Understanding the Modern Monetary System – Part 3
In part 3 we begin to cover the lead role of the private sector in the economy and the importance of the private banking system. I use a simple car analogy to describe the system and elaborate on how the private banking system works. The myth of the money multiplier is also briefly touched upon.
If you missed parts 1 and 2 I recommend seeing here and here. If you want to read the entire paper with all 6 sections please see here. I hope you find this section helpful. As always, comments welcome.
Part III – The Lead Role of the Private Sector & “Inside Money”
Understanding The “Machine”
The monetary system is a machine. The metaphor of a car is useful to understand how all the pieces fit together. Monetary policy is akin to the brake and accelerator pads. When the central bank raises the Federal Funds Rate it does so typically to suppress inflationary pressures. When the Fed increases the Federal Funds Rate (i.e. the short-term interest rate on which monetary policy pivots) this raises borrowing costs across the spectrum of credit products thus putting a brake on economic activity. Vice versa when the Fed lowers the Federal Funds Rate, typically to counteract a swelling in the number of underemployed, this decreases borrowing costs across the spectrum of credit products (especially loans made on a shorter-term basis) thus accelerating economic activity. Monetary policy is mainly about manipulating short-term interest rates though there are other factors.
Fiscal policy is the gear stick. Economists often talk about aggregate supply and aggregate demand. The former is the total amount of final goods and services produced by an economy over a given time period. The latter is the total amount of final goods and services purchased by agents over a given time period. What we produce as a nation and the market prices at which goods and services are sold can be different; hence, the labels of aggregate supply and aggregate demand.
When the economy is booming during an upswing aggregate demand can exceed aggregate supply leading to inflationary pressures. When the economy is depressed during a downturn aggregate supply can exceed aggregate demand leading to disinflationary or even deflationary pressures. If the economy is suffering from a lack of aggregate demand the government sector can, through larger deficits (i.e. spending in excess of revenues), shift the economy up a gear (please note this can be done by reducing taxes OR increasing spending). In fact, as tax receipts and certain government outlays (e.g. unemployment benefits) both rise and fall in a countercyclical fashion, much of the federal government’s budget stance is beyond the control of policymakers and instead determined by the endogenous performance of the economy. This is known as automatic stabilizers. Things like unemployment benefits and other “automatic” forms of spending can rise without any new government action during a downturn.
As Michael Kalecki has famously noted, Government deficits (whether it be via lower taxes or increased spending) can also help sustain the revenues and profits of businesses enabling them to employ more people. You may have noticed the sharp rebound in corporate profits over the course of the post-financial crisis period. This was due, in large part, to government deficit spending; though as of 2012 it has failed to translate into a strong and sustainable recovery. I won’t dive into this in great detail, but the reason for this is rather simple as seen in the following equation derived from Kalecki’s work:
Profits = Investment – Household Savings – Government Savings – Foreign Savings + Dividends
Continuing on with the metaphor, government regulation can be annoying (bureaucratic red tape) but when not overdone it is like the safety features built into modern cars (e.g. seatbelts, airbags, etc.) with the purpose to keep economic activities within acceptable boundaries, but without constraining the vehicle from moving. In some respects the government sector is like a “safety net” there to correct and curb market failures (though admittedly, it can also exacerbate problems if misunderstood). Hyman Minsky has noted that capitalist economies are periodically prone to what he called “endogenous” financial instability by which he meant that the “normal” workings of the market system can generate financial excess. He advised on the need to update regulation in view of new developments and for policymakers and theorists alike to humbly acknowledge the possibility that what worked in the past may no longer do so. Minsky was overlooked. I believe that humans are inherently fallible and inherently irrational. Since economies are the summation of the decisions of these irrational actors it is not surprising that the economy has a tendency to veer in the direction of extremes at times. As Minksy famously noted, “stability breeds instability” as economic agents becoming increasingly comfortable and complacent during the boom phase of the business cycle inevitably leading to excess and bust.
Everything else in the car is the private sector. The nonfinancial business sector is the engine, the chassis, the wheels and the seats (what we might think of as the “core” pieces of the car). Nonfinancial businesses are the biggest employers and make most of the products and services essential to increasing living standards. The household sector is the driver and any passengers in the car. As employers, employees, investors and consumers we determine the overall direction of the economic system. The financial sector provides the lubricants in the car (e.g. the oil, coolant, etc). The main role of finance is to facilitate the development of the productive capital assets of the economy and to provide the monetary and financial resources that allow us to undertake activities of our own liking (e.g. buy or build homes). The fuel in the car that motors the economic system is the drive to earn a living, make a profit and save for the future.
Private Bank “Inside Money”
The US monetary system is designed to cater for the creation of the public’s money supply primarily by private banks. Most modern money takes the form of bank deposits and most market exchanges involving private agents are transacted in private bank money: it is “inside money“ which rules the roost so to speak in the day-to-day functioning of modern fiat monetary systems. The role of the public sector “outside money” creation is comparatively minor.
Like the government, banks are also money issuers, but not issuers of net financial assets. That is, banking transactions always involve the creation of an asset and a liability. Banks create loans independent of government constraint (outside of the regulatory framework). As we will explain below, banks make loans independent of their reserve position with the government. So the textbook money multiplier model where banks lend deposits is in fact wrong.
