the private sector.  They’re correct that these securities are a net benefit to the private sector, but so too is the stock of private financial assets.  A corporation that issues stock provides a vehicle through which it can raise funds for investment while also providing the buyers a vehicle through which they can save.  To portray this as though it’s some sort of net drag on the private sector while only government securities are a net benefit is not only a misinterpretation of some basic transactional functions of financial markets, but also egregiously misleading with regards to how various securities benefit us all.

3.  MR disagrees with MMT’s stance on inflation

Because MMT focuses primarily on vertical money creation (government spending and taxation in the creation of the cumulative deficit) they believe any inflation issue can be controlled directly through the fiscal channels.  MMT also advocates a permanent 0% Fed Funds Rate which would essentially eliminate the Federal Reserve as an inflation fighting tool.  Lastly, MMT believes their Job Guarantee (a large scale government employment program) can serve as a “price anchor”.  MR finds these positions extreme and inflexible.  Although we sympathize with the idea that fiscal policy can be enormously powerful and monetary policy has a tendency to be a blunt instrument, we take a more balanced view on both approaches with the idea that it’s better to have and not need than to need and not have.

Since MMT views money as a “simple public monopoly” they say that the price of money can always be controlled by the government.  Mosler says:

“the price level is necessarily a function of prices paid by the government of issue when it spends, and/or collateral demanded when it lends.”

This flawed view is due to the fact that MMT views all money as being issued by the state or merely an extension of state powers.  So they incorrectly refer to the state as the money monopolist even though the state actually issues very little money in our current system and banks do almost all of the money issuing.  This government centric view of the world leads them to believe the government can and should control the price level even though the money supply is almost entirely controlled by the banking system.

Fiscal policy is notoriously slow to enact and relying on Congressman to control inflation through changes in the tax code is an unrealistic policy response without a fixed policy tool (something MR is in favor of).  We do not agree that monetary policy is as ineffective as MMT believes.  MMTers will often claim that interest rates have no discernible impact on the economy.  This is a bold comment considering the fact that research proves that 9 of the last 10 recessions in the USA have been preceded by an inverted yield curve.  Surely, the cost of inside money (the primary form of money in the economy) plays a crucial role in the economy.

Additionally, the Federal Reserve can have an enormous impact on the economy because it sets the cost of lending which influences the money supply provided by banks.  MMT downplays this impact because they view all money as coming from the state and not just the banks.  MR views the Fed as an entity that exists to support private banking and its existence of not nearly as inept or pointless as MMT often argues.  The Fed was designed to facilitate private banking, but in a world where you view the issuer of money as the government (and not the banks) one can easily see how the Fed might not work into that model.

As previously discussed, the MMT Job Guarantee’s inflation fighting powers are substantially overstated by MMT.  The Job Guarantee is not a price anchor.  It is a price buoy (that is, it would not put a ceiling on prices, but would cap the bottom wage rates and allow other prices/wages to float up).

MR also finds that MMT is very weak on understanding what it calls the true constraint for a sovereign currency issuer.  What is the level of inflation that becomes problematic?  How is a government supposed to manage spending in a manner that doesn’t deteriorate living standards?   How can a government spending/taxing platform be managed in a similar fashion to understanding a solvency constraint?  Can the MMT platform actually be implemented and managed at the government level with resulting in massive waste?  These are all questions and concerns that have not been modeled or designed in the MMT literature.  They are quick to dismiss the neoclassical solvency constraint, but have yet to develop their own literature describing the constraint they consistently claim is most pertinent.  How can MMT base the government budget constraint on inflation without having a sophisticated and complex model for inflation?  One would presume, after 20 years of publishing academic literature, that this would have been accomplished yet it has not.  It is a glaring hole in the theoretical framework.

More importantly, however, MMT often states that a sovereign government has no solvency constraint and is not revenue constrained.  This is true in the sense that the government has a printing press, but that’s hardly a controversial understanding.  What’s not underst00d and articulated in the MMT literature is why the government’s printing press has any power to begin with.  A government ultimately derives its taxing powers from the strength of the private sector.  After all, if there are no private sector resources to tax then the government cannot obtain the tax revenues.  Of course, the government’s central bank could simply fund the government.  The government can always print its own money to spend.  But it’s not the printing press that will save the day, but the real economy’s output.  Government can play a positive role in helping generate output, but it could also play a negative role in generating output.  And that’s the real solvency issue regarding government spending.  A government who pays all of its citizens to sit on their couches all day doing nothing will inevitably bankrupt its own private sector in the sense that they will spend while output will stagnate.  So it’s not about understanding that a government has a printing press, but understanding how government can both positively and negatively impact the private sector through the use of its printing press.  A government in a democratic nation does not derive its power from its ability to enforce power, but from the people who give it that power in the first place.  MMT often gets this relationship backwards acting as though the government printing press is more powerful than the private production line.

MMT is also very weak on understanding hyperinflation.  If hyperinflation is the modern equivalent of insolvency for a fiat currency issuer then this issue should be extremely well understood and modeled in a manner that thoroughly explains this constraint.  But there is very little research and material documenting the causes and cases of hyperinflation in modern fiat currencies.  Aside from a few blog posts, the literature here is underwhelming, incomplete and often times misleading.

MMT also states that inflation is only a problem at full employment when the output gap has been minimized.  But this is not historically consistent.  There have been plenty of cases of hyperinflation where the output gap widened and the economy operated at less than full employment resulting in inflation.  This is because the MMT model uses a flawed assumption revolving around the output gap.  MMTers just assume that growth will continue at a trend rate so any output gap can be “filled” by having the government fill it.  But history has shown that declines in output are often due to a structural change in the economy or a reduction in the quality of overall output.  This supply side problem cannot merely be “filled in” with government spending.  In fact, history shows that when government’s counteract this problem it often leads to the high inflation as structural supply has declined and any increased demand causes inflation.  History shows that many inflations and hyperinflations occur outside of full employment with an output gap so the general vagueness of the MMT “true constraint” is a major weakness in the theory.

All in all, MR takes a more balanced approach and agrees with MMT that fiscal policy can serve as an inflation fighting tool, but we disagree with MMT on its effectiveness alone in fighting inflation.  We take a more flexible approach regarding monetary policy and believe we can work with monetarists on a more balanced approach to maintaining price stability.  Because fiscal policy can be slow to enact and even slower to take effect, we believe it is prudent to keep all tools at our disposal and not discount the potential positive effects given the dynamic and changing economic environment.

4.  Current accounts are not a concern?

We believe MMT downplays the negative impacts of running large, persistent current account deficits and the global imbalances (or in MMT “what imbalances“) and the demand leakages that result.  We also believe MMT exaggerates their view that all nations have the option to remain sovereign in their own currency.  Monetary Realism doesn’t always view large current account deficits as sustainable as they require ever larger global imbalances, larger budget deficits and potentially result in a reduced standard of living.

The first point of importance here is that not all nations have the option to remain sovereign in their own currency due to risk of sub-standard growth.  For instance, many nations that lack resource wealth or sufficient domestic demand have few options on the foreign trade front.  A nation without resource access is essentially forced into purchasing foreign resources which might require the accumulation of foreign denominated debts.  Or a nation without insufficient domestic demand might find that an export strategy is their only viable economy option and could find that a currency peg is their only choice to sustain competitiveness.  The options in such scenarios are essentially – eliminate sovereignty and accept the potential risks or suffer a lower living standard.

These sorts of sweeping MMT statements, that nations should remain sovereign no matter what, are not always realistic.  The world is not so simple and not all nations are in the position to remain sovereign although MMT generally points to very strong developed nations like the USA to present their examples.  This is merely one form of exorbitant privilege that misrepresents reality.  A simple example is the current regime in China.  China has long been an export driven economy with weak domestic demand.  And they have run a currency peg in order to optimize what they believe is in the best interest of their nation – maintaining a favorable RMB/USD exchange rate.  Now, in the MMT world China is not really sovereign because they are running an economic strategy that requires them to obtain USD’s.  But the alternative situation is for China to allow the RMB to rise in value against the USD and hurt their domestic economy before they are in a position to generate strong domestic growth from domestic demand.  So China chooses to reduce their sovereignty by running a currency peg because they believe it is in the best interest of their nation to do so.  As you can see, the world is not so simple as the one MMT describes when they say:

“What is important for our analysis, however, is that on a floating exchange rate, a government does not need to fear that it will run out of foreign currency reserves (or gold reserves) for the simple reason that it does not convert its domestic currency to foreign currency at a fixed exchange rate. Indeed, the government does not have to promise to make any conversions at all.”

There are times when it is in the best interest of a nation to utilize a strategy involving the accumulation of foreign currency.  MMT might counter that that is a choice, but it is not really a choice for some nations.  For many nations there is no choice because this is the optimal (some times the only) strategy for economic prosperity.  There are ample examples of such instances throughout history.

As for nations who are sovereign – the risks are not eliminated despite the claims by MMTers that a nation who issues its own currency has neither a solvency risk nor a foreign current risk.  For instance, budget deficits can exacerbate current account deficits so it’s easy to imagine a society that turns increasingly into a society of consumers as opposed to producers. In the words of Nicholas Kaldor:

“If (a large trade deficit is)continued long enough it would involve transforming a nation of creative producers into a community of rentiers increasingly living on others, seeking gratification in ever more useless consumption, with all the debilitating effects of the bread and circuses of Imperial Rome”

If one views the global economy as a whole, we should not seek merely to consume and import from our neighbors.  As a whole, this sort of mentality is dangerous since global acceptance of this policy would certainly lead to a reduction in the overall quality of production.  If the entire world tried to consume without producing then the overall quality of output would be diminished.   This point is again downplayed by MMTers in an attempt to bring the focus back to the state and the importance of government spending.  But the reality is that exports represent demand for high quality goods and services and balanced trade is a sign of a country whose consumption/production is balanced and healthy.  MR does not say that a sovereign currency issuer has no constraint at all.  The matter is simply not that black and white in all circumstances.  There are times, when even a sovereign currency issuer, can be constrained by unusual circumstances.

MMTers often refer to exports as a “real cost” and imports as a “real benefit” based on the idea that the exporter receives pieces of paper rather than consuming their own domestic production.  But this is a highly misleading perspective.  For instance, in the case of the China/USA relationship the USA is receiving goods that will largely end up in a landfill in 5 years while China is receiving real jobs, real skills, and real investment as a result of the production boom.  These are very “real benefits” in the eyes of this developing nation.  The USA on the other hand simply becomes a consumption led economy losing jobs, losing skills with a deteriorating production base.  MMT does this in order to be able to promote their fiscalist view of the world.  For instance, if the USA became a current account surplus nation they could run budget surpluses in perpetuity like Singapore or Norway does.  But MMT would never support such a position because then one could argue that there’s no need for government budget deficits which puts a wrinkle in the fiscalist position that MMT builds the entire theory around.

Consumption and production are two sides of the same coin and not a tug-of-war.  Forgetting this balance and the importance of both threatens the trajectory of our future living standards by reducing the productivity of the global economy as a whole and leading to lower potential living standards.  So much of economics today is a “this or that” story.  Production versus consumption, Republican versus Democrat.  But the truth, as always, lies somewhere inbetween and MR hopes to bring greater balance and perspective to the economic reality we all face.

Lastly, this environment of large trade deficits is politically unsustainable given the misunderstandings of the monetary system and poses enormous risks to the economy through demand leakages.  This doesn’t mean we support trade surpluses or trade deficits per se, but we do not support the MMT notion that large and persistent current account deficits are nothing more than a “real benefit” that allow us to consume more while also allowing for larger budget deficits that essentially paper over a larger problem.

On a similar note, MMT often claims:

“THERE IS NO LONG TERM DEFICIT PROBLEM!!!!!!”

Of course, that’s not the whole story.  MMTers would argue that inflation is the long-term problem.  But, like the Kaldor misinterpretation, MMTers never seem to clarify their point here.  It’s completely possible that the deficit could result in a deterioration in overall output.  For instance, to put the Kaldor quote in modern day context, if the USA paid 40MM people to sit on their couches all day long it’s possible that this could result in an equal amount of spending for less and less output.  Of course this could cause higher inflation, but MMT doesn’t seem to account for this potential outcome.  Instead, too often point to the exorbitant privilege of developed nations and simply assume that output will remain at some sort of steady trend using a generic output gap model.  And if you criticize MMT on this point or claim that they say “deficits don’t matter” then they’ll claim you’re misconstruing their arguments or building a “straw man”.  The problem of loose language and inexplicit commentary is a persistent problem within MMT.  Too often they are talking out of both sides of their mouths.

This is all problematic from an MMT perspective because MMT views these risks as less than benign.  In fact, MMT goes so far as to claim that a nation need not even produce that which it can consume from abroad while also claiming that “the higher the trade deficit the better”.   The fact is, without increased government spending to offset the demand leakage the higher trade deficit is a persistent risk.  And this all assumes that the spending results in productive output and not a positive feedback loop resulting in a case of “bread and circuses of Imperial Rome”.

5.  A state money system versus a market based money system.

“We would thus insist that any modern circuit should begin with the recognition that the “bank money” created at the beginning of the circuit is denominated in the State’s money of account. Further, recognizing that banks use HPM for clearing (more specifically, the reserve balance portion of HPM), the circuit should also begin with HPM.” – Wray, Kelton, Fullwiler

One of the most fundamental and simple differences between MR and MMT is the idea of where money comes from and how we use it.  In MMT all money is essentially state money.  That is, all money is an IOU of the government who is the issuer in MMT.  MR believes this view is incorrect and that the US government, for example, has outsourced the creation of money to private for profit banks.  As a result, the government, BY CHOICE , is not only a currency ISSUER (for instance, an issuer of notes, coins and reserves), but a USER of private bank money as well.  The US government could, in theory, take back this power and issues its own money free of the banking system (or by nationalizing the banking system), but it does not do this.  Consistent with the free market ideals in the USA, the USA’s money supply has been privatized for all intents and purposes.  That is, private for profit banks create most of the money in the monetary system and do so almost entirely independent of any government control.  A change to the MMT “general” case would require a sweeping change in the laws and the way our government is actually structured.  It would, in essence, give the government unconstrained control over the money supply.

A good example of the erroneous MMT position is in this introduction to MMT by Warren Mosler (see minute 4) where Mosler states:

“If you’ve got a dollar in your pocket, where did it come from?  Your first hint is it came from the Treasury Secretary.  Unless it’s counterfeit, it came from the government.  And they’ve spent it, and they haven’t taxed it yet.”

There  are two crucial errors in this commentary.  First of all, ALL cash is what MR calls “outside money”.  It comes from outside the private sector.  But most of our money is created by banks as debt.  We call this “inside money”.   Over 90% of the money supply in developed economies is inside money that exists because a loan created a deposit.  Cash is outside money because it comes from the US Treasury.  But the way cash comes into existence is simple.  Cash facilitates the use of inside money account holders.  What does that mean?  It means that you need an account in inside money to ever draw down or access cash.  For instance, if you take out a loan and the bank deposits funds in your account you can then go to the ATM to draw these funds down and buy a new car or whatever.  Technically, the government creates those dollars, but the actual money (the inside money account) came from the bank, not the government because the inside money preceded the outside money!  Cash is always a facilitating form of money.

