Richard Werner Explains Our Money
There’s a clash of ideas in Richard Werner’s work and that of Monetary Realism’s. I’ve had a stack of papers on my desk here by Werner, a German economist, that I’ve been meaning to write posts about for weeks. But they’re so good that I don’t to do them injustice. But then today I am clicking through my FT links and I see this:
“There are different types of money. The first is legal tender paper money. This is mainly used by the public for petty transactions and amounts to only about 3 per cent of the total money supply. Another type of money also created by the central bank is solely for the use of its clients, the banks. This is reserve money. It stays in the banks’ accounts at the BoE to settle their claims against each other. If one bank reduces its reserves, this raises those of another bank, leaving the total amount of this closed-loop money unchanged. It normally also amounts to about 3 per cent of the money supply, but it never circulates in the economy and as such is not really money. So what about the money that is used for most transactions and accounts for the bulk of the actual money supply?
As Martin Wolf has pointed out, it is created by profit-oriented companies, the banks, when they do what is commonly referred to as “lending money”. But they don’t lend existing money. Instead, they newly invent the money that they lend…”
That’s perfect. MR describes the money types as outside money and inside money. That is, inside money is the money that’s created inside the private sector by banks (bank deposits). And outside money is the money created by the government outside the private sector. As Werner notes, the money that matters most is inside money. Outside money just facilitates the use of inside money (for instance, cash allows withdrawal of money for someone who has an inside money account and reserves or central bank money simply help settle interbank payments and smooth the efficiency of the payments system).
Anyhow, he has some other thoughts on having the government borrow directly from the banks, but that’s the policy side of things. Me, I am more interested in getting the operational description exactly right and Werner seems to really get it.
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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A sincere question for Professor Werner that I hope you’ll be happy to answer. The claim that
“Instead of decision-makers well versed in fiction, we need a bit of non-fiction know-how about how our monetary infrastructure works. Paul Tucker’s suggestion that negative interest rates on reserves might encourage banks to lend more is likely based on textbook descriptions of “fractional reserve” banking and the notion that banks can withdraw the reserves to lend them to the economy. These belong to the world of fiction.”..
Even if you believe banks lend out of their capital, not their reserves – surely the interest they earn on their reserves (whatever it may be) serves as some sort of “hurdle rate” on their decision to lend money? If you assume that – they would presumably lend more at lower IOER than higher IOER. So what am I missing? Not that I’m trying to suggest negative IOER is any sort of solution.
Also, the New York Fed has long argued IOER is exceptionally important and is the mechanism due to which the multiplier won’t kick in. That’s why they introduced the IOER when they started QE.
Delta, this bit of your comment confused me: “Even if you believe banks lend out of their capital, not their reserves”
I believe they lend out of thin air, not capital. Are you using capital here as a synonym for equity? As in capital = assets – liabilities?
BTW, I’ve been trying to create simple balance sheet examples for some basic bank lending operations. I just added one with capital requirements. I’m not sure its 100% correct, but take a look:
http://brown-blog-5.blogspot.com/2013/03/banking-example-3-capital-requirements.html
The point is that capital requirements are a regulatory constraint on loans (while reserves are a regulatory constraint on deposits).
Read the Carney article for more info (link at top).
But as to your question, JKH, at monetaryrealism.com, touched on this subject in a response to another commenter (the infamous Morgan Warstler):
http://monetaryrealism.com/krugman-on-says-law/#comment-15559
I’ll repeat the key paragraph here:
“The technical stuff on reserves is a well travelled road, so no need to plunge into that in detail here. But here’s a pragmatic question: Excess reserves are now, what: $ 1.5 trillion give or take? Interest of 25 basis points a year on that amount is $ 3.75 billion pretax, which is probably around $ 2.5 billion after tax. Do you really think it’s conceivable that a banking system that makes $ 100 billion plus per year after tax is going to knock the lights out with aggressive new lending just because it loses $ 2.5 billion in reserve interest? That’s naive as a real world assumption and as economic thinking. More fundamentally, market monetarism appears not to understand the difference between bank liquidity management and bank capital management, and the relationship of those two things to bank lending decisions. And in this case it also fails to consider the way in which banks consider overall pricing strategies when faced with any systemic shock to interest margins – they tend to adjust through asset and liability pricing responses that are directional in their effect in preserving return on capital. They don’t try and make it up on volume. That latter expectation is quite frankly asinine, and belies an ignorance of the way in which banks actually operate that is almost unbelievable for people who are supposed to be seriously interested in monetary policy.” — JKH
He elaborates on this in later comments in the same post in response to questions from Morgan and me.
