Monetary Realism starts with the understanding that there are two forms of money in our monetary system. The most important kind of money is the kind we all primarily use – credit money. MR calls this “inside money” because it is created inside the private sector through banks. Banks create this money by extending loans. Loans create deposits. The other type of money is “outside money”. This includes cash, coins and bank reserves. It is created outside the private sector by the government and serves as a facilitating feature to impact the use of inside money. For more on this please see here.
The dominant form of money in our monetary system is inside money or credit. Our entire monetary system is based on credit since the vast majority of transactions occur in this form of money. As we like to say, inside money “rules the monetary roost”. Most economists get this relationship entirely backwards and build some sort of government centric model for understanding the monetary system. They generally start with the idea of the money multiplier which implies that the central bank has some sort of control over the supply of money when the reality is that the money multiplier is a complete myth and the central bank actually has far less control over the supply of money than most presume. MR flips this all on its head and starts with understanding the banking system and the fact that the money supply is almost entirely privatized in nations like the USA. In other words, the money supply is controlled by an oligopoly of private competitive entities who battle each other for the demand for money (loans).
But all money is not created equal. The private competitive nature of this arrangement can be both extremely positive and extremely disruptive. This is elaborated on in a concept that originates with German economist Richard Werner. He calls it the “disaggregation of credit”. I don’t have the time nor the space to do it justice here, but I will provide my brief analysis with a MR flavor since it complements our work so nicely.
The demand and issuance of credit can occur for many different economic transactions and purposes. This can involve productive and unproductive uses. A simple example of productive uses would be a corporation that maintains a line of credit with a bank in order to pay its expenses such as salaries, R&D or other investments. As we like to say with MR, “investment is the backbone of private saving”. This is the essential idea behind understanding our central equation S=I+(S-I). But there are also unproductive uses of credit. For instance, when loans are made to meet the growing demands of speculative real estate purchases you get environments like 2003-2007 where asset prices simply inflate due to the extension of credit for unproductive uses. This is the essence behind the idea of a disaggregation of credit. It is essential to understand that all credit is not created equal. Money can be abused for the purposes of profit. This is not remotely surprising in a capitalist monetary system like the USA. But this is not an excuse for not understanding this concept.
While most of the economics profession is busy building government centric models that figure out various ways to blame the government (or give it credit) it’s equally important to understand how the private sector itself can be the cause of this economic disequilibrium. Understanding the design of the modern monetary system and the concept of disaggregation of credit is central to this understanding.