So the second error in Mosler’s description is the concept that the cash was “spent” into the economy.  It absolutely was not spent into the economy ever.  The only way cash gets into the system is when a member Fed bank tells the US Treasury that it needs cash because its customers demand more withdrawals for cash transactions.  So the member Fed banks order cash from the US Treasury who prints it up and ships it to the banks.  The US Treasury does not “spend” it into existence.  It comes into existence because the customers of member Fed banks desire more cash via ATMs (for example) and the member Fed bank meets this demand by ordering the cash from the Fed (who gets it from the US Treasury) so their customers can spend cash for convenience purposes.   So the cash comes from the Treasury, but not through spending, but through the desire from someone who already has an inside money account to draw that account down.  Again, inside money precedes outside money.  Mosler gets it backwards and assumes that outside money or cash just magically appears in the economy through the government’s actions.  No, it appears in the economy through the actions of the banks and their customers.

The system we reside in is designed so that private competitive entities distribute money in what is really a market based system and not a truly state money system.  This is structured by choice, but it is the structure of the system we have today.  This feature results in dual money issuers – banks and the government.  Unlike China’s state banking model (which is actually very close to MMT’s state money system), the USA’s model is more market based with competitive private banks and a clear separation in types of money (outside and inside money).  The primary purpose behind this is dispersing the power of money creation away from the government.  That is, the private market actually controls the majority of money creation through a market system.  As a result, the government is a user of bank money and borrows and taxes private funds to obtain funding.  MMT notes that this is a choice, but it’s an incredibly pertinent choice as it changes the entire structure of the way the monetary system is structured and how money is created, dispersed and utilized.

MMT often states that the government is “not revenue constrained”, as in, “taxes don’t fund spending”.  This concept is void of value in terms of understanding the institutional design of the money system.  The US money system is designe din a way that the government must obtain inside bank money from the private sector before it can spend.  This is paramount in understanding the flow of funds through the economy.  The government does not merely decide how money is spent and print it at will.  It must be able to procure funding in the form of tax payments or bond sales because our monetary system is designed in such a manner that banks create almost all of the money and the government determines itself as a user of bank money.  In MMT all money is state money so the state would never borrow back its own IOU.  But this is clearly not the way our system is designed or the state would spend without procuring funds in the first place.  The MMT position is only relevant if private banks are part of the government issuing money on behalf of public purpose, but they are clearly private profit driven entities who issue money for private purpose.

The fact that government must procure funds can best be seen during most hyperinflations.  During a hyperinflation tax receipts generally decline and the deficit explodes as spending continues.  The government will then create money by monetizing its debt because there is no demand for the current.  This occurs because the government is unable to cover its spending with tax receipts.  In other words, the government has lost the ability to procure funds from the private sector.  They are no longer able to raise revenues from the private sector.   So the idea of an autonomous currency issuer being unconstrained by revenues is a concept that is largely void of value.  In MR we describe the fact that the autonomous currency issuer can’t “run out of money” due to institutional design (a government does not technically “run out of money” in a hyperinflation), but this is a very different concept than saying the government is not revenue constrained because it implies that the government is the issuer of all money in all instances.

MR views the State Theory of Money as incomplete and often used to justify the monopolist argument that MMT advocates.  MMT often engages in disturbing examples of an authoritarian monopolist holding a gun to our heads, starving children or forcing students to perform community service in order to graduate.  This derives from the view that the government’s currency is only as good as its ability to enforce its acceptance.  As Mosler says:

“The currency is only as good as the government’s ability to enforce tax payment.”

MR views this position as narrow, misleading and inconsistent with the current system (bear in mind, MMT is inherently progressive so it often views the world for what they WANT and not necessarily what we HAVE).  Instead, MR views money as a pure social construct which is not a construct of some exogenous government holding a gun to our heads or threatening us, but rather it is a construct of the people, by the people and for the people.   The currency users can always reject the money of issue and there is no monopoly power that gives the state power over the people in this regard.  But MMT’s monopolist view is based largely on this concept that money is a creature of law or the state and should therefore be issued in quantities or set by price as a monopolist would.

When one understands that the banking system issues most of the money in our system and the concept of a monopolist is an abuse of the terminology, it becomes clear that the MMT position has flaws in it.  For instance, MMT will arrive at specific policy ideas based on the concept that, if the monopolist doesn’t set the price or quantity of the money, then there will be unemployment.  Remember, in MMT money is merely a creature of law so it doesn’t matter to them if the government outsources money creation to banks because they’ll state that the government gave them that power to begin with.   It’s like stating that the government is the “monopolist of financial advice” because it requires financial advisors to obtain a state issued license.   Of course, it is the financial advisors themselves who actually distribute the financial advice so while they might be constrained by some regulatory requirement the state is not therefore the “monopoly supplier” of financial advice.  The responsibility of issuing and dstributing financial advice is regulated in the public domain but controlled and distributed entirely by the private domain.  Calling the business of financial advisory a “state monopoly” is incoherent and illogical.

As stated elsewhere, monopolists control price and/or quantity.  If the government does not control the price and/or quantity of the majority form of money in the system then it is not a monopolist and has far less power than it believes.  Indeed, the government has legislated its monopolist powers away to the banks and they now determine price and quantity.  The power to issue the license to issue the money does not make the government a monopolist over anything except the licenses.  But that’s not where the real power is.  The real power is in the ability to issue the money in the first place.  As a result of legislating this monopoly power to the banks the government has been forced to support and facilitate the role of banking in the economy.  Banks are so powerful that they can issue unjustified quantities of loans and if the government does not use their taxing authority to support the banking system it can result in systemic failure.  Anyone who understood what occurred in 2008 knows that the banks brought the US financial system to a halt and the government had no choice but to bail the money oligopolists out.  This is the result of having legislated the power of money creation away to the banks.   The real power is in having the right to issue the money, not in issuing a license to issue money!

It works like this.  Say GM has the legal authority to determine the only types of cars that can be used on US roads.  So it designs a specific type of car, determines the rules of the road and all that good stuff.  But then, GM goes to private autoshops and gives them the blue prints for the cars and tells them they can make the cars in the quantity and price of their choosing and keep all of the profits.  That’s how banking in the USA works.  The government determines the type of money that can be used, sets the rules of the payments system, but allows the banks to control both price and quantity of the product while keeping all of the profits for themselves.  The idea that the government is a monopolist because it issues the right to the banks to create the money is largely irrelevant here.  The real power is in earning the profit from making the money and via setting price and quantity as any monopolist would.

Of course, this concept could be applied across many things.  It could imply that the government is the speed monoplist because it sets speed limits, or the education monopolist because it charters schools or the food monopolist because it regulates how food is distributed or really the monopolist of just about anything since regulations touch most goods and services in the economy.  This is an abuse of the actual reality and terminology involving the idea of a “monopolist”.  For instance, if one were to state that full employment is the domain of the state because it regulates the labor system then we might be inclined to believe that society is better off by having the government provide jobs for everyone.

That may or may not be true, but shouldn’t be abused due to an overstretch of language.  To use an extreme example, one could envision a world in which the government hires millions of unqualified “workers” to provide an “work” in a public system to resolve its role as the job monopolist.  Will our society actually experience an improved standard of living?  Will they all necessarily be better off?  Will the government have made everyone better off by fulfilling its duty as the “job monopolist”?  Or will the government mismanage the labor program, provide inefficient jobs, unproductive work, induce inflation, etc?  It’s hard to know without seeing such a program in place.  The world is not so black and white as implying that legal authority implies government can or should do something.

The concept of a monopolist due to legal powers is misguided and overstretches the actual responsibilities that a government has simply because it has some legal powers.  But MMT takes the concept to an illogical extreme to imply that because the government HAS some authority that it then has overarching authority over virtually everything and therefore responsibility for everything.  This sort of thinking could lead one to believe that the government is the monopolist of just about everything since it regulates many things within the economy.  After all, if regulations and legal power are automatically equal to monopoly power then the concept of a command economy would obviously always be more applicable and appropriate than any alternative.  But to state that this concept is an overstretch of our reality is a vast understatement and abuses the ideas and policy options that could potentially produce greater living standards.  And this concept of a “monopolist” shouldn’t be used to describe broad government powers.

In fact, the system in the USA is specifically designed to avoid this concentration of power.  Ultimately, the currency is only as good as the willingness of the people to transact in that currency.  Enforcement plays only a secondary role to the far more important role of the currency as a viable means of exchange for goods and services.  If the social construct is not seen as a viable tool for exchange then no amount of enforcement can halt its demise.

MMT further conflates the point on state money by claiming that banks are merely agents of the government that issue money in service of public purpose.  But the reality is that banks are privately owned, privately managed institutions that primarily serve PRIVATE PURPOSE and not public purpose.  This is a clear contradiction in much of the MMT work.  MMT often vilifies banks and bankers, but when discussing this monopolist idea they claim banks are agents of the government who serve public purpose.  Clearly, there’s a conflict in these ideas.  This is because banks are issuers of money serving private purpose and not public purpose.   The entire existence of a market based money system like the one designed in the USA is at odds with MMT’s state theory of money.  So MMT has no choice but to attack the banks because their very existence voids the MMT idea that all money comes from the government.  

There is no “money monopolist” in a system where banks are provided such vast powers.  It is true that the government COULD create a full money monopolist (state controlled banking much like China has), but that is simply not the system as is designed in the USA today.  In advancing this claim MMT advocates will often state that “money is a public monopoly” or that the “currency” is a “public monopoly” and they therefore go on to justify the government as a “price setter” or “employer of last resort” (hire all the unemployed who want to work).  But these are very misleading statements.  MMT says:

“we should view “money” as a public monopoly. We can apply the theory of public monopolies to money to provide an alternative view of its source and importance in the modern economy.”

This is problematic in that it applies the idea of a monopolist to the private banking system where private banks wield enormous control over the supply of credit and the price of credit.  A true monopolist controls both supply AND price.  But the government controls NEITHER in the private banking system.  They have only a very loose influence over both.  There is no “monopoly supplier of money” in such a system.  If anyone is the monopoly supplier of credit it is the private banking system.  The current structure of our monetary system is designed so that the private banks issue most of the money in what is truly an oligopoly run by private banks.  It is anything but a government monopoly.

It’s like this. Say GM builds a fantastic and unique car. There’s huge demand for these cars, 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 government could 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. MMT says 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).  It outsources the creation of cars to private for profit entities.  The entire MMT thought process is inconsistent with a private banking system and much more in-line with a system like China’s which has state owned banking.

MMT would respond by stating:

“Sovereign government really can’t borrow, because what it is doing is accepting back it’s own IOU’s. If you have given your IOU to your neighbour because you borrowed some sugar, could you borrow it back? No, you can’t borrow back your own IOU’s.” – Wray

This theory is predicated on some enormous assumptions.  The most important of which is the theory that all money is state money.  As described above, all money is not state money.  Most money is in fact “inside money” or bank issued money.  Outside money, or government money is relatively minor when compared to bank money.   If you eliminate this idea that all money is state money and that the private banking system is provided the responsibility to competitively distribute most money then suddenly the story changes dramatically and the government becomes a user of money by virtue of the way the system is designed (with banks as private money issuers).

Also of importance there is this idea that all money is an IOU.  While there are elements of credit in money the truth is that all money is not an IOU.  IOU’s get paid back eventually.  They must, by definition.  But that is not how a fiat monetary system is designed.  It is designed to expand elastically as the needs of the economy grow.  In this regard, there is no such thing as the IOU’s ever being repaid.  Therefore, all money cannot be an IOU.  Money’s primary function is in the process of exchange.  That is the essence of money.  Yes, money has elements of credit and trust in it, but this does not mean money equals credit.  Credit must be repaid, but the money in a fiat monetary system cannot be repaid.  The money supply must perpetually inflate in order to continually grow and service the old debt.  There is simply no such thing as an economy paying off its debt.  Not at the government level nor at the private sector level.  It is impossible.  So the idea of money equalling an IOU is incomplete to begin with.

MMT uses this monopolist terminology to give the impression that there is some sort of hierarchy of power within the monetary system that the government resides at the top of. The reality is that fiat currencies are always built on a hierarchy that is based primarily on private sector production and not state powers or state moneys (what MR refers to as outside money).  Yes, it is true that acceptance value plays an important role in defining the unit of account and medium of exchange.  But this plays a secondary role to quantity value and the purchasing power of this money.  MMT designs this state centric view to give the impression that US Dollars are the dominant form of money in the economy because of the state’s power to enforce its use.  The reality is that the US Dollar is the dominant form of money in the economy because there is enormous private production that supports this money.

To better understand this hierarchy of money idea one must be familiar with the concept being discussed here.  It is widely theorized that money is hierarchical in any monetary system.  This has been theorized for years and ironically, primarily occurs in literature referring to commodity backed moneys.  While MMT is often quick to reject the idea of commodity backed money, they are quick to use this hierarchical idea as a starting point for their theory.  For instance, in a gold based system gold sits atop the hierarchy of money since this is the thing which all payments can be settled with.   It is the ultimate means of payment.  Of course, a fiat monetary system has no commodity backed asset.  But it is backed by something very real – the production of the monetary system in which it is denominated (see below for more on this point).

Interestingly, MMT often highlights that a monopolist’s powers are about price and not just quantity.  As Mosler states:

“With today’s central banking and monetary policy with its own currency, it’s always about price (interest rates) and not quantities.”

This is an accurate description of the way the Fed operates because the Fed is the monopoly supplier of reserves to the banking system.  The Fed, however, is not the price setter of all credit (although it could theoretically set the price of all government debt if it wanted to).  Rather, the Fed sets a “target rate” and the market determines the spread from there.  The price of your personal credit is largely dependent on your creditworthiness as a borrower and not just the state’s powers over money.   The state does NOT control the price of credit, therefore it is not the monopolist on the money supply.  But MMT takes the idea of a “money monopolist” and extrapolates it out across the system to apply monopolist powers where it is convenient.  MR believes this is an abuse of the idea of a monopolist and that current structure of the monetary system does not justify these monopolist actions.

When it comes to credit the government wields only a loose control via the “target interest rate” (the Fed Funds Rate) and other measures.  Congress could theoretically enact a fully state money system, but the reality is that we don’t reside in what MMT refers to as a fully “vertical” system (Fed & Treasury combined with nationalized banking system - a system some of MMT’s founders are already advocates of - though others claim bank nationalization is not an MMT principle). Despite this, evidence of bank nationalization within MMT is well founded:

Bill Mitchell, MMT founder: “nationalisation of the banking system is a sound principle to aim for. ”

Tom Hickey, proprietor of MMT website MNE: “I personally favor nationalizing most “retail” banking”

Joe Firestone, MMT enthusiast: “As for the present banking system, I’m all for changing it, but I’d just like to nationalize the banks and place them under Treasury.”