I was curious how David Glasner (who is a mainstream (neo-classical?) economist, and a fan of NGDP targeting, a la Market Monetarism) would respond to JKH’s comments. I think Glasner is a pretty thoughtful in general (he believes in inside money, and thinks it’s time to shelve the money multiplier concept), but I know he thinks IOR is a problem. Here’s his response:
http://uneasymoney.com/2013/02/07/another-nail-in-the-money-multiplier-coffin/#comment-14268
By “cash” I’m pretty sure he means “reserves.”
I next pointed David to the continuation of JKH’s new thread of comments (JKH get’s a little annoyed w/ Morgan at the beginning):
http://monetaryrealism.com/krugman-on-says-law/#comment-15607
To which David responded:
http://uneasymoney.com/2013/02/07/another-nail-in-the-money-multiplier-coffin/#comment-14630
Anyway, I thought you might like to see some other opinions on the subject.
Whoops,… should read:
“(while reserve requirements are a regulatory constraint on deposits)”
rather than
“(while reserves are a regulatory constraint on deposits)”
This is awesome to see. You guys need to collaborate. MR and Werner sound all too similar to ignore each other forever.
You should reach out to him Cullen. It’s nice that MR has one PhD, but this guy would really put some weight behind what you all are doing.
Are you saying I am not good enough without that precious PhD?
The general public only seems to care what PhD’s think. Or, they believe that whatever a PhD says must be true. A PhD only knows something about 1 particular thing!
“Newly invent the money they lend?” Can you elaborate how that works? Please don’t refer me to just the other writings of yours; i’ve read them and still don’t get how the banks are inventing the money…
Will, take a look at this simple example:
http://brown-blog-5.blogspot.com/2013/02/banking-example-1.html
If you want to add in reserve requirements to make it more like the system we have in the US, try this:
http://brown-blog-5.blogspot.com/2013/02/banking-example-2.html
This is a slight variation on Example #1:
http://brown-blog-5.blogspot.com/2013/03/banking-example-11.html
The above brings in a second person, person y. At the end of this scenario, person y has $100 of permanent inside money which is completely bank created. The central bank’s balance sheet is clear.
I hope to sketch out in balance sheets another simple example as a variation on Example #2, with capital requirements added in. A simple example with both capital and reserve requirements is spelled out here in words in this John Carney article:
http://www.cnbc.com/id/100497710
I found simple examples like this invaluable to understanding answers to questions like yours. I hope that helps! Of course Cullen’s write up is great, and I have a link to a Scott Fullwiler article at the bottom of Example #1 that I found very helpful. Plus there’s econviz.org.
BTW, the second bank is not required in these examples… I just included it to illustrate a few more points about the system. The simplest examples would only include a single commercial bank in addition to the central bank. In a no-reserve-requirements system (Example 1 and 1.1), but with only a single commercial bank, the central bank wouldn’t even need to temporarily create reserves for the commercial bank to create money. econviz is good for visualizing that since in the macro visualizer they consolidate all banks in one spreadsheet.
Tom, really excellent balance sheet portrayal. That example #1 is really clean. Of course, people will ask, “where does the bank get the money to make a loan”? The right answer is, the govt gave them a charter to make USD denominated loans within the US payments system!
Really nice work. Thanks.
Thanks Cullen! If you give that John Carney capital requirements example your blessing, I’ll take a stab at spelling that out in balance sheets too. Maybe I’ll do it regardless and correct it after the fact if it needs it.
I’ll take a look at it. I am just so swamped this week. I have about 50 articles on my desk I am dying to read….
Cullen, here’s an example with both reserve and capital requirements, following the lead in Carney’s article (not exactly, but close):
http://brown-blog-5.blogspot.com/2013/03/banking-example-3-capital-requirements.html
Indeed. Thanks for doing this Tom. I’ve been badgering Cullen for visuals for ages. These are really really helpful
Let me try this.
Don’t think of banks as lending money in the same sense that you or I might lend money. If I want to lend money I have to obtain funds to give to the borrower. A bank works differently. It is legally allowed to create loans from thin air. A bank really just runs a payments system where it promises to settle payments for its customers. And it can create the funds for this payment at will. In other words, when a bank makes a loan it does not check to see if it has reserves or deposits or a “funding source”. It makes the loan and if it needs funds to settle payments it will borrow them in the Fed Funds market or from the Fed itself. If the bank makes a loan to someone where the deposit is deposited at the same bank then the bank doesn’t even have to change anything.
