Social Constructs, Self Constraints & Monetary Myths

I really liked this piece by Paul Krugman on money in general.  Of particular importance is this paragraph:

“For people like me, on the other hand, the economy is a social system, created by and for people. Money is a social contrivance and convenience that makes this social system work better — and should be adjusted, both in quantity and in characteristics, whenever there is compelling evidence that this would lead to better outcomes. It often makes sense to put constraints on our actions, e.g. by pegging to another currency or granting the central bank a high degree of independence, but these are things done for operational convenience or to improve policy credibility, not moral commitments — and they are always up for reconsideration when circumstances change.”

Boy, that almost sounds like MR verbatim.  Money is most certainly a social construct.  It is something we create primarily for efficiency as a medium of exchange.  Money has other characteristics, but this is the root of the tool that is money.  The aspect of the monetary system as a “social system” requires some elaboration because I think it’s easy to confuse the balance of private sector and public sector.  The monetary system exists primarily to facilitate private sector exchanges.  It does not exist primarily to facilitate public exchanges.  Another way of saying this is that we leverage the strength of our private sector to move resources into the public sphere.  Resources precede taxation.  So the stronger the private sector the stronger the public sector can be.  As I like to say, government is designed to facilitate, not to lead.  Of course, this doesn’t mean government is bad or even mostly bad.  Not at all.  But like money, it is a tool that we create to achieve a certain social goal.  It can be abused, misunderstood and counterproductive.  But that is generally because its users allow it to be corrupted.  Not because government is an inherently evil institution.  Understanding this is all about maintaining a sense of balance.  Too often these discussions fall on deaf ears due to the extremist position taken by one side or the other.  That doesn’t help anyone better understand any of this.

I think Dr. Krugman’s comments on self imposed constraints are equally important.  The USA is a government and monetary system that is designed around checks and balances. No single entity has a monopoly on any sort of power.  One of the most confused notions in the USA is the fact that we have privatized money creation to private banks.  In other words, private corporations compete for the demand of loans in a market based money creation system.  Further, we have designed a Federal Reserve system that facilitates and supports this design primarily through an efficient payments system that brings interbank settlement into one market.  I’m no Fed apologist (I think their powers are at times abused), but I think it’s crucial to understand the institutional design of the Fed and its rather rational existence (as a support mechanism for a market based money system that is inherently unstable).

There’s a lot more to add to these points, but that’s a good starting point for discussion….As always, I highly recommend reading the MR recommended readings on these subjects as they provide, what I believe is the single best publicly available description of the monetary system that currently exists.  To me, this is about studying history, understanding our system and understanding why certain institutions exist the way they do.  It’s not entirely irrational though it’s also not perfect.   But it’s imperative that we better understand why we have what we have because there is a dangerous amount of mythology circulating about all of this resulting in deeply misguided policy responses….


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

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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  1. MR FTW. It’s only a matter of time before this becomes the mainstream description that all economists and analysts use. MR’s understanding of the platinum coin was only the beginning. Keep up the great work guys.

  2. The platinum coin actually started with MMT. It’s a much more valuable concept to them as it could potentially be used as evidence of a govt’s ability to self finance. Carlos is technically MR now, but was MMT when the idea was first spread.

  3. I first heard about it from Yves Smith… and I must say I was a little shocked by the concept back then. She must have heard it from Carlos then.

  4. Yes, but JKH has been clear on the MR site that the coin wouldn’t be used for self financing, but as a temporary solution to the debt ceiling. To me, that’s one of the values of MR – using the expert analysis to understand policies. I know you don’t like to get too involved in policy, but your expertise and opinion on policies is valued.

  5. Nice commentary Cullen… I’d like to see you calmly explain all that to Alex Jones and his audience in his talk radio studio… perhaps while simultaneously trying to talk him into relinquishing his AR-15… or AR-15s… something tells me he’s got more than one.

  6. Man is a thermodynamical system, it uses energy to produce work. Societies are made by millions/billions of interacting men all using energy from the the external thermodynamical system which we can call earth for simplicity. All (and I mean) all the economists do not consider this, for them energy is endless (and so not a variable) and we’re not constrained or, if they recognize this, they are cornucopians in the sense that they believe the current limitations will be solved by some technical improvements before feeling any shortage. The opinions of best scientists, anthropologists, geologists, field engineers, do not find attention on any discussion about the nature and evolution of our society/economy. The opionions of the economists with their limited scope models and/or the industrial or political leaders monopolize the official press and the internet blogosphere of which this blog is one of the best sample. There is just one exception: ample resonance is given to the proponents of the apocalypse which have always found a fertile terrain in the fragile human mind. They are essentially just the other side of the cornucopians.