Rodger Mitchell, Monetary Sovereignty Founder: http://mythfighter.com/2012/05/12/at-long-last-are-we-ready-to-end-private-banking

Wray and Minsky are/were advocates of community development banking in the USA which is pseudo-nationalization.

This price setting function is an inconsistent position by MMT and often contradicted depending on their political preference.  For instance, MMTers understand that the natural rate of the overnight interest interest is zero, but don’t believe that the Fed should be the price setter of overnight loans even though they say it is the reserve monopolist.  Instead, they prefer for the Fed to leave rates at their “natural rate” of zero and instead prefer to focus purely on fiscal policy to control the price level and achieve full employment.  But when it comes to net financial assets MMT invokes the monopolist argument in favor of price setting.  But they will never say that the government should be the price setter of all net financial assets (I presume because it would be politically unpopular).   Of course, the amount of net financial assets at any given time are not dictated by the government because automatic stabilizers determine the amount of NFA in the system at any time.  The government never controls the supply of NFAs rendering this idea of a NFA monopolist void.

This idea is further muddied by MMT’s position that the government should be consolidated into the Fed + the Treasury.  But for some reason when it comes to monopolist powers they break-up the entities and often reject the Fed’s monopolist powers and various policy options offered to it through these powers.  MMT is rarely in favor of the Fed using its supposed monopolist as reserves powers and are in fact in favor of the Fed ceasing in their setting of interest rates.  This is inconsistent with the overall monopolist argument and gives the appearance that they are merely trying to promote a fiscally based policy while downplaying or minimizing the potential powers of the monetary side.

MMT also makes the same contradiction when discussing the Euro crisis.  They rightly understand that the problem in Europe is that none of the nations are currency issuers.  They are strategic users of the Euro because the ECB is not a politically or institutionally integrated entity.  But MMT often refers to the ECB as a currency issuer, but when discussing the USA they do not generally refer to the Federal Reserve as a currency issuer, but refer to the US government as a currency issuer.  In fact, MMT states that the US Treasury creates money.  This is not an accurate portrayal of the institutional designs in place.  The USA is only a strategic currency issuer because its central bank can be harnessed by the government.  The Federal Reserve is in fact the currency issuer in the USA just as the ECB is the issuer in Europe.  But MMT consolidates the Fed and Treasury in their models and then describes the US government as a whole as a currency issuer.  They should simply refer to the Fed for what it is – it is a bank like any other bank and it can print money as its customers so demand.

Most interestingly, the state theory renders the horizontal component unnecessary.   So if taken to its logical extreme, the monopolist argument (which we believe is incomplete as the system is structured and unjustified) would render the government the price setter of all money including credit.  Mosler understands that the existence of banks as price setters is a purely political choice:

“This introduces an entirely different set of incentives vs publicly owned institutions. And the choice between the two, and the two alternative outcomes, is a purely political choice.”

But MMT will not take the monopolist argument to its logical extreme by arguing that the government should be the monopolist on all forms of money.   MMT chooses not to take this position and instead cherry picks which prices should and should not be fixed by the government.  This inconsistency raises red flags for the monopolist argument and renders it very weak and politically motivated.  If the state theory is taken to its logical extreme then MMTers should fully support a state controlled credit system with the government as price setter for all forms of money.  But they wisely choose not to take this stance because it would render the entire MMT position a political non-starter.

MMTers further conflate these points through the use of vague language.   Bill Mitchell has explained the MMT idea that clearly shows how they try to create a government centric view of the money system based on this vague idea of banks “leveraging” high powered money:

“Modern monetary theorists consider the credit creation process to be the “leveraging of high powered money”. The only way you can understand why all this non-government “leveraging activity” (borrowing, repaying etc) can take place is to consider the role of the Government initially – that is, as the centrepiece of the macroeconomic theory. Banks clearly do expand the money supply endogenously – that is, without the ability of the central bank to control it. But all this activity is leveraging the high powered money (HPM) created by the interaction between the government and non-government sectors.”

In his criticism of MMT Professor Marc Lavoie references the use of the term “leverage” in MMT literature:

“the bank-money-supply process is horizontal; it can be thought of as a type of ‘leveraging’ of the hoarded vertical fiat money.

…

Personally, I don’t see how anything can be gained by making references to vertical components or to leveraged horizontal components, but these expressions keep being used. They ought to be left aside.”

Of course, banks don’t lend reserves.  Loans create deposits and banks do not create new loans based on their prior reserve balance.  This is contrary to the money multiplier which MMTers also reject.  But the use of the term “leverage” is intended to create a 1:1 relationship between state money and bank money when there is none.   This is all intended to bring the illusion of an all powerful state that wields a “money monopoly” when the reality is that the banks wield substantial and independent control over the monetary system.  There is absolutely no “leveraging” of HPM occurring here.  Banks create money independent of their reserve position with the government.  But in an interesting way, MMT, just like neoclassicals, builds a theory around HPM instead of the banking system where the focus should be.

An even more confused version of this idea of “leveraging” exists in Wray’s seminal text “Understanding Modern Money” where he states that bank lending “can be thought of as a type of “leveraging” of the hoarded vertical fiat money”.  He specifically defines fiat as “Treasury coin, Federal Reserve Notes, bank reserves”.  This is better known as high powered money.  But more recently, the argument has shifted to include ALL government net financial assets including Treasury bonds in this argument.  Wray goes on to claim that “a reduction in government spending can generate a ‘short squeeze’, where the borrowers of banks are not able to obtain sufficient money to make payments on loans”.  This argument is incoherent though.  The money to pay for past loans in a fiat money system does not come from the government.  It comes from future lending and income spent.   There is nothing unsustainable about a system based on credit where there is sufficient income to meet interest payments.  The problem with a credit based system is that there are demand leakages in addition to the inherent cyclical reality of modern economies that result in periods of boom and bust.

This position is further confused in MMT where they blur the definition of “money”.  In fact, in MMT a Treasury Bond IS money.  They state:

“A dollar bill is just a Treasury bond without duration and without an interest payment. In other words, they’re pretty much the same.”

 But while a bond IS money in MMT (it’s actually just a financial asset denominated in USD with very low levels of moneyness), bank deposits are definitely NOT money in MMT:

“It is necessary to distinguish between money as a measuring unit and those assets denominated in the money of account. Thus, bank deposits are not money, but are denominated in the social unit of account—that is, money (the dollar in the US).”

For a school that claims to be based in large part on endogenous money they certainly don’t believe that endogenous money is even money at all.  Rather, the entire theory is built around a government centric view of the world that is not so different from a reserve centric money multiplier type view of the world (though MMT obviously understands that banks don’t leverage reserves).

Of course, the government does not create the primary form of money in the private sector (bank deposits) so this reserve centric view of the world cannot be right.  The government only creates cash (which can only facilitate the use of inside money by allowing an inside money account to be drawn down, e.g., via ATM withdrawal).  The government also creates reserves, but the non-bank private sector does not use bank reserves for purchases and banks don’t leverage reserves.   The reality is that a government bond is a promise to deliver dollars.  And the government does not deliver outside money for your use.  It will deliver bank deposits in much the same way that a private sector corporation might deliver bank deposits to you upon bond expiration.  This creates further confusion. If a t-bond is money then where do we draw the line on money?  Is a AAA rated bond issued by Berkshire Hathaway a form of money?  Is a stock certificate money?  I would argue that these are forms of money, but have a substantially lower level of “moneyness” than something like a bank deposit.  After all, you can’t buy a sandwich with a t-bond, stock certificate or corporate bond.  But MMT blurs the lines on these definitions (again) in order to force a square peg in a round hole.

The simplest refutation of MMT can be seen in a one bank system.  In a one bank system controlled by the state there would be no need for a Fed because there would be no interbank settlement.  This is actually the world MMT creates by consolidating the fed into the treasury.  They create what is essentially a one bank form of system.  But this system is entirely inapplicable to our actual monetary system.  In our system the banks dominate the money system and issue almost all of the money.  The government facilitates this private money system and the Fed helps settle interbank payments through the use of the Fed Funds market.  If there were a single national bank then this system would be unnecessary.  But it exists in present form because private banking dominates the money system and is inherently fragile.  Therefore, this Federal entity helps facilitate and support a private bank controlled monetary system.  If we had a true MMT world there would be no need for the Fed and the interbank market.  Clearly, that’s not the world we have!

This flawed MMT position can also be seen through better understanding the history of NFA in the US economy.  As you can see below, there is no discernible relationship between total credit outstanding and government net financial assets. Periods of high NFA relative to debt have been consistent with both financial instability and periods of instability.  What is always true is that recession tends to increase the amount of spending in the economy through automatic stabilizers, but this is a separate point.  The way MMT emphasizes this idea of “leveraging” is both a misuse of the term and a misleading portrayal of the relationship between NFA and total credit.

MMT goes on to create a confused idea of where money comes from by claiming that anyone can create state denominated money:

“Do you notice a pattern here? Money is always created out of “thin air”.

So Krugman has got to have this banking business all wrong. Whatever deposits you make into banks are almost entirely deposits of bank IOUs. It is all bank money. Where did it come from? Well, from banks. Where did they get it? They created it. How? Thin air.

Look at it this way. You can write an IOU to your neighbor: “I owe you five bucks”. It is your financial liability and your neighbor’s financial asset. Where did it come from? Thin air.

Did you have to get cash first to write the IOU? No. Do you have to have $5 in cash in your pocket to write the IOU? No.

Now, you do have to “redeem” your debt at some point. Your neighbor presents your IOU to you for redemption and you cough up the cash, or you write a check on your bank deposit, or you provide something else of value that is mutually acceptable. When you satisfactorily redeem yourself, your neighbor hands back your IOU and you tear it up.

In this process, you “created money” out of “thin air”; the “money” was your IOU denominated in dollars. (The money you created is destroyed when you repay your debt.)

Now, you might object: but how can that be money? It was just my debt held by my neighbor. It didn’t circulate. The neighbor could not buy anything with it. Yes, that could be true.

On the other hand, it is conceivable that you are well-known and trusted across your entire neighborhood. In that case, the neighbor holding your IOU certainly might be able to pass it in payment for her own IOU to another neighbor (a “third party”). In that case, this other neighbor can present it to you for redemption. Or, your neighbor might hire a local kid to mow the lawn—and then the kid presents it for redemption. So, at least in theory, your IOU could circulate to pay debts or to buy services.

As Minsky always said: anyone can create money; the problem is in getting it accepted.”

There’s a lot wrong in that paragraph.  First, if you obtain an IOU from your neighbor the purpose is to transfer purchasing power.  You must dissave in order to lend.  A bank does no such thing.  A bank creates NEW purchasing power.  So you would never write an IOU to your neighbor if you did not also accept cash or some other specific form of money from him/her.  That’s the purpose of an IOU.  It is a record of debt owed.  So an IOU involves borrowing money from your neighbor and promising to pay him back.  What’s the difference between borrowing from your neighbor and borrowing from a bank?  When you borrow from your neighbor you simply TRANSFER purchasing power from your neighbor to yourself.  When you pay back the IOU you transfer the purchasing power back to your neighbor.  Your neighbor did not create new purchasing power.  On the other hand, if you go to a bank and take out a loan your bank creates new money from thin air.  The bank does so without leveraging reserves, acquiring reserves or reducing its own purchasing power.  It increases your purchasing and the total purchasing power of the economy by making the loan.

This example is further conflated by the implication that the banks “redeem” their IOUs.  But this is a meaningless concept.  Banks do not redeem their IOUs.  Again, MMT creates a money multiplier relationship between reserves and loans where one does not exist.  It is pure doublespeak as they tell us banks lend without being reserve constrained, but then change their story to build a hierarchy of money and create the illusion of a relationship where there is none.

So, yes, Wray is right that anyone can create money (I could technically say anything is “money”), but not anyone can create new purchasing power denominated in dollars – in fact, you’ll likely go to jail if you do it).  The primary issuers of new dollars are private banks in what is really a privatized money system.  The government has outsourced the creation of money to the private banking system.  And banks issue this money without “leveraging” reserves or redeeming money (which is a totally inapplicable concept in terms of operational realities).  As you’ll see below, this is a complete misrepresentation of the purpose of the Federal Reserve System and the purpose for its creation in the first place….

MMT further conflates this point by emphasizing net financial assets and the fact that banks cannot create net new financial assets.  They often claim that money is “destroyed” when a loan is repaid.  Wray says:

“When IOUs complete their journey back to their issuers, they are destroyed.”

But this is only true in the narrowest sense.  In the aggregate, loans are not being repaid and money is not being “destroyed”.   Loans are largely rolling over in what is a perpetual increase in assets and liabilities within the private sector as private sector net worth expands.  Just like the federal government doesn’t “pay down” its debt, neither does the aggregate private sector over the long-term (though this idea should not be confused with the differences in having a solvency constraint which all private sector actors do).  The private sector debts grow perpetually along with the real economy:

We believe MMT takes this state theory and monopolist view to an extreme in a similar way to metallist’s (believers in the gold standard and fixed exchange rate systems take their faith in the market based system to extremes).  Chartalists say:

“Under the metallist vision, the state takes a back seat to the market. The chartalist theory, however, places the state on center stage”.

Or said differently:

“We would thus insist that any modern circuit should begin with the recognition that the “bank money” created at the beginning of the circuit is denominated in the State’s money of account. Further, recognizing that banks use HPM for clearing (more specifically, the reserve balance portion of HPM), the circuit should also begin with HPM.”

As explained previously, we don’t have a money system with the state on “center stage” or the state taking a “back seat to the market”. We have a hybrid system where private banks wield huge control over the price of money and the supply of money and this is combined with a state control on components of money that have a huge influence but not a monopolistic influence on all money. MR brings this view back to the middle where it should be and recognizes that both positions are extreme and misleading.

MMT uses this monopolist argument to build their position on a hierarchical basis with the government playing the central role in settling payments.  The second quote above implies a strange sort of money multiplier argument that is very similar to what most neoclassicals do.  But this view is completely wrong.  While it’s true that the government’s powers as monopolist on components of the money supply is crucial, we should avoid downplaying the role of the banking system in our monetary system.  The reality is that the credit system is the lifeblood of the monetary system.  Stating that the government is the monopolist due to a “hierarchy of money” or settlement of payments is misleading in helping one understand the ways this system operates in the real-world.  And that reality is that the state controls neither the price nor the quantity of credit rendering a monopoly on money impossible.

MMT will often argue that taxes can only be settled in reserve balances due to this “hierarchy of money”.  But MMTers have fully admitted that the private banking system forces the creation of reserves through lending.  Mosler has stated:

“With floating lending is never reserve constrained, as this particular institutional structure allows banks to create their own reserves.”