It might be easier to think of what a credit card is. A credit card is not trillions of dollars sitting around in banks waiting to be spent. A credit card is a payment processing system that creates temporary loans made by the bank and processed through the credit card payment system which settles in the banking system (which is why most credit cards are owned by banks). So, if I spend $1,000 on my credit card to buy a horse, the credit card company is making a loan to me that creates a $1,000 deposit in the donkey owners bank account. If the horse owner banks at my bank then there is just a creation of an asset (the loan for the bank) and a liability (the deposit) and the books settle. The bank will make money doing this business so long as its liabilities are less expensive than its assets (and assuming people pay the bank back!). When you settle up your account with the bank at the end of the money the bank writes down a liability (your old deposit) and the asset (the loan it made you). And we start all over again.
Guys, correct me if I am wrong on any of this.
I like it but a couple of things threw me: how did the horse become a donkey and then back to a horse? … and… are you providing meatballs to Ikea?
Second, I couldn’t quite decipher this sentence: “When you settle up your account with the bank at the end of the money the bank writes down a liability (your old deposit) and the asset (the loan it made you). And we start all over again.”
Did you mean to write “at the end of the day?” Even then I wasn’t sure.
It’s funny how questions like this from Will get lots of attention now! You, I, and Cullen jumped on this one pretty fast! Ha!
Ha. You beat me to the good joke.
I think maybe he meant “month” and not money. Just a guess. You guys are getting this stuff way faster than I did….
I think that’s pretty good overall. Why does the donkey change to a horse? Do you have something against donkeys?
I’ve gotta eat something stat. I forgot to eat today. I’ll get back to you shortly. Promise. And no links.
Yes, Cullen and him appear to be on a collision course.
Read his book Princes of the Yen. A good book, however he seems to claim that the Central Bank should have done fiscal policy to get Japan out of its private dept crisis. Wanting the Central Bank even to buy tomato ketchup.He does not care who rakes the benefits of these operations.
If I remember correctly he coined “Quantiative easing”, however he did not mean it as an asset swap, but as fiscal policy and overpaying for private goods and assets. The Fed probably did some of that during QE1 when they overpaid for GSE securities. This is one of the reasons for the skewed distribution of wealth.
Someone should tell the poor people in the US, but it will not be me. A Red-Neck would probably kill me for being a foreign communist for telling how the rich rob the poor in America.
Hoffa? As in Jimmy? We all thought you had been killed already!
Cullen, did you mean to write this:
“But they’re so good that I don’t to do them injustice.”
or did you mean:
“But they’re so good that I don’t want to do them injustice.”
Is this the same Richard Werner?: http://www.youtube.com/watch?v=zIkk7AfYymg
Most of this interview makes him sounds very MMT-ish
No, listen to his interview again. Werner uses my exact terminology (and I’ve never heard this interview or read him say this). He says the money supply has been “outsourced” to the banking sector. Of course, like me, he also understands that MMT is a possible option (ie, the govt COULD just spend), but it requires a change in the system away from pvt banking to public banking.
My mistake. I wasn’t clear in my comment..
He does describe existing operations in line with how you do: outsourced money creation. What I meant is he seems critical of that outsourcing… as some MMTers do. Whereas you seem much more supportive of the outsourcing.
I don’t necessarily support the outsourcing. I think there is a rationale for it and I don’t think it’s as evil and crazy as many imply. I don’t know if an alternative will be superior. This was my problem with MMT from the start of the JG debate. MMT doesn’t provide any evidence that their alternative world is better. Or, it’s weak at best. So how can one say that the status quo is worse when there’s no evidence that the alternative is better?
Werner supports the Positive Money people who support debt free money. Which is essentially what MMT should be backing, but doesn’t say so outright. Instead, MMT tries to claim the world they want is the one we have. Which has been my beef with MMT since the start of MR.
“it never circulates in the economy and as such is not really money”
Clearing balances do circulate within the CB system & are distributed accordingly – by the highest bidders within the interbank market(e.g., money center banks). It’s called reserve velocity. Reserve velocity is defined as the ratio of the average daily value of transactions on FEDWIRE, divided by the daily average value of inter-bank demand deposits (reserves).
Using “inside money” to describe how money functions muddies important distinctions:
The CBs are credit creators. However, the NBs (the customers of the CBs), serve a more important role, NBs are credit transmitters. NBs are responsible for completing the circuit income velocity of funds (matching savings with investment).