  7. i like your take in this article …makes me want to give MR more time given i already dig MMT

  8. How do laws like the Homestead Act’s play into the mix of MR thinking that
    “we leverage the strength of our private sector to move resources into the public sphere”

    Aren’t laws like the Homestead Act’s moving Public Resources to the Private Sector?

  9. “should be adjusted, both in quantity and in characteristics, whenever there is compelling evidence that this would lead to better outcomes…”

    Great! But there are several questions. Should be adjusted by whom? A combination of all “social” actors (the market)? By an elected body under a republic law? By unelected “economists”, who, supposedly, know the things better, and can lead us to “better outcomes”? What are these “better outcomes”. For a buyer it is a low price, for a seller – high. For a lender it is a high rate, for borrower – low? Who shoud set it, if not in getotiations between these two parties? If money is created through credit in the private sector, why to limit the “adjustment” to downside, and not to limit the “adjustment” to the upside?

    All these topics are, as usually, omitted, but they are the key. Yet, what I clearly see in Krugman’s view, it’s there is always a Krugman sitting somewhere high above, who “adjusts” money presumably for my “better outcome”, as he certainly knows with “compelling evidence” what is my “better outcome”, and he knows it much better than myself.

  10. “Government is designed to facilitate, not to lead.”

    I am in 100% agreement with that.

    In fact, I think it should be engraved in stone and mounted in the halls of every federal, state, and local government building in the country!

    Hell, let’s use it as the motto on the trillion dollar coin!

    But I am also aware that there is a HUGE percentage of the population who believe the government’s proper role is to lead.

  11. Well, there are occasions when the government’s role… or at least a politician’s role is to lead. For example, in taking the nation to war. There should be checks and balances… but a president should be able to make his case for war to the congress, and then congress should decide! How would the government “facilitate” a war? Sell United Fruit the drones they need to suppress the leftist rebels in central America… sell Exxon the aircraft carrier they need to protect their shipping lanes in the gulf?

  12. And what if Exxon and United Fruit get into it… taking opposite sides. Do we try to facilitate both in their war with each other?

  13. Check out these works by sociologists and anthropologists on money as a human artifact. Lots of stuff out there on money as a social construct that developed into an economic institution.

    The Nature of Money by Geoffrey Ingham

    The Sociology of Money: Economics, Reason and Contemporary Society
    by Nigel Dodd

    The Phenomenon of Money by Thomas Crump

    The Social Meaning of Money by Viviana A. Rotman Zelizer

    and, of course, the recently published Debt: The First 5000 Years by David Graeber

  14. Who’s “social” in the social construct. Does China buying our (public good) Tsys to export their demand to the US, which accepts it by leveraging within the private sector, count? Does an ultra-wealthy American hoarding Tsys in an offshore Tax haven, count? Yes, it is a social construct; watch out for the company you keep! :-)

  15. These comments remind me the financial system is more than inherently unstable in which it cannot balance.
    It is actually dynamically unstable because it contains forces that actively keep it in motion.

  16. Not sure where to post this really, so I’ll try to fit it in context here:

    What do you all think of Jack Lew… er… with regard to his effect on “social constructs,” “self constraints,” and the continued perpetuation of “monetary myths.” … or just what kind of Treasury Secretary do you think he’ll make?, if that’s easier.

  17. So you’re saying stay out of long positions on equities because the universe looks like it’s headed for heat death (in another 15 billion years)? Point taken… hard to argue with that.

  18. I heard some interviews with Graeber… and he wrote an EXTENSIVE set of detailed comments over at (in response to a Charles Murray piece on his interviews about the book).

    So I tried to read the thing (the book). It is interesting in parts… but he gets too philosophical for me. I like reading about concrete examples … and they’re there! … you just have to “fast forward” a bit to get to them.

    In retrospect, I almost think I like the set of comments better… plus they were free!

  19. Jack Lew is not a very senior level nominee for Treasury. That makes him less likely to be an independent thinker, and more likely to do exactly what Obama asks him to do. He moves from White House chief of staff to architecting the Treasury Dept as an extension of the White House. Obama named him in order to attempt to give the Republicans maximum frustration in their attempts to make meaningful cuts in gov’t spending.