They further conflate this point by claiming that all payments settle in high powered money rendering it the top of this hierarchy.  For instance, in a recent presentation Kelton says:

“here’s an example. Suppose that you go out to dinner and you purchase your meal with your Visa card. Is that the final payment? No. You get a bill in the mail from Visa, and what do you do? You write them a check. Is that the final payment? Well, maybe the last time you see anything happen, but it’s not the final payment. At the end of the day, Visa doesn’t want your check. It doesn’t want what you’ve written down. What it wants is a credit to its bank account and that happens as that check goes through a clearing process and Visa’s bank account is credited with reserves. What are bank reserves? Government IOUs. Federal Reserve money. government money. Only the government’s money can discharge a payment as final means of payment. We are the users of the government’s currency (Kelton; 2010).”

This clearly displays a fatal flaw in the MMT hierarchy of money argument.  MMT far exaggerates the importance of the reserve system in settling payments as an excuse for all money being “state money”.  According to this thinking, one might believe that private transactions do not even matter since they don’t “settle” as the “final means of payment”.  Of course, the logic is completely wrong here.  First, the example makes no sense since Visa does not issue credit cards or receive payments.  Visa facilitates electronic funds transfers.  Banks and finance companies use Visa branded cards to allow these transfers to be processed.  But more importantly, when you go to dinner, final payment is settled in whatever the restaurant accepts.   The restaurant gets paid in bank deposits in most cases, not reserves.  In fact, it cannot be paid in reserves and could not use the reserves even if it could be paid in reserves.  Further, if this transaction occurs at the same bank then the bank will not even alter its reserves.  I.e., there is no “final settlement” in the “government’s currency”.  The fact that banks are required to maintain some level of reserves has absolutely nothing to do with the fact that the restaurant accepts payment in bank deposits.  The entire example is illogical and an attempt to create a relationship between bank and government money where there is none.

MMT also conflates the institutional design of the monetary system by consolidating the Fed and Treasury into the same entity in their accounting descriptions.  In doing so, they are able to claim that tax receipts are settled in bank reserves which are a liability of the Federal Reserve which would mean the government is accepting its own liability (which is not legally true).  They will claim that this means the tax payments “destroy” money and the spending creates money.  Of course, the Fed and Treasury are not the same entity so the entire accounting is flawed from the start, but this still blurs the actual way the taxing and spending process works to begin with.  There is a very specific flow of funds that occurs within the money system that helps us understand how the system functions.  As the NY Fed has described:

“The Treasury maintains its primary account for making and receiving payments, the Treasury general account (TGA), at the Reserve Banks. An increase in the balance of that account means that funds have moved from depository institutions’ accounts at the Banks into the TGA. This movement of funds reduces the amount of reserves in the banking system.  Conversely, a decrease in the TGA means that funds have moved from that account to depository institutions, thereby increasing the amount of reserves in the banking system.”

The Fed has also described this specific flow of funds:

“The Treasury’s receipts and expenditures affect not only the balance the Treasury holds at the Federal Reserve, they also affect the balances in the accounts that depository institutions maintain at the Reserve Banks. When the Treasury makes a payment from its general account, funds flow from that account into the account of a depository institution either for that institution or for one of the institution’s customers. As a result, all else equal, a decline in the balances held in the Treasury’s general account results in an increase in the deposits of depository institutions. Conversely, funds that flow into the Treasury’s account drain balances from the deposits of depository institutions. These changes do not rely on the nature of the transaction. A tax payment to the Treasury’s account reduces the deposits of depository institutions in the same way that the transfer of funds does when a private citizen purchases Treasury debt. Both actions result in funds flowing from a depository institution’s account into the Treasury’s account.”

In order for the TGA account to ever obtain a positive balance the Treasury must procure funds via taxes or bond sales.  The Treasury does not simply “create” funds as MMT implies.  There is a clear flow of funds that occurs in this process whereby bank deposits flow into the government’s account, allowing it to spend and then results in an equal bank deposit on the other end in the banking system.  From start to finish, the flow of funds begins with the creation of money in the form of a loan which creates deposits.  The issuing bank has an asset which results in the creation of a deposit liability.  If this deposit is used to pay taxes then the government most definitely does not “destroy” the loan made in inside money or bank money.  It simply redistributes the loan’s resulting deposit through the system where government spending results in the crediting of a bank account (and the original loan asset remaining in the banking system).  It is best to think of most transactions in our money system as starting in inside money and ending in inside money. Money is created primarily by banks when loans are made and can only be destroyed by banks when loans are repaid.

One can also see MMT’s flawed reserve centric view of the world by understand the distinction between inside money and outside money.  Inside money, as mentioned, is bank money (deposits created via loans).  Outside money includes cash, coins and reserves.  MMT will state that a tax payment is money being “destroyed” because the bank no longer has a deposit liability and instead obtains a reserve credit which is then used to “fund” the Treasury General Account.  Said differently, inside money has been transferred to outside money within the reserve system.  This outside money is then transformed back into a deposit when the government spends.  Thus, MMT calls this “money printing” and has referred to the tax payment as “unprinting”.  But this is inconsistent with the actual flow of funds described previously.  It is exactly the same as stating that an ATM withdrawal “destroys” money because a bank no longer has a deposit liability.  No, it merely transforms inside money to outside money temporarily.  Inside money is transformed into outside money which will then be transformed back into inside money when it is deposited back into the banking system.  Would MMT describe this as “money printing” because it is precisely the same process that occurs when the government taxes.  Of course you wouldn’t say that this is “money printing” because that would make no sense.

MMT will first consolidate Fed and Treasury and then claim that the reserve system’s cash settlement of taxes implies the “destruction of money”.  But this cannot be right because the money was created via a loan (which created a bank deposit) and the loan absolutely was not destroyed in the process of government taxation.  Therefore, the money system requires that inside money to be redeposited into the system, which is precisely what the US government does.  It does not destroy or transform inside money.  It simply redistributes it through the system.

In a mythical world the Fed could just credit the TGA account, but in the real world this is not what occurs (though MMT’s reserve settlement explanation is essentially the creation of a new deposit).  What occurs is a debiting of a private bank account, a crediting of the TGA account, and the subsequent crediting of a bank account.  In other words, the government is a user of bank money in that its account at the Fed must be funded via taxes or bonds before funds can be disbursed.  Inside money does not get transformed, destroyed or created in this process.  It merely flows through the system.  Blurring this process due to what is actually monetary policy and reserve maintenance procedures completely distorts the flow of funds that is occurring in the monetary system through these processes.  Government taxation does not destroy inside money the dominant and relevant form of money in the economy.  And spending does not create inside money.  Blurring this process through the distortion of the reserve accounting process entirely misconstrues the actual flow of funds and the fact that banks dominate the monetary system through their creation of inside money.  MMT, by consolidating the Fed & Treasury and claiming that banks leverage horizontal money, completely distorts this reality into something it would only be in an entirely different type of monetary system in which the government were a true issuer of all money.

There are also multiple legal misrepresentations in the MMT description of the money system.  As previously discussed, the constraints imposed on the US government from being a money monopolist or having monoploy powers are very specific in the way the institutions are designed in the USA.  MMT is often sloppy with terminology referring to the “state” as having monopoly powers over the money supply or the right to determine who can issue money.  But this confuses the specifics in the laws that determine who has the power.

Article 1 of the Consistution refers to the Congress and its powers, Article 2 concerns the powers of the Executive branch, Article 3 refers to the judicial system and Article 4 refers to the states and their powers.  The Fed was designed as an independent agency because the Congress did not trust the President with the power of monopoly over the money supply.  In designing the Fed system the President was specifically forced to share his powers (and those of his Treasury Secretary) with the private banking system and the Federal Reserve.  MMT consolidates the Fed into the rest of government, but this misconstrues the powers of the Fed.  Even under a consolidated view the Treasury Secretary or President has no power to veto a Fed decision due to its specific design as an agency outside of the “the state”.

MMT’s “general case” assumes that this is not so.  That the Executive Branch (or its Treasury) can control the banks and their power over money.  MMT might respond to such a criticism by stating that the government determines what can be used to pay taxes, but this simply misconstrues the true purpose of the Fed and the reserve system as a facilitating agent to the banks.  They might further respond by stating that the government has monopoly powers over the right to issue bank charters, but this is also misconstrued because the states (small S) also have the power to issue bank charters.  The entire MMT construct is a sloppy generalization of the actual designs that have been put in place for specific reasons.  So the justification of the state as a “money monopolist” is completely irrelevant.

It’s also important to understand the MMT argument and the idea that the Fed’s liabilities are the liabilities of the Federal government (hence their rationalization for consolidation of the Fed and Treasury). 12 USC § 411 states:

“Federal reserve notes, to be issued at the discretion of the Board of Governors of the Federal Reserve System for the purpose of making advances to Federal reserve banks through the Federal reserve agents as hereinafter set forth and for no other purpose, are authorized. The said notes shall be obligations of the United States and shall be receivable by all national and member banks and Federal reserve banks and for all taxes, customs, and other public dues. They shall be redeemed in lawful money on demand at the Treasury Department of the United States, in the city of Washington, District of Columbia, or at any Federal Reserve bank.”

Note that the law states that “Federal reserve notes” are obligations of the US government.  This appears to be another point MMTers often conflate.  The Fed does not print the currency.  The Fed is simply an intermediary in currency issuance.  The Fed actually orders cash from the US Treasury who orders the US Bureau of Engraving to print the new dollars (via NY Fed):

“Each of the 12 Federal Reserve Banks keeps an inventory of cash on hand to meet the needs of the depository institutions in its District. Extended custodial inventory sites in several continents promote the use of U.S. currency internationally, improve the collection of information on currency flows, and help local banks meet the public’s demand for U.S. currency. Additions to that supply come directly from the two divisions of the Treasury Department that produce the cash: the Bureau of Engraving and Printing, which prints currency, and the United States Mint, which makes coins. Most of the inventory consists of deposits by banks that had more cash than they needed to serve their customers and deposited the excess at the Fed to help meet their reserve requirements.”

Further, 12 USC § 411 does not state that all bank reserves are liabilities of the United States government.  But MMT rests their entire case on this idea that Fed reserves are a liability of the US government.  There is no such law specifically stating this.  This has become a more contentious issue in recent years with the various complex Fed policies, but remains unsettled and unspecified despite MMT’s claims otherwise.  For now, bank reserves are not defined as a liability of the US government.  They are a liability of the Federal Reserve, an entity that is neither public nor private.  The cash they distribute to meet various banking needs, however, is certainly a liability of the US government.

Much of this confusion derives from MMT’s consolidation of the Fed and Treasury.  But this is a false premise.  The fed is clearly defined as neither a public nor private entity.  As the Fed has explained:

“The Federal Reserve System fulfills its public mission as an independent entity within government.  It is not “owned” by anyone and is not a private, profit-making institution.

As the nation’s central bank, the Federal Reserve derives its authority from the Congress of the United States. It is considered an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms.”

The Fed exists primarily to support private competitive banking.  It actually enacts all policy via the banking system and must therefore help sustain a healthy PRIVATE banking system before it can ever achieve PUBLIC purpose of full employment and price stability.  Therefore, the Fed is clearly an entity that serves private purpose BEFORE public purpose.  In fact, the Feds mere existence renders MMT void in the current system.

In MMT, this idea is turned on its headed and completely misconstrued as they argue that the nation’s central bank is part of the Treasury.  They then consolidate the balance sheets to piece together the story of state money.  And one could argue, under 18 USC § 8 that the fact that the Federal Reserve is an “act of Congress” means that it does issue liabilities of the US government.  This all gets a bit messy here.

But this also raises an interesting point regarding banking in the USA.  If bank reserves can reliably be considered “obligations” under 18 USC § 8  or USC 12 USC then one has to seriously consider the idea of private banking as it pertains to this definition.   Banks are charted under act of Congress in the USA to distribute various forms of money as described under 18 USC § 8:

“The term “obligation or other security of the United States” includes all bonds, certificates of indebtedness, national bank currency, Federal Reserve notes, Federal Reserve bank notes, coupons, United States notes, Treasury notes, gold certificates, silver certificates, fractional notes, certificates of deposit, bills, checks, or drafts for money, drawn by or upon authorized officers of the United States, stamps and other representatives of value, of whatever denomination, issued under any Act of Congress, and canceled United States stamps.”

Does being given this power to distribute “representatives of value” under an “act of Congress” mean that all banks are distributing liabilities of the US government? This also puts the Fed in a much more murky place.  I cannot say that there is a definitive answer to this issue except that it is clear that the world MMT envisions is not entirely applicable as they often describe it because that would mean not only that the Fed is part of the US government (although it says otherwise) it would also mean that the nation’s banking system derives its powers to issue money from the government and is therefore also part of the US government (something that is categorically false).  This thinking would also appear to confirm my thinking that MMT requires a fully nationalized banking system with all bank liabilities officially being deemed liabilities of the US government before the MMT world can be fully applicable.

It’s also important to note that what is a clear cut current law is the no overdraft law which states that the US Treasury cannot run an overdraft on its account at the Federal Reserve.  This means the MMT theory cannot be correct because the only way the US government can obtain funds at present is if it taxes or sells bonds thereby allowing the crediting of its TGA account.  In theory (yes, MMT) the government could just credit its own account.  But the current system does not allow this.

Frankly, I don’t think a change in the law would matter much because it doesn’t change the flow of funds that is described above by the Fed.  There is a very clear flow of funds from the private sector to the public sector back to the private sector.  The TGA account does not obtain credits without a private account first being debited.  Whether this settles in US government liabilities is irrelevant.  The US government cannot legally run an overdraft in its account at the Fed and can only fund this account by debiting the accounts of private sector accounts.  To obscure this process as the “destruction” and “creation” of money is to misinterpret the importance behind the actual flow of funds that occurs in the system. It creates an erroneous illusion of money creation when the reality is that taxes result in a private debit, public credit and then spending results in a public debit and private credit.  This is not destruction and creation.  It is a redistribution.

More importantly, the Federal Reserve system exists in large part to facilitate the smooth settlement of payments in a multi-bank system (this payment facilitation process includes the funding of the federal government).  The very creation of the Federal Reserve System was to maintain private competitive for profit banking (read, privatized money creation) with government as a facilitating role in helping to set policy that influences the cost of inside money while also supporting the value of inside money through a central clearing house.  As the Fed has explained:

“By creating the Federal Reserve System, Congress intended to eliminate the severe financial crises that had periodically swept the nation, especially the sort of financial panic that occurred in 1907. During that episode, payments were disrupted throughout the country because many banks and clearinghouses refused to clear checks drawn on certain other banks, a practice that contributed to the failure of otherwise solvent banks. To address these problems, Congress gave the Federal Reserve System the authority to establish a nationwide check-clearing system.”

The Fed system was created to support the private for profit banking system.  It did not magically nationalize all the banks or make them all servants of public purpose just because reserves settle with Fed accounts.  This is a vast misrepresentation of the facilitating purpose of the Federal Reserve System.  The Fed was created to support inside money. MMT’s claim that reserves sit atop the hierarchy of money is patently false.  Reserves only exist as a support mechanism to inside bank money.  That is the only reason for their existence.  Something that facilitates cannot possibly take the lead role in the monetary system.  It is like saying that a crutch is more important than the legs that carry most of the burden.  The order of importance is entirely wrong here with MMT essentially stating that the crutch is suddenly more important than the man (the government is more important than the private competitive banking system which feeds almost all of the money to the economy that results in economic output).