From the standpoint of the entire system, the CBs are simply custodians of stagnant money (holding unused or unspent balances). I.e., the lending capacity of the CBs is a function of the velocity of deposits, not a function of their volume.
Reserves are determined exogenously by the central bank and don’t leave the banking system. This is not a controversial point and has been repeated in a multitude of Fed documents. Anyone who understands the reserve system knows this to be true.
Your comments from the other day make me wonder what your motive here is? You referred to me as a “fucker” and a “target”. What exactly does that mean and what exactly are you trying to achieve by populating the comment section with these vague “clarifications”. I think you should explain yourself.
Cullen, I doubt you care, but the M M T people are talking about you and this post:
“Once you’ve painted yourself into the ideological corner of “I hate the JG so much that everything M M T says about state money must be wrong” the next logical step is to paint a cartoon door on the wall and step through it into never never land.”
http://www.blogger.com/comment.g?blogID=2761684730989137546&postID=2599419185473605548
Actually, I do kind of care because people like “geerussell” were around when all of this got started a few years back and are now revising the historical record to try to make their position look better than it actually is. This comment thread was where everything kind of started to become clear to me. In these comments I stated that I did not support a “full” Job Guarantee because I didn’t think the evidence was there. I said:
“I’m not in favor of paying people to do nothing. The push back from Scott is harsh, but I don’t see what’s so unreasonable about starting a JG on a small scale? It seems like the logical way to go. Ease people into it. If it works then we can enlarge it over time.”
The MMT people went bananas and started calling me all sorts of names and saying that if I didn’t support a full JG then I didn’t wasn’t an MMTer. I said their argument was flawed and that the logic behind a JG was misguided. I told them that the US govt was not a pure “money monopolist” and that they were not representing the system accurately in describing it that way. Now they revise history and say ridiculous things like “(Cullen) hates the JG”. I never “hated” the JG. I said I wasn’t in favor of it as MMT presents it (as in, hiring 10MM people right off the bat). But they scratch and claw and call other people names and misrepresent people’s actual words to try to make everyone else look bad. It’s pathetic.
But they weren’t having it because MMT is ALL ABOUT the Job Guarantee and the fundamentally flawed argument that backs it. So, I started MR and now we describe the US system for what it is. It is a system designed around banks and not some silly “money monopolist”. But MMT will attack anyone who doesn’t agree with their ideas in their entirety. So they go around promoting this silly “money monopolist” idea and the absurd concept of “taxes destroy money”. Sorry, but if anyone’s walked through a cartoon door it is them. It’s preposterous to describe a system by banks as a government “money monopoly” or to say that that same system is one where the govt “destroys money”. Only a bank can destroy money. End of argument. MMT is a flawed ideology. That’s all. They’re all living in never never land dreaming about how some big govt “money monopolist” can lead us all into the land of prosperity with their Modern Money Tree.
MMTers, like Austrians, are professionals at capturing the ear of amateur economists and laypeople with grand sounding concepts and overly simplistic explanations. Of course, once you dive deeper you realize that it’s all a policy driven agenda just like Austrian econ. It sounds great in theory, but a lot of it is nonsense when you get into the “semantics”. I am tired of reading the same nonsense from the same 4 or 5 people who religiously defend their ideas on various websites. The idea of a bank run system is so easy to understand that the MMT govt centric mind repels it.
Interesting history there!
“The idea of a bank run system is so easy to understand that the MMT govt centric mind repels it.”
You might need to trademark that.
Intuitively, the MMT ideas sound logical if you don’t understand banking or even if you have a neoclassical understanding of banking. The concept that our government creates all of the money stems directly from most of neoclassical economics. And most neoclassical economists work with central bank based models of the economy that center around reserves.
The thing that I find most interesting about MMT is that they claim to hate neoclassicals, but they actually design their model of the economy in a similar manner by making reserves the center of the money system.
Now that their ideas are coming to public awareness they’re being debunked. Good riddance.
Cullen you wipe out anything you deem controversial. I know the Gospel. You don’t.
The Gospel According to Coco Chanel???
http://www.amazon.com/The-Gospel-According-Coco-Chanel/dp/1599215233
Then you should probably stop reading his website. Honestly, he should get a restraining order on you after your comments from the other day. You’re a stalker and a creep.
“can you please chack out the following on banking”
I did. My comments were edited. The entire discussion is moot. JKH doesn’t know money from liquid assets.