  20. I like Graeber’s book, but I found it insufficient. I think money can be best understood if you avoid the recent history of money and instead study highly primitive animals. Do they use money? Of course they do. There are studies proving as much. What we find though, is that money is found in social animals in what are essentially social bonds. It’s sort of a “scratch my back, I’ll scratch yours” kind of thing. All we’ve done, as we’ve evolved, is replace social bonds with increasingly complex ways of tracking these bonds. Money went from unspoken bonds to physical things and now is evolving to electronic entries that exist in no physical form. But the essence of money hasn’t really changed even though its form has.

  21. Interesting perspective, thanks Boston Larry. I’d really like to see Cullen’s perspective when he gets around to it. I’m a fan (in general) of William K. Black, and I was pretty certain he’d have an opinion… and he didn’t disappoint (HuffPo)… but in a sense he did disappoint. He is not a fan of Lew, but his perspective is very different than yours. Black claims Lew will be Mr. Austerity (among other things). I got the impression there wasn’t enough info about Lew out there for Black to eviscerate him properly (not that I KNEW that’d be Black’s position). His piece brought in a lot of extra characters… I got the impression Black was indicting him more for the company he keeps rather than what the man has done, said, or written. Of course Black comes at it from the position of being an advocate for tough regulation… but he didn’t convince me of the smoking gun on Lew’s regulatory failures.

    I sincerely hope that Lew surprises his critics and does a better job than they think he will, but we’ll see.

    If Lew is, like you say, basically going to take orders from Obama, then at least we’ll get to see what the real Obama policies are! I’ve always wanted to believe that Geithner, Summers, etc won the internal argument w/in the admin, and effectively got Obama’s ear (much like I think Cheney got Bush’s ear on foreign policy). So what will he do now that they’re gone? Has he internalized the Geithner outlook? Did he always have that outlook? Or will he change course now that Geithner’s leaving?

  22. Oh, I think money HAS changed. The monetary system is an isolated system, which means it can’t dispose of waste. The real world economy exports waste – mainly useless heat but also material waste to the wider environment which thus far has been more or less capable of absorbing it. Herman Daly pointed out that life can’t exist amidst its own faeces. But there is nowhere for financial waste to go now. And it certainly exists, it must unless one considers financial activity lossless.

    People talk about net private sector savings etc, which puts the matter in a nice light. But from this it is trivial to derive that private sector NFAs are just the sum total of unrecycled private sector profits accumulated since the beginning of public debt issuance (a very long tme ago).

    A very simple case can be made that unrecycled profits are toxic, so one might then question why it is a good idea to facilitate more of them, especially if the financial architecture offers no method of ever deleting them.

    A somewhat more complex case can be made showing that the in terms of information entropy (aka information insensitivity) public debt is the most high grade waste of all, but for most people the notion of unrecycled profits should be sufficient, if that is coupled with the reality of incredibly unequal distribution of physical capital that actually attracts nominal profis.

  23. Agreed.
    Also I find it interesting that Krugman doesn’t mention that ‘money’ is also a store of wealth. It’s not just a way for me to exchange my labor for your labor; it’s a way for me to store up my labor so I can spend it at another time.

  24. I’m afraid that Krugman, like those he advises simply doesn’t understand the real world that people live in. Here’s a couple of excerpt from a student’s perspective on money (not mine).

    “Money is a human concept, made to help us trade and function together. Money can be blinding, causing people to worry more about paying the bills and making ends meet, a tragic waste of human potential. I want to see a day when the human spirit can be elevated beyond a rat race. That is unless I win the lottery.”

    “Money is the reason people work every day at jobs they hate, why politics is the disgusting mess it is today, why people do terrible things to each other. Capitalism has turned society into a giant shopping mall, where the only point is to produce more shit to buy, and people to buy it. And we slave ourselves out to jobs just to supply the demand.”

  25. Absolutely correct Alberto. Cutting edge ecology and life systems science (NET, MEPP) is far closer to actually understanding how financial systems work than any other field of science (or social science).

  26. The role of money as a store of wealth is always and everywhere secondary to its role as a medium of exchange.

  27. What Krugman and you are saying Cullen, is undeniably true of THIS monetary system. It seems to me that the fact that this system developed without an overt expression of the consequences of every next move to fiat money is part of the reason that we have so many myths floating around. Remember the gold window was suspended “temporarily”. So, in some sense, America as a nation embraced the social contract and gave up on the notion of inalienable rights (to some extent) on the sly, not through considered debate. I think a lot of the right’s radicalism today comes from not having understood how things changed when we adopted this monetary system. Just to be clear – are you in general agreement that MRs entire construct applies to FIAT money and not every monetary system ever conceived?