The existence of private banking puts MMT in a bind because it is completely at odds with the essence of a self funding government.  In the USA, the government has chosen to outsource the creation of money to a private competitive market based system of banks.  The alternative to this system is having the government issue all money and manage all loan distribution.  But MMT tries to have it both ways.  They attempt to say that private banking is consistent with MMT and the idea of the state ruling the monetary roost.  The existence of private banking is inherently at odds with MMT’s entire theory.  In our system, the government must willingly support private banking (which is inherently unstable) if we are to maintain a private competitive based money distribution system.  This support is provided in various ways including subsidies, asset issuance (government bonds) and the Federal Reserve’s very existence.

This can also be proven clearly, for instance, in a one bank system where there is no settlement of payments involving reserves – such a transaction would settle at the bank in its own deposits.  The only time reserves are used for payment settlement in an example like the one above is when there are multiple banks involved in which case the reserve system is utilized to streamline payment transfer.  This system was established due to what was essentially rogue banking from the 1800′s when some banks would not clear payments from other banks during crisis.  By bringing settlement into a central location the Fed substantially bolstered the banking system.  So it’s clear that the Reserve system exists to support private banking, not to establish some sort of state money system where the state issues the money or where reserves sit atop a hierarchy that is similar to the money multiplier.  The Federal Reserve System exists explicitly to support private banking and a market based money creation system.  The very existence of the Fed means MMT’s theory is falsely presented.  If we had a true money monopolist there would be no need for a Federal Reserve.

Further, some banking systems don’t even have reserve requirements and operate fully functional banking systems with minimal reserve requirements.  But MMT exaggerates the role of reserves in settling payments in order to bridge the divide between the private banking system and the government’s management of the payments system.  They stretch the truth in order to create a “future [that] has already happened” and bring the state “back to center stage”.

The Federal Reserve System sustains a competitive private banking system while allowing for a unified payment structure through the reserve system.  If all money was truly state money there would be no need for the Reserve system in the first place.   Ie, the reserve system’s very existence is to facilitate the private competitive nature of inside money and a large facet of this involves helping the government procure funds without disrupting the competitive nature of the interbank/private banking system.  So the idea that “taxes drive money” because tax settlement occurs in reserves is purely contradictory and void of value.  This is why MMT would like to eliminate the Fed and consolidate the system.  Without what is essentially a one bank system the MMT paradigm is untrue.   The reserve system and outside money exists almost entirely to facilitate the competitive private nature of inside money.   The very existence of a reserve system at all renders the MMT description void.  

MMT builds their hierarchy to give the impression that money is accepted as payment due to government decree.  But this is only true in a narrow sense.  Fiat moneys are accepted because they are supported by underlying production.  Indeed, when a currency collapses it is almost always due to the fact that the productive base of the economy has collapsed and not because the government has failed to support its currency through enforcement of the law or exercising its powers.  For instance, President Mugabe did not run out of guns and soldiers in Zimbabwe.  He ran out of a productive economic base.   Another example is the US Dollar.  Why is the US Dollar viewed as the world’s reserve currency?   It is primarily due to the fact that holding these dollars is a claim on up to $16 trillion of global output.  Fiat moneys are backed by a productive base first and government powers in a secondary sense.  A more recent case of where MMT goes wrong in this understanding is Iran’s recent hyperinflation.  The Iranian government did not run out of the ability to tax or to enforce taxation.  What happened in Iran is that it no longer became viable to hold Rial’s when foreign sanctions reduced exports of Iran’s primary resource – oil.  Not only does this hyperinflation disprove the idea that “taxes drive money”, but it also invalidates MMT’s thinking that any nation can be autonomous in their own currency.

MMT constructs their hierarchy by claiming that inside money is less important than outside money or further down the hierarchy of money.  But this cannot be true because it is inside money that is the means of exchange for all productive output that backs the fiat money to begin with.  Payments in the means of production occur almost exclusively in inside money which is the dominant money in a market based fiat money system.  The idea that the supporting form of money (outside money) is more important than the very money (inside money) that is the direct means of exchange for the production that backs the currency to begin with, is highly misleading.  MMT distorts this view to confirm the State Theory of Money and the centrality of government within the theory.

Interestingly, MMT founder Randall Wray has explicitly contradicted the idea of the hierarchy.  In “Money as a Public Monopoly” Wray said this regarding bank money:

“The bank money (a banker) creates while running the bank into the ground is as good as the government currency the Treasury creates serving the public interest.”

This obviously contradicts the idea that there is a hierarchy of money or that bank money is somehow lower than government currency.  But MMT has spent years building these ideas without realizing that Wray’s comments here are totally accurate – banks are private money issuers who issue money that is every bit as useful (even more so) and important as government currency.

Clearly, the hierarchy argument is flawed and attempts to create a relationship between the private banking system and the government issued money that can be highly misleading when viewed through the lens of a state centric perspective.  Additionally, the existence of dual money issuers clearly shows that there is no monopolist power here.  The fact that banks are required to hold reserves at the central bank does not change this.  And while the Fed might be the issuer of reserves, they don’t really have a choice in the matter.  As the overseer of a smooth functioning payments system the Fed MUST supply the reserves.  They are not willingly supplied due to some overarching power they maintain.  In fact, the private banking system wields the power of influence here as they force the Fed to respond to their private credit creation powers.  As a support mechanism, the Fed is designed to be a facilitator of inside money.

MMT uses this misleading argument to build their position in achieving full employment and price stability, both of which revolve around the MMT Job Guarantee, a policy proposal that should have zero influence on understanding the modern monetary system.   The argument is essentially a price fixing scheme in which they justify monopolist style intervention in private sector wages by claiming that the government has a monopoly on a small sliver of the money supply.  Of course, a true monopolist controls the supply of its entire product and the US government very clearly does not control the supply or price of bank issued money.  This does not stop MMT from taking this monopolist argument and extrapolating it out across the entire spectrum of money.  In doing so they essentially alter the reality of our monetary system and its operational realities in order to rationalize a policy agenda.

6.  Do Taxes “Drive Money”?

MMT advocates will often claim that “taxes drive money”, but we do not view taxes as being entirely sufficient in justifying the monopolist argument (which we already explained is based on a false foundation). Although important, taxes and enforcement alone are not enough to maintain a stable monetary system and cannot be proclaimed to sit atop the hierarchy of money demand.  GF Knapp, the founder of the State Theory of Money understood this idea and in fact argued that “money is a creature of law”.  The first line in his book “The State Theory of Money” says:

“MONEY is a creature of law. A theory of money must therefore deal with legal history.”

 This is interesting from the MMT perspective because they will often claim that the only thing that renders MMT incomplete are “self imposed” constraints.  In other words, the laws that constrain a government (for instance, from being able to print money without first procuring it via bond sales or taxation) are somehow inapplicable because they’re “self imposed”.  Of course, all laws are “self imposed” and provide as guidance for how money can and cannot be used.  But one cannot claim that money is a creature of law (using Knapp’s State Theory) and also claim that “self imposed” constraints do not apply to that nation.  That is obviously contradictory.

MR says this idea of “money is a creature of law” is incomplete.  We instead focus on the living standards of the people within that monetary system with the understanding that any monetary system is only as stable as the living standards of those who create it.   We know that money is a social construct and we know that money is always a tool of exchange.  Based on this understanding we can derive that money always has an element of trust as trust is a crucial element involving this tool of exchange.  As Mitchell Innes stated in “what is money“:

“credit and credit alone is money.”

I would argue that money can be many different things and that money is not always credit, but this idea that money is faith based is pertinent.  ”Credit” comes from the Latin word credere meaning “to believe”.  Money, always being a social construct is based on trust between parties.    Therefore, money is always driven by trust and the belief that what you are exchanging in return for this “money” is of equal or greater value to you.  But ultimately, what money really gets you is some end.  In the case of modern fiat monetary systems money is primarily a tool or a medium of exchange that allows you to purchase output.  The end is not a tax payment or the elimination of a debt.  The end is the ownership of output.  We use this tool to obtain output.  The tax is always secondary.  So it is impossible for taxes to drive money.  If anything output drives money.

It’s also important to note other primary drivers of money.  Economist Hal Varian has described the use of a prominent form of money as a “network effect”.   The reason why we use a particular form of money is primarily because others use money.  In the USA the dominant form of money is bank deposits because bank deposits are the dominant form of money that populates the US payments system.  That means if you want to engage in the US economy you must be able to access the private banking system to obtain the deposits that are most widely accepted as a medium of exchange.  Like the utility of a fax machine, bank deposits are useful so long as others use them.  But it’s also important to note that the US payments system is largely a creature of law.   So the government plays a crucial role in overseeing and regulating this system and determining that which can be used within that payments system, but the system is not “driven” by tax payments.

This can also be proven by understanding a few real-life examples.  An interesting case occurred in Iraq following the first Gulf War when the Iraqi Dinar was replaced by Saddam Dinars.  Here’s how Hal Varian describes it:

“After the gulf war of 1991, Iraq was divided in two: the south ruled by Saddam Hussein, the north governed by the local Kurds. Mr. Hussein needed money to finance government spending, and in the time-honored tradition of dictators, created it himself.

The government could not import more of the bank notes then in use, because of United Nations sanctions, so Mr. Hussein ordered the local printing of a new currency. In May 1993, the Central Bank of Iraq announced that citizens had three weeks to exchange their old 25-dinar notes for the new “Saddam dinars,” which bore his portrait.

During the next few years, so many Saddam dinars were printed in southern Iraq that they became virtually worthless. The face value of cash in circulation rose from 22 billion dinars in 1991 to 584 billion in four years, and inflation averaged about 250 percent a year over that period.

Residents of northern Iraq could not exchange their notes. The 25-dinar notes continued to circulate and became known as the “Swiss dinars,” because they were printed with plates made in Switzerland.

The fact that the Swiss dinars continued to be used at all speaks to the power of social conventions. The Kurds in the north despised the Baghdad government, and would have much preferred to have their own currency. But there was no government in place powerful enough to mandate a currency change, so they kept using the old Swiss dinars by default.

The Swiss dinar was in fixed supply, while the Saddam dinar was flying off the printing presses, so it is not surprising that the Swiss dinar quickly became more valuable. By spring 2003, it took 300 Saddam dinars to buy one Swiss dinar.”

Not does this case study prove that a government mandate alone cannot give money value, but it proves that taxes are not enough to drive the use of a particular form of money.

MMT will often introduce the hierarchy of money to claim that tax liabilities are the “driver” of money because users of the currency must obtain state money to extinguish this liability.  But even with this understanding we are hesitant to use the idea of a hierarchy of money here.  The primary purpose for desiring fiat money is for the purchase or sale of output.   This can perhaps best be seen in a hyperinflation.  The state does not lose the ability to tax in a hyperinflation.  What generally occurs is a collapse in productive output resulting in a decline in tax receipts that is not countered by reduction in government spending and often met with monetization in order to sustain the government.  The “driver” of the collapse is the collapse in the tax system that RESULTS from the collapse in productive output.  RESOURCES PRECEDE TAXATION so it is impossible to claim taxation drives money.  If anything, resources drive money.  Government is merely a user of private resources.  And since greater output means greater resources we can also conclude that output drives money.  Ie, capitalism makes socialism possible since more resources means more resources available for transfer from private to public domain.  So again, it is impossible to say taxes drive money when the foundation for the driver of money is not taxes, but output.  We are aware that hyperinflations are extreme and rare events, but like the death of a human being, they can be extremely informative events in that they show us precisely what the weaknesses of a particular system are and are not.

It’s also important to understand that fiat money might be a creature of the state and its laws, but the state is ultimately a creature of the people. Resources precede taxation so while taxation plays a crucial role in binding the monetary system they are by no means the only link (or even the most important link) in the chain.  Rather, money is driven by many factors with credit or trust in this specific form of money being the primary driving factor of money.  This faith is not built on the shoulders of the government, but rather it is built on the shoulders of private producers and consumers.

State monetary systems are merely an evolution of money as debt from unspoken bonds to formal institutionalized constructs with laws, taxes, and systemic infrastructure as the framework for a specific type of money.  In a constitutional republic like the USA we choose how our government and hence our monetary system exists. Our system is specifically fragmented to avoid the capture of power by any one entity.  We use the government as a form of partnership to better our collective living standards. The creation of state money and our monetary system exists to mobilize resources in an efficient and accepted manner so as to help improve collective living standards.  Demand for state money is ultimately an extension of this societal understanding of which taxes, laws and systemic infrastructure merely help to organize the institution of state money.  The existence of the state also plays a crucial role in helping to establish trust in the currency.  But the state alone cannot force the private sector to trust state money.

It’s imperative to understand the payments system in a monetary system when discussing what drives money.  Ultimately, the moneyness of money-like items is derived from its acceptability as a final means of payment.  MMT takes this to mean that the final means of payment is taxes, but that is not always the case.  Taxes receipts actually represent a very small portion of the transactions within a system.  What really drives the use of money in a system is the way a certain system is driven by the legal system that dictates how the payment system operates.  For instance, in the USA, the private banks are the issuers of money in the payments system and in order to engage in that payments system you must obtain bank deposits.  While the government plays an important role in dictating the use of this system and designing the “rules of the game” inclusion in this payments system does not REQUIRE the payment of taxes.  It merely requires involvement by doing business with a private bank.  Since most transactions in a modern money system occur within the banking system it is clearly the organized payments system that “drives” money and not merely the tax system.

As we will discuss below, it’s also important to note that banks are the primary issuers of money in our monetary system.  It’s important to understand that banks are also issuers of money in the form of credit.  Innes also understood this point:

“If banks could not issue money, they could not carry on their business”

Banks issue credit without government constraint.  The money multiplier is a myth because loans create deposits.  Banks are never reserve constrained in a modern monetary system.  They create loans entirely independent of their reserve position.  In this regard banks are the primary issuers of new money or credit in our monetary system.

Based on this understanding, we disagree with the notion that money has “value” or is “driven” by the idea that it is accepted at state pay offices for tax purposes.  For instance, the MMT statement that ”the value of certain money derives from its acceptance at state pay offices” is incomplete, misleading and at odds with our style of government.  As JM Keynes stated, “money is the measure of value, but to regard it as having value itself is a relic of the view that the value of money is regulated by the value of the substance of which it is made, and is like confusing a theatre ticket with the performance”.   Ultimately, money derives its value from the quality of the goods and services that the public is able to efficiently mobilize and not the authority of the state in requiring payment of taxes or enforcing laws.  Further, the creation of state money is not merely an extension of the government’s authority, but is an extension of the understanding that state money is a tool that can be used by its citizens to improve collective living standards.

The idea that “money is a creature of law” is a foundational piece of MMT and the state theory of money.  So it’s interesting that MMT often rejects the current laws as they’re in place.  For instance, MMT will often claim that the laws we’ve implemented are “self imposed constraints” (see Fullwiler here & Wray here).  The reason they claim this is due to the inability for the US Treasury to spend out of its account without first having credits.  In other words, it is illegal for the US government to run an overdraft at its account.  Of course, there is a purpose for this (the government must procure funds from its private sector as a user of the money that is issued in a market based system and not a state system), but MMT rejects the rule of law and says that it is unimportant.  This entirely contradicts the very essence of the state theory of money which states that money is a creature of law.  If laws define the nature of money and the current legal arrangement states that the government is a user of money in a private market based system then MMT’s position cannot possibly be correct.

7. Horizontalism, Verticalism, Outside Money and Inside Money.

As is seen in this page, MMT often uses confusing terminology and overly simplified metaphors in their descriptive component of the monetary system.  One of the confusing uses is that of vertical and horizontal.  These terms can be confusing for some economists because the MMT community does not use them in the traditional sense as Basil Moore first used them in his book “Horizontalists and Verticalists”.  MMT does the same thing using the traditional terminology of “inside money” and “outside money”.  MMT often refers to “inside money” in a form that is not traditional.  For instance, in this piece Warren Mosler says:

“The dollar is a ‘closed system,’ what’s called a case of ‘inside money’ due to the fact that they all come from government and/or its designated agents (apart from counterfeits).”

This is incoherent though.  ”Inside money” is bank issued money and “outside money” is government issued money (notes, coins and reserves).  The whole purpose of this terminology is to make a clear distinction between the two forms of money that are in existence.  Claiming that all money is state money or trying to establish banks as “agents” of the government confuses the actual workings of money under the current institutional design.  MMT totally confuses these terms and abuses the way they’ve been used in economics for decades.  It does this to try to blur the lines between the private banking system and the government.  But the fact is, our system is designed with private banks in an oligopoly and a government who facilitates the money creation process of these entities.  The two forms of money are entirely different with inside money being that of the private banking system and outside money being that of the government.  In our monetary system, inside money is the far more dominant form of money.  Outside money merely plays a facilitating role.

MMT builds a problematic and conflated view of the monetary system through the idea of a “money monopolist” and their views of the horizontal (private banking level) and vertical (government level) aspects of money.  The state theory and the monopolist argument used by MMT is at odds with the existence of horizontal money creation (a privately owned banking system).  The state theory of money actually renders horizontal money unnecessary.  The only logical base case that could establish a true monopolist in a state money system would be a fully integrated and nationalized banking system within the vertical level (Fed and Treasury centralized with a nationalized banking system – as mentioned, some MMTers support this approach).  Despite claims that MMT’s “base case” is the Job Guarantee, the purest “base case” is nationalization of the banking system with the Federal Reserve fully integrated with Treasury into one national central bank.

The simple reality is that MMT must result in bank nationalization.  It can be no other way.  If the government decides to distribute net financial assets via bond issuance (as it does now) then it’s implicitly supporting the capital structure of private banking by providing the risk-free assets that the private sector desires to save and built benchmark rates around.  If the government self finances by distributing net financial assets via bank deposit issuance (thereby circumventing the bond issuance) then the private sector will search for yield elsewhere resulting in growth in the private financial sector and shadow banking sector.  Because these assets will not be risk-free they will be destabilizing to some degree as the private degree replaces the lost risk-free assets that are eliminated from self financing.

MMT might propose for the government to issue the bonds in which case we’re simply sterilizing what was already done and there’s essentially no purpose behind the self financing as that system is essentially what’s in place today.  And if the government permanently self finances without supplying the risk free assets then the private sector banking system will become inherently more unstable.

So this form of self financing implicitly supports a massive growth of the private financial system – something MMT would never support because it will inevitably result in destabilization and bailouts.  So the options are simple – you either support the system we have where government NFA supports the private equity capital of banks or you are proposing a self financing scheme that is inherently destabilizing and likely to lead to more government support of the financial system.  MMT tries to have it both ways.  The only other obvious answer is to bring the financial system under government control.  This is MMT’s natural base case.

Of course, this world of government self financing with nationalized banking doesn’t describe the modern structure of the monetary system where inside money is issued almost entirely independent of the government and government is a user of inside money.  In other words, the state does not have a monopoly on money as the private banking sector (the horizontal level) wields substantial control. MMT begins with the flawed state theory of money and takes the the monopolist argument to an extreme and misrepresents the degree to which the USA is a truly state money system.

Because of this flawed foundation, MMTers tend to view the banking system in a way that does not represent our reality.  For instance, Mosler says banks exist for “public purpose”:

“U. S. banks are public/private partnerships, established for the public purpose of providing loans based on credit analysis.”

But this is a strange comment because Mosler’s colleague Randall Wray states that banks don’t necessarily serve public purpose under the current regulatory/corporate structure:

“In the run-up to the Global Financial Crisis, there was much talk of aligning the interests of the top management of these firms with that of shareholders. This could be consistent with the public purpose, although that is not at all guaranteed.”

Of course, private banking is not designed to serve public purpose (except in a narrow sense).  Although the government conducts monetary and fiscal policy through the banking system private banks exist for one primary purpose – to generate a profit for their owners.  This is not necessarily in the interest of serving “public purpose”.  Public purpose, in case we’re unclear is government action intended to benefit the populace as a whole.  This is certainly not the business private banks are in.  Most of the large banks in the USA are publicly traded corporations and serve only one master – their shareholders, not the “public as a whole”.  This has been the cause of many of the problems in the banking system over the last 20 years.  The profit motive left unchecked by government regulation has resulted in a banking system that does anything but serve “public purpose”.   The reality is that we have a very powerful banking oligopoly that serves its owners and not public purpose.   We have banks who issue their own form of money at will.  The only way to rectify this would be to nationalize the banking system and create a horizontal component that is designed to serve public purpose rather than being pure profit maximizing entities serving its owners.  I don’t know whether that would be a good idea or not, but the reality that we live with today is a banking system that does not serve public purpose.  Yet MMT designs much of its theoretical framework around this idea.  It’s entirely inapplicable and MMT persistently contradicts itself in near daily attacks on modern banking while basing their model on the false idea that banks serve “the public purpose”.  It’s incoherent and wrong.

MMT often villainizes the banking system or the “rentier class”, but this position is vastly overstated and even obscured.  Rentier capitalism was a Marxist term that demonized unproductive land owners who charged rents. Although MMTers don’t refer to “rentier capitalism” directly (they prefer to call it Minsky’s “money manager capitalism”) the idea is similar.  In MMT the financial industry is not a productive cog in the capitalist machine.  Mosler, for instance, has stated that the financial sector produces nothing of real value:

“I don’t agree that the financial sector produces real value.  at least I’ve never seen any come out of it in the last 40 years.”

This is a dramatic misrepresentation of the financial sector’s role in the economy.  MR likes to think of the financial sector as the oil that greases the engine of capitalism.  Yes, it’s true that bankers are not innovators in the same sense that Thomas Edison was, but that does not mean they are not serving a crucial role in the economy by helping entrepreneurs find new financing to start a business, by extending credit to a student who is making a substantial investment in their own education or providing credit for the homeowner who doesn’t have $500,000 cash in hand to purchase a new home where they will reside and raise a family.   The financial sector is probably excessively large in the USA, but that does not mean it is producing nothing of value.  Far from it.  We often like to use the analogy of a machine to describe the monetary system and the financial sector plays a crucial lubricating role in the smooth functioning of this machine.

While the state theory renders the horizontal system unnecessary there is no need to villainize the banks to the degree that MMT does.  In fact, the horizontal component serves a crucial role in the monetary system by dispersing the power of money creation away from government, providing price discovery, smoothing the payment process, helping regulate loan creation and numerous other services.  As previously discussed, the logical MMT base case is a fully vertical component with a nationalized banking system.  This would provide the government with a true money monopoly.

This raises an important question that MMT never provides a clear answer about.  Does MMT want a private sector banking system supported by private sector equity capital investment or not?   A system of government self financing conveniently overlooks that question. If the answer is yes, then you need adequate return on equity within the banking system and you need pricing discipline to get that. You can’t just start extracting interest margins (or economic “rents” in MMT lingo) and get that. So, if the answer is yes then the system should remain with private banking (or something closely resembling this). If the answer is no then you’re now onto the road towards nationalization. MMT has a long and storied history of arguing against economic rents and the financial sector.  But they try to have it both ways.  They won’t claim nationalization is a core piece of their theory, but they also want to tear down Wall Street which would, by definition, weaken the financial sector’s infrastructure requiring even more government support or a partial takeover of certain financial sector services.

Our system is designed in such a manner so as to fragment power across different entities.  Banks, while often villainized by MMT, play an important role in dispersing the power of money creation away from the government.  The issue today is not that banking is an inherently evil industry or that the industry does not serve a meaningful and positive role in the economy, but rather that the powers of the banking system are often without proper oversight.  Because banks are granted extraordinary powers they should be subject to extraordinary regulatory oversight.  This would rein in the banking sector and the potential risks it generates in the economy while also maintaining the dispersion of power (which would not exist in a truly state system).

MMT emphasizes a verticalist (government driven) view of money in a need to “place the state back on center stage” whereas MR tries to bring a balance to this perspective with emphasis on the horizontal level while also understanding the necessity of the vertical component.  MR understands how important the vertical view of money is to the monetary system and the enormous power the government wields over the currency users, however, we do not reside in a fully vertical system (Fed and Treasury combined with nationalized banking system).  We reside in a system where the horizontal banking system wields the majority of power over money creation.  From this perspective we emphasize the focus on the understanding that the majority of output and increases in living standards are not driven by the vertical component but by the horizontal component.

When one dives into the accounting behind this we can see that it is Investment that is the backbone of private sector equity and not net financial assets issued by the government.  MRists will often cite the equation S = I + (S-I) to shed light on the private sector balance in the sectoral balance equation (S-I) + (T-G) + (M-X) = 0.   MMT often uses the sectoral balances equation to imply that net financial assets or government spending is the backbone of  the private sector (S-I).  By highlighting the breakdown in Investment and (S-I) MRists bring this story back to the reality that Investment is the backbone of private sector equity.  We drill down into the private balance to show that it is Investment that drives increasing living standards and not government spending or issuance of net financial assets.  And because Investment is almost entirely financed through private horizontal banking transactions it is misguided to emphasize the vertical level’s importance in the wealth creation process.  It’s important to note that while we view the horizontal level as wielding great power over the monetary system we also recognize that the state, as an autonomous currency issuer can utilize its strengths to positively impact the economy.  So while we might focus on the horizontal level due to its sheer size and impact, we also appreciate and emphasize the importance of understanding the vertical level.

8.  MR disagrees with MMT’s consolidated government view

MMT consolidates the central bank and the treasury in order to meet certain ideas such as government “government spending comes prior to taxation”.   This all ties into their incorrect idea of the government being a “money monopolist” and using taxes to “drive money”.  Banks are used by the Federal government in the USA and harnessed to provide the necessary funding.  In this regard, the government cannot “run out of money” and has no solvency constraint.  MR and MMT agree on these points, but we disagree with the institutional arrangement under MMT as it results in a distorted view of our reality and confuses monetary policy with fiscal policy.  As fiscalists, MMT essentially eliminates monetary policy all together.

The reality is that the Treasury is a currency user under the current institutional framework and the Fed is the currency issuer.  So the Treasury must obtain funds for its account at the Fed before it can draw on these accounts.  It’s completely possible that the banking system can create and does create ex-nihilo money in order to provide funding for the government or the private sector.  In fact, almost all of the money in our monetary system is “inside money” or bank money.  Not what MMT refers to as “vertical money”.  So it’s illogical to say that spending must precede taxation.  It clearly doesn’t.   Banks can and do create money without government constraint and as previously mentioned, bank money can be used to pay one’s taxes.  The majority of money in circulation today is in fact bank created money and not government money.

MMT refers to the consolidated government as a “currency issuer”, but this view distorts the reality that the government is also a currency user in some aspect.    Ie, it cannot just spend without procuring funds from the private sector.  MR clarifies this point by describing how the quantity value of a currency (purchasing power) can be destroyed and essentially result in rejection of the currency by its users.  A lack of clarification on these points will lead one to believe that government can merely force its currency on its users because of some totalitarian control.  It’s a false description of the reality of money.  MMT creates the previously discussed hierarchy of money to resolve this conflated point and establish a relationship between bank money and government money.  But MMT then contradicts itself by stating that banks create their own reserves thereby nullifying the whole purpose of establishing a “hierarchy of money”.

Further, this consolidated view confuses monetary policy with fiscal policy.  MMTers are truly fiscalists which means that they would prefer not to use monetary policy at all.  They truly believe the economy can be driven by changes in fiscal policy.  This consolidated view is consistent with this idea of the fiscalist approach in that it essentially turns all policy into fiscal policy.  These views are simply not consistent with the reality of our world so the consolidation of the Fed and the Treasury offers us little in actually being able to understand the operational realities of the monetary system.

Lastly, MMT often simplifies things to make a point more palatable.  For instance, they often use the analogy of government being a scorekeeper to push forward their idea that taxes don’t “fund spending”.  Mosler says:

(government) spends by marking up numbers in bank accounts at your Fed, just like your Fed Chairman Bernanke has testified before you.

When you (government) tax, the Fed marks numbers down in bank accounts. Yes, the Fed accounts for what it does, but doesn’t actually get anything”

Mosler often says that tax money gets “destroyed” by the Treasury:

“Consider what happens should you go to the Federal Reserve to pay taxes with actual cash.

First, you hand over a pile of currency to the Fed as payment.

Next, the Federal Reserve counts it, and then gives you a receipt and a thank you for helping to pay for social security, the interest on the national debt, and the Iraq war. And as you, the tax payer, leaves the room and closes the door behind you, they take that hard earned cash you just forked over and throw it in a shredder.

Yes, they throw it away. Destroy it! Why? They have no further use for it. Just like a ticket to the Super Bowl. As you go into the stadium, you hand the man a ticket that was worth maybe $1000, and they tear it up and throw it away.”

This is completely contrary to the way our monetary system actually works.  The Treasury is a user of the currency, not an issuer.  Its account at the Fed must always be funded before spending can occur.  You cannot debit the Treasury account before first having it be credited.  It’s incoherent to say that tax money gets “destroyed” or isn’t used for spending.  Of course it is used.  The government is not just an issuer of currency, but also a user of the currency.  But MMT, in an attempt to bring government spending back to center stage, creates the illusion that government is not a user of the currency in some capacity.  Rather, they are ALWAYS the issuer in MMT.  Mosler even states:

“The funds to pay taxes and buy government securities come from government spending. “

The reality is that the private banking system issues most of the money in the monetary system and the government ends up using this money and essentially having to allow the private sector serve as its funding source.  This might be by choice, but it is an incredibly important choice as it completely changes the dynamics and understandings at work here.  The funds to pay taxes and buy bonds do not come from the government.  They primarily come from a private banking system that issues money independently of government.