  28. I think that’s a great insight about the anxiety of the right about this system…. perhaps we should all be so anxious! … this stuff was DEFINITELY not explained to us when I was in school… and if the goal is that every American should be educated at least well enough to be an informed voter… than that is a TERRIBLE failure of our educational system. Instead, we have intuitive sounding appeals that we’ve got to get our “fiscal house in order” etc. … leading us to think that we can draw a good analogy between a household’s finances and that of the government.

    And I think you’re right about this being done on the sly too… w/o adequate debate… ironically with the help of the “right” (I’m thinking specifically of Milton Friedman) in devising this system.

    I guess you could argue that being on the gold standard was the exception, and that credit based economies have been the rule over the centuries (as perhaps David Graeber would), but it’s certainly not very intuitive, and we could use some better resources to grasp it!

  29. Why does money need to be able to protect against purchasing power loss? The USD has fallen 95% in real terms since 1913. Are we all worse off because of it?

  30. What is NET, MEPP? I agree with some things Alberto says, although there seems to be a touch of despair. He has commented here before, and I think he has his own site (cassandra something?). I am curious: Are you working on a mathematical model of MR? Are you applying thermodynamic principles and complex systems theory to economics in a scientific way? Do you have any references? Have you heard of econophysics? I am looking for knowledge and I believe you are on the right track.

  31. You need a way to convert 8 hours of labor today to 8 hours of spending later. That could be a day later, a month later or 20 years later. That’s why money must be a store of value.
    Does it have to be that way? I don’t know. You can use stocks or land or gold or insurance or derivative contracts, too. Youl could say that Social Security is a store of value, too.
    USD depreciation has winners and losers; unfortunately, the losers are those at the bottom of the income scale.

  32. USD depreciation favors debtors at the expense of lenders because the debtors can repay their loans in less valuable dollars. And since “those at the bottom of the income scale” are more likely to be debtors than lenders, I think you have “winners and losers” reversed.

  33. NET=non equilibrium thermodynamics. Its mainly a life/complexity science in which thermodynamics is applied to natural systems far fro equilibrium (as opposed to a gas in a box). It applies to both living and non living phenomena.

    MEPP = Maximum Entropy Production Principle. It is a derivation of NET.

    Both are discussed eloquently and briefly by S.N.Salthe, a respected scientist, here. Very well worth your time if you have the slightest curiosity about this.

    I don’t know what MR is since I’m a fresher here, but I’m well aware of MMT. JKH taught me most of what I know about it (and financial accounting) some years back.

  34. Practically speaking, however, it doesn’t work that way.
    Low-income debtors tend to be perpetually in debt and tend to run out of income gains long before the debts are paid.

  35. It’s not uniform. The point is, 8 hours in 2013 buy a hell of a lot more output than 8 hours in 1913. We are infinitely more productive. You’re just assuming that living standards are worse because a currency falls in real terms. That’s false.

  36. Maybe Krugman realises what you clearly don’t. That money is not effective at storing wealth or value.

    Money always loses value against real things.

    And we’ve seen that for millennia.

    Some people are doomed never to learn though.

    Soon you will learn, the hard way!

  37. Thank you scepticus for the information and link! I am a biophysicist who specializes in thermodynamics so I understand NET and MEPP (I am just not familiar with the acronyms). MR = Monetary Realism that Cullen developed along with others (I believe also JKH). This site is a main supported of MR.

  38. Because it does hold value over at least the short term and crucially, it is information insensitive. The idea is that a dollar of bank debt is the same as a dollar note over the short term. And two dollars of bank debt cannot be distinguished. That property failed briefly in 2008 and all hell broke loose.

    Lots of other things that are easily transportable and even divisible that do store value can’t act as money because it doesn’t possess that crucial mutual information. Equities for example.

  39. No problem android. If you know about MEPP is it a principle you subscribe to? After all we only just opened the book on all this stuff, right?

  40. Yes, scepticus, i would subscribe to MEPP. However, there is another theory that says a nonequilibrium system will take the path to an equilibrium system that does not maximize entropy production but maximizes the rate of entropy production. I need to reread that material to compare and contrast the two theories. NET has been around for awhile, basically since Onsager’s reciprocal relations in the 30’s. However, QM shadowed the field around then and work in thermodynamics in general was marginalized. However, since the 60’s and 70’s there is a resurgence in thermodynamics especially in NET stemming from work on critical phenomena and phase transitions, as well as computers being able to analyze complex systems. So, anyway, yeah, we basically just opened the book on this stuff :) I plan on making my career in this field; it is very fertile ground I believe.

  41. I think MEPP does specify ‘maximum RATE of entropy production’, which correlates to minimising the internal entropy of the system in question. I guess you could restate MEPP as ‘maximum rate of entropy export’.

    Now if one accepts MEPP as a likely driver for life systems, then it applies to us, and that implies in turn our economic system must somehow assist in that endeavour.

    A weaker implication is that our financial system would somehow also exhibit characteristic entropy production, but that would need to be proved since it doesn’t necessarily follow from accepting physical MEPP. Hope that makes sense.

    If this is close to the truth then there is a usable model there. And yes, a great career choice I think!

  42. Excellent piece Cullen

    I do have a quibbe with this though

    ” No single entity has a monopoly on any sort of power”

    I think banks/hedgefunds/wall st have a monopoly on the money system right now. Yes it was granted them years ago, but our social system is not working better because of the money system, its working worse now.

  43. I’d call banks an oligopoly, but I totally get your point. I’d say it’s primarily a regulatory thing. I don’t think private competitive banking is inherently evil. I just think it’s inherently unstable because the profit motive = inherently higher risk = inherent instability. I think you can regulate that out in various ways.

  44. So basically: money is a tool but instead of using that tool to produce more, people want to hoard the tool? Making us all tools……….

  45. Is that why central bankers squawk when people save instead of spend because it is the movement (velocity) of money (tool) that is at work instead of sitting in the tool box getting rusty?

    Seems odd though because spenders are over using the tool via credit thus causing a balance sheet issue that limits them credit and they need to work off, so now like Bernanke alluded to savers they are owed nothing so spend it, thus prompting a shift to help alleviate the balance sheet of the spenders who kept using the tool when they should have let it rest for a day.

  46. “You need a way to convert 8 hours of labor today to 8 hours of spending later. That could be a day later, a month later or 20 years later.”

    This sounds like a form of trying to turn lead into gold……..alchemy.

    I think this comment highlights a very common but also very wrong idea about money and saving. I have no problem with the notion of converting 8 hours of labor today to 8 hours of spending tomorrow or next week……… but TWENTY YEARS!! Cmon, thats really absurd I think, yet we have grown to think this is normal and necessary. If you want something get it soon. Dont wait too long. This whole notion of expecting your buying power to stay constant or growing over a 20 year period (as you do nothing but NOT SPEND) is………
    absurd. And then sit around and blame government for your woes as they moved on from twenty years ago and invested in education or computers or whatever?

    You are right about who the losers are, but WE can determine what the losers are left with. When people are left with nothing that can be rectified. Thats a choice of the electorate. We can build the floor wherever we wish. We can set the minimums we will not let our fellow citizen fall below. There IS an alternative.

  47. “Government is designed to facilitate, not to lead.”

    I also agree with the sentiment of that comment, mainly because I think I know Cullen well enough to know what he means by facilitate.

    But that comment can certainly be misconstrued and oversimplified by those who wish to hamstring public efforts. Facilitation requires leadership as well. Govt does not need to micromanage everything (neither does your boss BTW) but facilitation requires leadership.

    I like to word it this way. We need leaders not bosses. Leaders are natural facilitators by putting the right people in the best place to succeed and letting them succeed, bosses like to just tell people what to do.

    Today, the Tea Party is just a bunch of wanna be bosses. Not willing to listen to anyone else, just pursue their agenda, with full frontal assault, consequences be damned. They are not leaders.

  48. on the strength of this article i went to read up on MMR . i think you do a great job of framing the big picture . True MMT is too gov centric and too JG centric . Our success over the years has not been about employing as many people as possible but we have improved our living standards exponentially . Simply cannot deny the resources at our disposal thanks to human innovation and productivity . What we take for granted today would have required more resources and time than what 99.999% of population could have had at their disposal 20 years ago. However i agree with a number of other comments that the most of MMR could just as easily be a subset of MMT .

  49. I’m happy to have captured some attention. In the economy blogs I’m currently reading I’m much more interested in the readers comments than in the posts themself. I’d like to understand how much pervasive is the “common view” about of our society/economy and how deep the damage done by the last two generations of economists. When the educators are so poor, the educated will have no choice and no future.

    Clearly my still evolving ideas have been profoundly influenced by “The Law of Maximum Entropy Production” (LMEP or MEP) which was first recognized by American scientist Rod Swenson in 1988/1989. This is a link about it:

  50. If you stuffed a $1 bill in the mattress in 1915 and took it out today, it would buy about what a nickel could have bought in 1915. But, if you had invested the $1 in risk-free T-bills or an almost risk-free, interest-bearing savings account, you’d have roughly kept up with inflation. In that sense, the USD has been a decent store of value over the past 100 years.