Similarly, fiscal policy does not result in an increase in the actual amount of money in the monetary system as MMT often claims.  Fiscal policy results in the addition of a net new financial asset in the form of the bond, but fiscal policy involves procuring funds from the private sector and recycling these funds back into the private sector.  The actual amount of inside money, or bank money, does not change.  So the government’s fiscal policy has no direct impact on the amount of inside money within the monetary system (by far the dominant form of money) and actually has a very minimal impact on the total money supply (although the government is the issuer of notes, coins and reserves these are minor forms of money in the grand scheme of things).  MMT distorts this view by claiming that banks are essentially a part of the government and that all money is government money.  This is completely false as banks issue money not for public purpose, but for private profit and do so with almost no constraint from the government.  They are, for all intents and purposes, issuers of their own type of money (inside money) even though it is denominated in USD.

It’s true in theory, (I guess in Modern Monetary Theory) that the government could fully fund itself by having the Fed just credit accounts, but that’s not how the monetary system is currently designed.  It is designed to disperse this power away from the government.  So taxes do not destroy money.  They are a way for the government to procure funding and recycle funds for public purpose.  The metaphor of shredded dollars is an oversimplication that applies only to paper notes.  Yes, some paper notes are destroyed (and replaced), but the reality is that when the government procures funds for taxation it does not “destroy” that money.  It debits private accounts and then credits other private accounts using those exact funds.  The accounting here is very precise and irrefutable.  Tax credits DO NOT get destroyed.  They are debits and credits in exact dollar amounts that are nothing more than a simple redistribution of existing money.

Importantly, the government is not some exogenous entity wielding its will over the people just crediting and debiting accounts with guns at our heads.  The idea that taxes don’t fund spending defies the accounting logic behind actual monetary operations and the very real constraint that is quantity value (purchasing power).  These sorts of analogies are powerful in helping the novice economist understand MMT, but they only serve to confuse the actual operational realities of our monetary system.

MMT states that bonds don’t serve to finance spending and are instead just a “reserve drain”.  But again, this ignores the institutional design of the current system in favor of MMT’s consolidated view which doesn’t apply to the way the current system is constructed.  It’s true, in theory, that the government could issue funds without ever having to procure tax receipts or sell bonds.  But the system is designed so the Treasury is a currency user and must validate its use of the social construct (fiat money).  This is easily understood if one understands what occurs in a hyperinflation.  For instance, during a hyperinflation (the collapse in what MR calls quantity value or purchasing power) tax receipts collapse and the banks stop buying bonds as prices collapse at a rate that makes it unprofitable and threatens survival of the bank.  The Central Bank must then monetize, but in all likelihood the currency is well on the path to destruction.  This is due to the fact that a government is seen as being a “risk free” issuer of money because it can tax and sell bonds at will.  If it loses this capability then that currency is no better than a piece of paper issued by a private corporation (with a true solvency constraint).   So we can see in this example that the government is a user of the currency in the sense that if it ever loses the capability to procure funds then the fact that the central bank can just credit accounts is really a rather meaningless point.

The government can control what MR calls acceptance value, but cannot control quantity value (because it is always a user of the social construct, ie, money).  *Quantity value is essentially purchasing power while acceptance value is essentially the demand driven by legal necessity by virtue of state mandate regarding the social construct.  In this regard, the currency can always collapse if the public rejects the currency (regardless of the state’s power of the purse or status as representatives of the public) leading to a collapse in tax receipts or bond sales.  MMT tries to establish the state as a currency issuer who can control the value of its money without any taxing or bond sale constraints.  But this ignores the role of the public in using the currency in addition to the fact that the government is always a user of the currency in some form.  MMT uses examples of guns to people’s heads in describing currency demand because they believe the state can drive the value of its money.  But this completely ignores quantity value and the role the private sector plays in giving money its value (primarily through production).

9. Is the MMT Job Guarantee everything it’s cracked up to be?  

We reject the MMT Job Guarantee (JG), a government program that seeks to provide employment for anyone willing to enroll. MMT has described their “Job Guarantee as their “most important policy”, “central” to MMT and the “base case” for MMT.  Firstly, MR rejects the idea that any policy proposal should be “central” to what MMTers refer to as “Macroeconomic Reality”.  The MR position is not that we do not believe in full employment (we do!) or that we do not think the JG is well intentioned, but rather that we do not believe MMTers have offered convincing evidence proving that a JG could work to optimize the living standards of our society.

Many who first confront MMT believe it has a prescriptive and descriptive component.  But the operational realities that MMT uses are not the property of MMT.  Rather, they are our reality.  What makes MMT a “theory” is the specific application of this understanding and the way they distort our reality to emphasize their policy ideas.  In this case MMT believes (among other policies) that we should run an employment buffer stock instead of an unemployment buffer stock.  To reject this position is to reject MMT’s “base case”.  In other words, you either support the JG or you’re not MMT.  If you do not support the employment buffer stock then you’re supporting a different theoretical framework.  To accept this idea is to accept the fact that MMT has advocated (explicitly) running a government managed full employment program of as many as 30 MILLION workers.  Randall Wray has also said the JG “should be” $16/hr with health benefits. He’s also said the JG would add “10-30 million jobs”.  This is a near doubling of the current government workforce.  That’s quite a position to swallow if you’re skeptical of the efficacy of government spending and its impact on the economy.  For a policy that is entirely untested anywhere on earth (in this magnitude) MR views this policy recommendation as more ideologically driven than fundamentally driven.  The data simply doesn’t exist to support such a program.

MMTers describe unemployment caused via taxation as the “base case” (which, as previously discussed, is incorrect) and use the state monopolist argument to claim that only the government can create full employment and price stability via an army of employed.  But we feel that this view does not properly account for the potential risks that could arise with such a program and is formulated from the incorrect idea of the coercive monopolist.  The JG could create unintended consequences which reduce the potential living standards of the society over a multi-generational period. In addition, since the JG is unlikely to be demand supportive or an effective inflation buffer, it will rely heavily on other policies as a supplement. We believe the government should consider other policy measures to establish an environment of full employment and price stability.  Perhaps most importantly, we do not believe one must understand these sorts of government policies in order to understand the operational realities of the monetary system.  As stated above, we do not believe it is our duty to impose policy on the reader.  The Job Guarantee is presented in a way in which “there is no alternative”, but we do not believe this to be the truth.  Politics and policy should not get in the way of understanding the operational realities of the monetary system.  What the reader decides to do with his/her understanding is entirely up to them.  In this regard policy is 100% peripheral to MR.

To us, the most important element here is that we believe policy should be entirely peripheral to understanding the modern monetary system.   But it should not go overlooked that such a substantial government bureaucracy is entirely untested and is backed by very little evidence of functioning with the efficiency that MMT advocates assume.

10. What you consume or what you produce? 

MMT lacks emphasis on the idea that producers matter as much, if not more than consumers in the effort to create better living standards in the world. In fact, the MMT research is almost entirely based on increasing aggregate demand, the social safety net, the job guarantee and other forms of government spending. Though perhaps unintentional, we believe this is short-sighted as it is production that ultimately affords us the true holy grail of economics – time. It is through innovation, creativity, productivity and growth that we are able to consume more in the future (see here for more).

Some of MMT’s primary advocates are vocal about the fact that they don’t care about economic growth.  Bill Mitchell has explicitly stated that he doesn’t even think a nation needs to grow to be prosperous:

“A lot of readers write to me questioning why I consider economic growth to be important. It is a complex topic and beyond a single blog – especially one that I am writing late this Friday afternoon. The short response is that I am not pro-growth.”

MMT takes the stance that consumption is superior to production arguing that because we prefer to consume then that’s what we should seek as a societal goal:

“There is a strong presumption, especially from the progressive side of the political debate that manufacturing – or what you produce – defines the capacity for a nation to enjoy growth in real wages and therefore standards of living.

…I take a more experiential viewpoint. People prefer to consume than to work. What we consume is more likely to give us joy than what we produce especially if the latter is in the context of exploitative capitalist production relationships.

…Clearly it is more complicated but in general I do not think you need a manufacturing sector to enjoy strong growth in material living standards and perhaps a polluting manufacturing sector erodes the capacity to enjoy broader concepts of growth and well-being.

…from a monetary perspective I don’t think worrying about external deficits is valid.

…Is it necessary to produce goods if you can consume them via trade?”

MMTers make no attempt to hide their disdain for capitalism.  Wray is broadly noted referring to all capitalists are “undertakers”, a vast generalization intended to politicize and stoke a negative connotation:

“Personally, I like the original term for capitalist, applied by the “father” of economics, Adam Smith, to the businessman: the “undertaker”. Today, we mostly limit the term to the capitalist engaged in the business of death, but I think it is appropriate to reclaim the term for all our capitalists. It is the undertaker who does most of the bidding of the efficiency fairies—continually striving to weed out the inefficient, the unproductive, the unfit.”

MRists find these perspectives somewhat disconcerting.  It’s all consistent with their view that trade deficits are never a concern.  So long as you can import something you have no need to produce it.  Ah, if only the whole world could be consumers without producers!  Of course, it’s not so simple.   And naturally, we would all rather be able to consume and not have to produce anything.  Most people would much rather work at the beach giving surf lessons than sit in the office all day.  But this does not mean that surf lessons is a superior means to an end (happiness).

Randall Wray, another founding member of MMT, takes this perspective one step further by comparing capitalists with undertakers:

“Personally, I like the original term for capitalist, applied by the “father” of economics, Adam Smith, to the businessman: the “undertaker”. Today, we mostly limit the term to the capitalist engaged in the business of death, but I think it is appropriate to reclaim the term for all our capitalists. It is the undertaker who does most of the bidding of the efficiency fairies—continually striving to weed out the inefficient, the unproductive, the unfit.

He proclaims himself to be the “job creator”, but as we know, a good undertaker—like Mit–is a job destroyer. That is what the Darwinian process is supposed to do: increase efficiency by destroying jobs. It has long been understood—since the days of David Ricardo—that the “machine process” is a net job destroyer as we replace human labor with machines. It is true that new lines of business plus new markets open up job opportunities, but our undertakers will immediately begin to destroy as many jobs as they can in the quest to increase productivity. There is no market force to ensure that on balance new jobs are created more quickly than the undertakers can destroy them.  And destroying jobs also destroys markets for the output of the remaining workers—so the natural market force is always destructive (Schumpeter called it “creative destruction”).

All of our undertakers really are in the business of death.”

Again, this is a disconcerting and extremist view of reality.   We reside in a society in which we are rewarded based on the value of our productive contribution to that society.  Those who are innovative and highly productive are (usually) rewarded for giving much to society.  Those who are not are not rewarded.  This is the essence of a capitalist economy.  And it is the very foundation upon which greater living standards are achieved.  Whether one realizes it or not it is primarily through the optimization of time and labor that we achieve greater living standards.  If we all gave surf lessons for the rest of eternity our living standards would stagnate.  As the MR law states, it is through the optimization of time that we improve living standards:

The MR Law:  “We generate improving living standards through the efficient use of resources resulting in the optimization of time“

Sitting on the beach all day might sound great, but it is against human nature to sit on the beach all day satisfied.  The French philosopher Volney wrote about this in his classic Empire of Ruins.  He called man’s innate desire to improve and make progress “natural law”.  He said:

“And what is the natural law?” replied the simple men. “If that law is sufficient, why has he given any other? If it is not sufficient, why did he make it imperfect?”

“His judgments are mysteries,” said the doctors, “and his justice is not like that of men.”

“If his justice,” replied the simple men, “is not like ours, by what rule are we to judge of it? And, moreover, why all these laws, and what is the object proposed by them?”

“To render you more happy,” replied a doctor, “by rendering you better and more virtuous. It is to teach man to enjoy his benefits, and not injure his fellows, that God has manifested himself by so many oracles and prodigies.”

The world of beach bums consuming everything and producing nothing is a fantasy.  A pipe dream.  It is against the very essence of our being to become a world of consumers who seek only to consume that which others produce.  More importantly though, the MR law focuses on the fact that living standards are improved through the optimization of time.  How is this achieved?  It is achieved through innovative progress.  When Alexander Graham Bell invented the telephone he was indeed destroying the jobs of the messengers.  But in creating the phone he made us all substantially more productive.   He gave us all more time to consume other things, just like a washing machine means you can consume or produce instead of spending 3 hours lugging your laundry back and forth from the river.  This is the essence of how the entrepreneur creates future jobs, future demand and improves living standards.  Comparing these people to undertakers is a crime upon logic and an insult to anyone who has ever undertaken the risk to start a new business.

Consumption and production are two sides of the same coin, but it is through production that we grow the coin.  We highlight this point by expanding on the sectoral balances equation and showing that S = I + (S-I) in order to emphasize that I>S does not mean the private sector financial position is necessarily deteriorating or experiencing a “net loss” as MMT has described.  So while the sectoral balances equation is useful in understand the dynamic of the system it should not be used to imply that the private sector’s financial position is necessarily deteriorating because I>S .  When one takes this perspective you bring a more balanced understanding of the way our monetary system actually works instead of bringing the government back to “center stage” as MMT attempts to achieve.  Private sector saving can be decomposed into the amount of saving created by investment “I” and the amount of net financial assets transferred from other sectors (S – I). That is the focus of the equation S = I + (S – I) as it highlights the fact that the private sector is the primary driver of economic prosperity while government is a powerful facilitator.

None of this is to imply that Monetary Realism doesn’t appreciate consumption (or public purpose) or the power of deficit spending, but as mentioned above, we view consumption and production as two sides of the same coin rather than a tug-of-war. Maintaining a balance and focus on each is important and we will use our focus on MR to emphasize that a nation is not wealthy only because it can consume a great deal or because its government spends money, but also because it can produce a great deal.  MR seeks to provide a more balanced perspective not only in this regard, but in regards to all aspects of the monetary system.

11.  MMT Often Misrepresents Wynne Godley’s SFB to Generate a Government Centric View of the World

As we know by now, MMT is designed around the state theory of money, intends to “bring the state back to centre stage” and believes the monetary system exists to move resources from private to public domain.  We’ve touched on the many reasons why these views are extreme or misguided.   But it’s important to touch on another powerful visual tool that MMT often uses to promote this view – Wynne Godley’s sectoral balances.

The sectoral balances is a view of the economy through the relationship of flows.  It is generally presented with a private, public and foreign sector view and broken down using the following GDP equation:

GDP = C + I + G + (X – M)

MMT alters this equation to show how the sectors net to zero:

(S – I) + (G – T) + (X – M) = 0

MMT will present this to show how the government’s spending is the non-government’s saving.  Generally something like this:

(S – I)=  + (G – T) + (X – M)

 They will then present this chart to present this view of the world:

This is a powerful visual and accounting based presentation of the economy and its various components.  Unfortunately, it is limited in what it really tells us.  MMT uses a 3 sector SFB model that offers an ex-post snapshot of economic activity.  The view is intended to provide a static government centric view of the impact of deficit spending on the economy with the implication that government spending is crucial to economic growth.  While it’s true that deficit spending can facilitate private sector growth in various ways, it’s also important to maintain perspective here.  The 3 sector view completely obscures the private sector interrelationships and the complexity and importance of these relationships.  This is crucial in understanding the monetary system because the growth of the economy is driven primarily by these private sector transactions.