  51. Or if you’d put it in a broad basket of stocks (i.e. assets tied to productive companies) you’d be well ahead of inflation.

  52. How can MR be a “subset” of MMT when it’s a radically different description of the way things actually work? MMT starts with the govt and builds a govt centric view of money. MR starts with the pvt sector and says govt facilitates because it has chosen to outsource money creation. These are diametrically opposing views of the world. MMT is essentially following the neoclassical forebears by building a model around high powered money. MR is actually stating the opposite. High powered money is not what’s actually high powered. It is the non-govt sector that creates the most important money. Everything govt does just influences this money or supports it in some way. The crutch is not the main support system….We should get very clear on this point because it’s where MR and MMT most differ.

  53. I’m sorry, what? The profit motive equals higher risk. I’m hoping this is just a loosely worded statement and doesn’t reflect a very peculiar ideology at its core. The “profit” motive, if accompanied by a) skin in the game and b) symmetric payoffs actually reduces the likelihood of bad behavior – there’s tonnes of material that establishes this. The problem with banking has been a) The fed creates moral hazard, b) payoffs are deeply asymmetric, partly because of a) and to some extent due to FDIC and the lack of a separating wall (i.e. Glass Steagall). But, if that statement is meant to suggest that you actually believe that risk can be somehow managed more effectively by a bunch of bureaucrats writing rules based on the last crisis – I think you’re making a point that lacks any scientific credibility. So Cullen, the “I just think it’s inherently unstable because the profit motive = inherently higher risk = inherent instability” statement – was that just loosely worded, or do you really believe banking regulation is our path to a risk-free system?!

  54. No such thing as a risk free system. But if you don’t require banks to maintain certain capital ratios then you are almost certain to increase instability in the banking system because, bankers, being human, will reach for risk when stability appears certain. See the housing bubble when everyone thought housing prices couldn’t go down and bankers built that assumption into their lending models to increase profits. The reality is, bankers aren’t great risk managers. My regulatory call is simply based on the understanding that banking is too important to let a bunch of cowboys “self regulate” it. This isn’t your average industry. It’s the centerpiece of the economy….If it falls apart because a few guys made bad decisions then everyone gets hurt.

  55. “The reality is, bankers aren’t great risk managers.”

    If you believe that, you don’t understand human nature. Banks and bankers are doing quite well and have done so for a very long time with very little real risk.

    They have transitioned from a highly regulated service industry to relatively unregulated, horizontally and vertically integrated financial powerhouses with the clout to dictate financial policy and resist policymaker attempts to reduce their conflicts of interest activities.

    They offset risks onto clients, foreign sovereigns, taxpayers and each other. The impression that they are poor risk managers, or that they cannot manage risk because they are too highly regulated demonstrates an ability to manage risks in more sophisticated ways than you are considering.

  56. Every one of the largest banks in the USA would be out of business today if the US govt hadn’t backstopped them. How can you say they’re good risk managers?

  57. Wow Delta, just, wow. Even a cursory look at history will show you that a completely unregulated banking sector is a disaster.

    No one said that it takes a bunch of bureaucrats. You’re putting words in people’s mouths. Simple regulations (Glass-Steagall [which, thank God, at least we can agree on], capital ratios, audit requirements, etc) do a ton to stabilize the system. You think it’s any wonder that the financial crisis happened in short order after the deregulatory wave swept the nation?

  58. But my point, Perry – and I start much closer to your perspective is that this tendency isn’t some sort of conniving genius – it’s purely rational behavior tied to asymmetric payoffs. Too big to fail has been a central reality to the banking system at least since LTCM, if not before. Our wonderful bankers have merely been leveraging capital for pennies on the dollar, happy to ignore the eventuality that they will one day get wiped out, because getting wiped out invoked the TBTF trump card. Since this is true at the systemic level – this is the assumption under which banks have built profit maximizing structures.

    My point here is more along the lines of invoking losses as the only legitimate means of ensuring actual market discipline. Banks have been regulated forever – and were regulated pre-2007 as well. It’s just that the metrics (VAR) was completely inadequate.

    The big picture underlying point here is that the Fed and its kin create an incentive structure that rewards giant institutions at the expense of smaller institutions. The downside risk of failure of large institutions is much bigger than the failure of a smaller institution. So, the underlying system built is a fragile system. I want 10,000 banks, not 5 players. The notion that you’re going to outregulate 5 institutions that fundamentally have such large asymmetric risk is the kind of pie in the sky baloney that I don’t think has any place in a real debate.

  59. Right Pierce – I’m not arguing for or against regulation – I’m arguing that regulation is in and of itself completely inadequate. The essence of the old system was that banks were partnerships. So, there wasn’t much escaping liability. And like I said, I don’t care if banks are good, bad or rubbish. I want a SYSTEM which is robust enough to handle bank failure. I want a system which improves when a bank fails, not an interconnected set of cards, where they all go down when one fails. My thoughts on Glass – Steagall, since you ask – sound regulation for any bank of size. That isn’t the issue I’m flagging, here. This isn’t a republican talking point – sorry.

  60. The reality that these banks are not out of business; that they have not been dissassembled; that banking salaries are still rising; that the scope of their operations has not been curtailed; that they remain relatively unregulated and they still mostly dictate the policies in which they operate is pretty strong evidence that they have not suffered the prospective risks that you seem to think they have faced.

    They have been very effective in communicating the risks associated with their business models, but even more effective in managing those risks by spreading them across the entire population through political influence, policy writing and buying votes.

  61. This is strange. As I said, the only reason the 10 largest banks in the USA are still in business is because the US taxpayer backstopped them when they failed to manage their own risks….

  62. Okay. Gotcha. Then we’re in agreement.

    Not sure how we deal with it other than regulation or laws, though. (not laws like Dodd-Frank though…that is a terrible piece of legislation)

    Skin in the game is a huge thing, but there’s nothing illegal, currently, about raising equity via the stock market for banks and investment banks (I refuse to think Goldman isn’t still just an investment bank in commercial bank clothing), nor securitization (or issue-and-dump, as it could otherwise be known).

    Also, as you say, TBTF. Arguably, the largest banks should be broken up under anti-trust laws. I just don’t know how that’s going to happen given their lobbying power.

  63. Do you think the housing crisis would have occurred if there had been a 20% down law in place? I’ll tell you that it DEFINITELY wouldn’t have been as bad as it was if that simple rule had been in place. But no, having to put down collateral on a loan that is 10X your annual salary just makes no sense….why? Because the banks would make a lot fewer loans and earn a lot less profit if that sort of sane regulation existed….This isn’t rocket science. It’s common sense.

  64. Yes, Delta, I believe we are on the same page. I’m not a conspircy theorist. I’d like to see the financial marketplace reflect the poor risk managment that bankers have demonstrated in their operations – independent of their risk management through lobbying and policy writing.

  65. One way to keep the house of cards from falling down is to break them up into smaller banks. As I understand it, the Canadian banks whined and moaned about not being allowed to consolidate into mega-banks, complaining bitterly that they wouldn’t be able to compete. The Canadian gov turned a deaf ear to their bellyaching, and they’re doing just fine. So I don’t buy the argument that our banks make along the same lines. Let’s bust them into little pieces! … if you notice, the only frauds (in the banking system) our AG seems comfortable to go after are the little guys. Also, it’s only the little banks that get shut down by regulators. If the reason is because it’s too dangerous to the whole system to go after TBTF banks … then F ‘em! Let’s not have any of those! This is ridiculous.

    I’m getting into this late… so perhaps that’s what you’ve been arguing all along! If so, I apologize.

  66. That demonstrates that they managed their risks very well – unconventional perhaps, innovative – ways that only TBTF banks can do. In so doing, they did not fail.

  67. The high powered money part is, for me, the most important understanding of all. Reserves aren’t a big scary bogey man, and neither is the size of the Fed balance sheet. Reserves won’t some day be levered into a hyper-inflationary disaster scenario. At the end of the day, reserves really don’t do much of anything except help facilitate the settlement process. I’m not sure the other MM school would necessarily disagree (and I have huge respect for them and still visit many of their sites), but MR really hammered this point home for me.

  68. Well, OK, but that’s a little bit like praising Stalin for achieving an unprecedented level of political unity in the Soviet Union… through purges, NKVD police state tactics, massive propaganda efforts, a system of gulags, and general tyranny and terror tactics.

    … or perhaps praising Mobutu’s financial success.. which he obtained through his iron fisted cleptocracy while leader of the Congo.