MMT will often use a closed economy example to show that (S-I) = (G-T).  In other words, they show that governmetn spending IS private sector saving.  Viewing the closed economy through the (S – I) = (G – T) lens completely ignores the reality of the world which is S = I + (G -T) + (X – M).  The private sector does not only expand through government spending or trade.  It grows its real wealth through S primarily by maximizing Investment.  Looking at the sectoral balances through (S-I) treats investment just like consumption. This is a fundamental error as investment creates wealth.  MMTers do this to promote their fiscalist agenda and provide a government centric view of the world.  They will often claim it is the centerpiece of their “accounting consistent framework”, but their presentation of it is deeply misleading and inaccurate.

We find that MMT often uses the sectoral balances equation to proclaim things like “Without a government deficit, there would be no private saving.”  Or with a current account deficit and budget surplus the private sector experiences a ”net loss”.  These statements are categorically false and used to rationalize policy approaches in MMT that may or may not be productive, but contribute to deficits.  More importantly, these kinds of statements are based on a completely confused alternative perspective of private saving.

Much of the confusion in this discussion comes from MMT changing another definition.   In the MMT world net saving is (S-I).  But in the rest of the accounting and economics world net saving is as the OECD defines it.  ”Net saving is net disposable income less final consumption expenditure.”  The OECD definition comes from the United Nations system of national accounts, and is consistent with the BEA definition too. It’s also consistent with every economic school apart from MMT. For all these economists, saving is “income less consumption”, and for the private sector this is “S”. This is in contrast to the MMT definition of saving as “income less spending”, which is S-I.  The economist or layperson who learns this from an MMT economist will come away not understanding that the economy is built on a stock of financial assets, not a stock of government net financial assets, which is the primary takeaway from understanding the net finanical assets are created through government spending.  This is not to imply that net financial assets don’t matter, but the MMT view again tries to create a government centric view of the world where NFA matters most when the reality is that the stock of assets built up by the private sector far outweighs NFA in terms of balance sheet importance and real economic importance.

This results in a deeply flawed view of the world in which there is essentially no difference between Investment and Consumption. By treating all investment and consumption as “spending”, MMT makes a fundamental error and arrives at the conclusion that we have to increase G-T, to increase S. If instead, we recognize that wealth is increased primarily by I, and S can be increased by I, then we arrive at a whole different list of policy recommendations and a much more realistic view of the world which focuses on the fact that the private sector is the creator of most of the stock of financial assets that matter most to the economy.

In the MMT world, all money comes from the government so if the issuer of money does not make the money available then how can it be saved?  They present this view through the consolidated private sector view of S = (S-I) or Saving NET of Investment as opposed to the traditional definition of Saving.  Of course, as we’ve shown above, all money does not come from the government.  The private sector’s balance sheet is built primarily on these private transactions that create its net worth.  For instance, the USA’s private sector has a net worth of  $65T.  This stock of assets and liabilities is built primarily on the (S-I) component and the various assets and liabilities that exist WITHIN the private sector.  This stock is accumulated almost entirely through private sector transactions.  These transactions did not originate with the government.  The public sector’s net financial assets represent about $15T of this total (ie, that’s 77% or $50T in net worth represented by the non-government component).  Now, $15T is not an insignificant piece of the pie, but again, the balance and perspective must be maintained in this discussion or one will come to believe that it is government spending which drives growth when it is actually private sector transactions that drive growth.

Most of our savings is funded through the creation of private investment.  When someone takes on debt to invest in a new business the bank does not dissave to help fund this investment.  Bank loans create deposits.  Banks in the modern monetary system are not reserve constrained.  They are capital constrained.  So a bank does not have to dissave to create a new loan for new investment.  Yes, it results in no gain in net financial assets (the loan creates a liability for the borrower and an asset for the bank), but it’s incredibly misleading to imply that this process cannot still help the private sector as a whole.  In fact, this process is the primary way that the living standards of the private sector increase because that business owner will invest in his/her new business, hire new employees, innovate, create new goods and services and increase overall output.  In doing so, the corporation might issue stock or issue debt along the way.  These securities will be held by the public as a claim on the business’s future cash flows.  They are savings to the private sector.  And most of our savings is made up of these private sector liabilities like corporate bonds, money market funds or common stock.  They are liabilities of corporations and assets for the rest of the private sector.  But MMT nets out Investment thereby overlooking the importance of the private sector in this process.  They instead focus on the net financial assets provided by the government.  As the above $50T:$15T  example displays, this is a totally unbalanced view of the world.  This is a terribly flawed view of the world and could only be rationalized by viewing corporations as though they are households. Ironically, MMT loves to say that governments are not like households, but they have no problem treating corporations exactly like households.

This same error can be seen in Randall Wray’s latest book “Modern Money Theory” in which he uses the two sector model to describe how:

“if the government always runs a balanced budget…the private sector’s net financial wealth will be zero”

This is a narrow view of the world.  For instance, in the 15 year period between 1993 and 2008 the private sector ran a persistent negative balance  average -1.5% (see chart below).   Over this same period household net worth increased by 150% and nominal GDP increased by a staggering  105%!   Of course, MMT’s two sector model nets out private investment which grew by 100% over this period.  So, despite the lack of a substantially negative private balance, the domestic economy actually did remarkably well during a period in which MMTers like Randall Wray were consistently calling the US Economy a “contained depression” (as soon as the early 90′s).  15-20 years later the economy entered a crisis and the MMTers all claimed they got “everything right”.  All it took was nearly two decades of being wrong….

It’s crucial to emphasize how most of the money in our monetary system comes from private banks who issue money in a market based system based on demand for loans.  Loans create deposits and so loans contribute to the income of the private sector.  The most important understanding in how these loans impact private sector balance sheets is in understanding how (S-I) is broken down and how these debt and income levels are contingent upon one another.  This is why the 3 sector model is inadequate in offering a complete picture here.  You must use a 4 sector (or more) model to show the relationships between the various private sector entities.

For instance, when considering the US housing bubble it’s important to understand how the weakening HOUSEHOLD balance sheet led to an instability within the private sector.  What happened was rather simple.  As the economy slowed in the 2000′s households tried to supplant lost income via asset price increases.  The real estate bubble was a perfect source for this income since the world had become convinced that home prices can’t decline.  This resulted in a typical boom/bust cycle that was sustainable only so long as the asset prices were sustained and the income growth continued to support debt accumulation.  But what occurred within the private sector was an imbalance in the debt:income ratio due to the asset bubble.  Household’s were overly exposed to debt built on a very fragile income stream.  When the bubble popped (for whatever reason) the incomes dried up and the debt de-leveraging cycle ensued.  Understanding the government component is important, but not crucial to understanding the private dynamics of the housing bubble and how debt accumulation can be unstable when it’s attached to volatile asset prices.

The other problem MMT presents here is completely ignoring the importance of real assets.  As MR notes, investment is the backbone of the economy.  Why?  Because it is through investment that real assets and real improvements in living standards are primarily achieved.  For instance, when someone invests $100K to build a home they might do so by taking out a bank loan.  MMT would say the bank loan nets to zero.  But when the home is built and the loan is repaid the private sector has a real asset that increases their net worth by $100K (more or less depending on the market value of the home).   Our economy is built on real assets like homes, machines, inventories or other assets like corporate stock that don’t show up in MMT’s “net zero” equations, but are the backbone of the economy and the way we improve our living standards.  Real assets do not “net to zero”.  So MMT’s version of the world where “Private balance + Gov’t balance + Foreign balance = 0″ only applies to financial assets.  MMT distorts this reality to focus on (S-I) so that the novice economist will come to believe that the private sector is always better off via government spending.  This is not necessarily true though.

MR clarifies these misrepresentations by diving into the private component to better understand the monetary system and the drivers of growth.  MR uses a derivation of the above equations:

S = I + (S-I)

The purpose is to more accurately present the sectoral balances with the emphasis on the understanding that it is private Investment that primarily drives Saving and growth in the economy as opposed to the government centric view that MMT presents.  This equation shows that the backbone of private sector equity is investment, not Net Financial Assets and seeks a better understanding of the primary driver of living standards based on the MR Law and the understanding that living standards are best optimized when resources are utilized efficiently.

As mentioned above, MMT achieves this permanent deficit spending position by arguing that current account deficits are superior to current account deficits.  Of course, in sum, the world cannot only run current account deficits so MMT focuses on exceptional cases like the USA whenever possible.  In doing so, they are able to argue that persistent budget deficits are a must and that they’re a “real benefit” to the USA.  As mentioned above, this view is very narrow.  Singapore and Norway, two extremely healthy economies, run persistent current account surpluses and budget surpluses.  But you would never hear an MMT advocate promote such an economic position because then the walls of the theory and the central fiscalist components become totally void of value.

12.  MR is open to other schools of thought and policy options.  

MR doesn’t claim to know everything or to be able to prescribe policy options that will always work.  In this regard, MMT has proven very rigid in its policy response.  What we mean by this is that MMT tends to have one pre-set group of prescriptions that are always prescribed as “the fix”.  MR views the economy as a more dynamic and unpredictable machine that requires a broad array of policy options given particular environments.  There is no “one size fits all” policy response.  In this regard MR is much more open to monetary policy AND fiscal policy and prefers not to hamstring policy makers by claiming that one policy approach is necessarily always superior to another.  This gives us much more flexibility in surveying the economic environment and working with other economists and policy makers to provide the right policy perspective for the given environment.  While MR does not have a predetermined set of policy options that will define what MR is, we will at times offer varying opinions based on our understanding of the economic environment and monetary system.

13.  MR Seeks To Eliminate Politics From Economics

A bold statement we know!  One of the primary catalysts leading to the creation of MR was our vast disagreement with the approach of most economics, which embeds policy in economics and builds an understanding around this political preference.  What we want to focus on is an operational understanding of the money system.  We are seeking to describe how a fiat money system works.  This is unlike much of modern macro which starts with politics, policy options and then fills in an understanding of the money system around this.   Keynesians do this by believing that government intervention through deficit spending is superior.  Monetarists do this by believing that the Fed can control the money supply in a more government neutral approach.  Austrians do this by believing that government needs to be constrained through something like the gold standard.  And MMTers do this by believing that only the government can resolve the problem of unemployment through deficit spending.  In the case of MMT they design a theory based on the idea of government as having the ultimate power.  They build a “hierarchy of money” to give the perception that the government is a monopolist and at the top of the chain of influence.  This might be true to some degree, but we feel that it is misleading.  Rather, a monetary system is more analogous to a complex machine with many moving parts all of which come together to create a certain result.  Like most economic movements we find MMT to be based largely on a policy agenda that results in misleading or incomplete conclusions.   In fact, MMT explicitly states that it has a progressive and ideological agenda: “So MMT is inherently progressive.”   We applaud MMT and other macro schools for taking a proactive approach and promoting a policy agenda and proposals directly.  But MR takes a totally different and unique approach by focusing almost entirely on the operational aspects of the monetary system and letting the reader decide what policies are best.

We also find it disconcerting that MMT often tries to hide the fact that their approach is politically motivated by a left wing agenda.  MMTers are almost universally left leaning on the political spectrum with many of them being extreme left.  They often describe MMT as being politically agnostic and often use Warren Mosler’s tax cut proposals and involvement in the financial industry (as if this automatically makes him a red blooded right wing free market capitalist) as evidence that the theory is unbiased.  But even Mosler is a democrat and ran for Senate in Connecticut in the Democratic party.  So MMT’s version of “right” is actually “left”!  I don’t know why they try to hide the fact that they have a left wing policy agenda (and frankly I agree with many of their proposals and don’t really care that they have a left wing agenda), but I don’t know why MMT feels the need to obscure this fact.  It’s just one of many inconsistencies that have been highlighted here….

Unlike MMT, MR is based on a positive (as opposed to normative) economic approach.  So much of economics today embeds policy in their understanding of the world resulting in the “dismal science”.   Rather than envisioning the world for what it CAN be, we first want the world to understand what IS.  We know it’s impossible to completely separate the politics and normative from the positive, but we believe readers will find that MR is as close to apolitical economics as you’ll find.  We instead focus entirely on what IS and hope only to explain how the monetary system actually works.   We might opine on policy at times, but you’ll never find policy actually embedded as a necessary or central piece of MR.  We view this more from the scientific perspective.  Before we can prescribe fixes for the current system we must first understand it.  We are using MR to establish this foundation of understanding.

We explain how it works, YOU decide what to do with it….

In sum, our primary difference with MMT will be our emphasis on the operational realities of the monetary system.  We aren’t seeking to change people’s politics or force policies on anyone.  We seek only to provide the reader with an unbiased and apolitical perspective on how the modern monetary system actually works.  Where the reader goes politically is entirely up to them.  Any policy ideas that we might discuss on the site are our opinions and entirely peripheral to the core understandings in MR.  We hope this resource becomes a source for educating the public on the operational realities of the monetary system and we hope that this will help create a more informed public ultimately leading to a better and more prosperous environment for all of us.  We would also like to applaud MMT for taking a progressive policy approach to these matters. We believe MMT’s description is superior to the neoclassical model, but still lacking in that their message is not entirely clear and can often be confused with operational reality (as opposed to being inherently prescriptive and descriptive of an operational potential).   While Monetary Realism’s message is important it’s vital that the next steps be taken to actually impact policy.  We do not feel that it is MR’s job to force this change, but would rather educate the public on the way the system works.  We hope to continue to educate the public on these matters for years to come.

* I should note that I (Cullen Roche) was a proponent of MMT for around 18 months after discovering it in 2010.  As  former MMTer my understanding and mastery of the concepts is far superior to many of the MMT “critiques” that currently exist.  

Despite some criticisms, it should be emphasized that many of the broad MMT concepts are incredibly useful and a vast improvement over neoclassical economics.  The explanations of the banking system, busting the money multiplier myth, emphasizing the idea of a currency user and the fact that an autonomous currency issuer cannot “run out of money” are all very powerful and superb concepts that should be adopted by everyone in the field of economics.  MMT and its founders deserve enormous credit for their work on these matters and getting these messages out to the mainstream.  

MR’s disagreements go much deeper than these broad macro ideas and have more to do with the intricate details of money, capitalism and the operational realities of the monetary system as it is designed.  So while MMT is an improvement over the mainstream neoliberal views, I do believe MR is a necessary step in helping to better balance these big broad understandings with a more complete and balanced understanding of operational realities. Regardless of our disagreements, MMT has proven incredibly helpful in expanding the understanding of the modern monetary system and breaking the neoliberal views.  For this they deserve a great deal of credit.  That’s not to be overlooked in this critique.   

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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