  69. Cullen – you’re simply advocating a principle that would have prevented the last crisis. Not one that’ll prevent the next crisis. I don’t know where that will come from, but I do know that while you have asymmetric payoffs for the agents – bad behavior won’t be a one time occurrence. Of the few rational beings we have on this planet – bankers are pretty high on the list. They certainly won’t give up a free lunch, or more precisely – a lunch paid for with our collective money. All the upside, no downside is an incentive structure that’s flawed. You won’t regulate your way out of that. Not when they hold over $8.5 Trillion in total assets. And the big enabler – is the Fed, FDIC, etc etc. This is a problem of concentrated risk. And I agree with both Pierce and Tom; TBTF is the central problem – they need to be broken up; but with their lobbying power and ever-widening influence that isn’t going to happen. The rotating door between Wall Street and Capitol Hill doesn’t help, either. But for the rest of us, this should be priority number one. The construction of this banking system makes it fragile; we need to develop a much more robust system. And that means an overhaul – not a lengthy piece of legislation that makes it impossible for the little guy to compete.

  70. So, we just had the worst cancer of all time ripple through our system and you won’t impose a cure just because it can prevent that cancer from occurring again? Mortgage debt represents 75% of all outstanding household debt. Cut off that cancer and you’ve eliminated a big bad disease. I won’t fix the world, but it will certainly help. I don’t claim regulation can eliminate all risk from banking, but it sure can help….

  71. Agree with Perry here. The banks made their private risk a matter for the public to cover.
    A cynic could say they’ve done this by infiltrating government and putting their own men at Treasury and in other high ranking positions. And then bleating that if they fail, the whole country fails.

  72. Tom, you are correct about the Cdn banks. They received much undue credit for escaping the financial crisis relatively unscathed, but they would have been up to their necks in subprime like the rest of the banks if given a chance.

  73. When did I say I’m against a higher down regulation for the current system? I’d just prefer a more robust system than one where we decide some number is the cure to all ills.
    I’m amazed if you don’t want to take a system that just failed and transform it into a more robust system. I’m amazed if you don’t want to tackle the problem of TBTF at its roots. Or tackle asymmetric payoffs. You want to give a cancer patient a dose of morphine, I say bring on the chemotherapy.

  74. Cullen your point is taken . All the things you mention are what make MR attractive . Yet MMT gave me the tools to better appreciate your perspective .

  75. MMT is theoretically correct and it’s a superb thought experiment to undergo. It also helps one understand the economy better than most neoclassical economics. But make no mistake. MMT is a theoretical world and not the world we actually have. Pure MMT is a world of govt self financing. That is not the structure we have today. The structure we have today is rather simple. Banks issue the money, the rest of us use the money. Including the govt. The power of money is dispersed away from the govt quite intentionally. The MMT ideas bring the state back to center stage by exposing the fact that the govt can’t “run out of money” and has a printing press in essence. I think most of us understand that even if some people don’t understand that it means the govt has no solvency constraint like a household or business. But that doesn’t change the reason why we’ve dispersed money creating powers away from the govt to begin with. There are reasons why we have what MMT calls “self imposed constraints” (though some, like the debt ceiling, are very stupid). The govt borrows from the pvt sector because we have designed a market based money system. That’s why MMT hates banks. They hate that a private market based system is what’s keeping the govt from taking control of the money monopoly and completing the MMT world view.

    MR just describes all of this in realistic institutional terms. I couldn’t have ever come to these conclusions had I not learned MMT first. But MR didn’t exist in this form before we started it so I like to think of MR as an evolution of our thinking. It’s certainly not merely a subset of MMT because I think our rationalization of the Fed system and the banking system is totally at odds with MMT’s thinking….

  76. What do you mean ‘MMT is theoretically correct’?

    Empirically or theoretically? Newton’s laws of dynamics (and the maths he developed to describe them) were theoretically correct but far from the last word (e.g. incomplete), as we know know.

    How would you categorise MMT and MR? As applied science? Theoretical or applied accounting? Social science?

    Tyically theoretical science challenges axioms and now and again falisifies them. How does MMT and MR treat accounting rules? As axioms to be challaneged or fundamental laws?

    I’m fascinated to understand how you guys would categorise your search for knowledge in this area.

  77. MR is what is. MMT is what can be. The difference is that MMT is basically a description of a govt that self finances. MR is a description of the money system we have where banks are the primary money issuers and the rest of us just use that money (including the govt).

  78. But what is the theory to which you referred above when you said theoretically correct? I presume that you are referring to extant accounting rules, and no more.

    I realise this may seem pedantic but I think its actually quite an important question.

  79. MMT is Modern Monetary Theory. MR is Monetary Realism. MMT is a description of a govt as the issuer of money and a self financing entity. It’s theoretical though parts of it apply to our reality….

  80. Can we use these concepts to understand state driven economies? Does MR, for example, offer insights into the future of China’s economy? Being heavily state driven, it would seem that China monetary system is focused more on facilitating public exchanges (though not entirely so).