The monetary system in the USA is designed specifically around a competitive private banking system. It is not a public/private partnership serving public purpose as the Federal Reserve essentially is. The banking system in the USA is a privately owned component of the system run for private profit. This was designed intentionally in order to disperse the power of money creation away from a centralized government and into the hands of non-government entities. Because the Fed finds itself as an agent of the US government working its policies primarily through these private entities it is often the center of much controversy. This will at times appear like a conflict of interest as the Federal Reserve, an agent of the government, is often seen as being in collusion with the banks and at odds with the achievement of public purpose. The government’s relationship with the private banking system is more a support mechanism than anything else. In this regard, I like to think of the government as being a facilitator in helping sustain a viable credit based money system although the banks as private profit seeking entities sometimes find their motives at odds with the overall goal of public purpose.
The Myth of the Money Multiplier
It’s important to understand that banks are unconstrained by the government (outside of the regulatory framework) in terms of how they create credit. When we go through business school we are taught that banks obtain deposits and then leverage those deposits up by 10X or so. This is why we call the modern banking system a “Fractional Reserve Banking” system. Banks supposedly lend a portion of their “reserves”. There’s just one problem here. Banks are never reserve constrained! Banks are always capital constrained. This can best be seen in countries such as Canada where there are no reserve requirements.8 Reserves are used for only two purposes – to settle payments in the overnight market and to meet the Fed’s reserve requirements. Aside from this, reserves have very little impact on the day-to-day lending operations of banks in the USA. This was recently confirmed in a Fed paper:
“Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected.”9
This is very important to understand because many have assumed that various Fed policies in recent years would be inflationary or even hyperinflationary. But all the Fed has been doing is adding reserves to the banking system in exchange for (mostly) government bonds. Because banks are not reserve constrained, i.e, they don’t lend their reserves or multiply their reserves, this doesn’t necessarily lead to more lending and will not result in the private sector being able to access more capital. Because banks are not reserve constrained it can only mean one thing – banks lend when creditworthy customers have demand for loans. Loans create deposits, not vice versa. Banks create new loans independent of their reserve position and the Federal Reserve is in the business of altering the composition of outstanding financial assets in an effort to maintain a target interest rate and maintaining the smoothly operating payments system that it oversees. In the loan creation process, banks will make loans first (resulting in new deposits) and will find necessary reserves after the fact (either in the overnight market or via the Fed).
So, contrary to what we are all taught in school, loans actually create deposits and not the other way around, as the money multiplier would have us all believe. When a bank makes a loan it debits the Loans Receivable account on its books. To balance this transaction it will create a new liability in the name of the borrower. This loan will create a deposit somewhere else in the banking system (possibly at the same bank) that will cause this new bank to also account for its new liability (the deposit) and change in reserves at the Fed. Scott Fullwiler elaborates on this confusing point (see here for more on this from Fullwiler):
“The bank does not “use” cash to make a loan. The loan creates a deposit. If cash is withdrawn by the borrower this reduces its deposits. So, the cash is “used” in the process of settling a borrower’s withdrawal. This is the key point that confuses so many–banks don’t “use” cash or reserves to make loans since those are merely bookkeeping entries. They need cash or reserves to settle withdrawals that arise from creating the loan/deposit.”
It is important to note though that the banks wield enormous control over the money supply through the powers granted to them via the government. The modern banking system is fragmented in such a way so as to disperse the power of money creation across both the private and public sectors. This is consistent with our form of government that is structured in such a way so as to avoid providing any branch of government with unchecked powers. So while the banks wield enormous power over the money supply it is incredibly important that the check on the banking sector be enforced via regulation, but also that the government’s power over money be regulated by the people.
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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30 Comments
Cullen,
I like the use of the desire/ambitions of individuals as the fuel for the car and that the HH sector gets to direct the car. I can align with this philosophically and it ties in nicely with the demand for credit by private sector in the end being the determinant for the amount of credit money that gets added to the ecomony (regulated by policy)
When that loan gets created,the principal amount hopefully is secured by a responsible promise to pay and better still, backed by something with a proper loan to value. This principal amount is created but where does the interest part get created. Where does all this interest credit money get added to the system so that it will be available for discharge of loans for all this credit money that is created economy wide?
Hi LRM.
I owe Brett Fiebiger a big thanks for pulling that analogy together. He put a lot of time and effort into critiquing my paper and getting some of the details just right. So this was not just me. I should be posting references with these, but I’ll just do it at the end….Sorry.
The interest is paid using the same money that most of us use in our daily transactions – bank deposits. So it “comes” from the private banking system in large part.
A thanks to Brett as well then. A good “picture”helps in the understanding.
With regard to the interest credit money that was never created at the time of the loan, so if the interest portion of loan repayment is coming from the deposits from other loans, will there not come a point where due to the large amount of loans outstanding eventually there will be a shortage of credit money? Is this why there needs to be fiscal deficits to fill this hole in the demand for deposit money?
Maybe next part addresses this.
I wouldn’t say there is a shortage of credit money. What generally happens is that there’s an excess supply of credit money during the boom. And when the bust occurs cash flows die and all of the sudden there’s a shortage of credit money. This is what really causes the economy to seize up during the bust. Government can ease this downturn by running large deficits, adding net financial assets and getting the cash flow machine working again. Sort of like stepping on the gas while dumping more oil in the car (in keeping with our analogy). Gets the engine all lubed up. That’s how I think of it at least. Hope that helps.
OK,
I will stand by to see why there is the shortage of credit money to which you also referred if credit money was initially issued in the proper amounts required in the private sector. That is, where is this sufficient supply that was issued disappearing such that it becomes in short supply?
Missing hyperlink towards the end, I’m assuming the word ‘here’ should ink to somewhere: “(see here for more on this from Fullwiler):”
just read this from Mish shedlock.
http://globaleconomicanalysis.blogspot.com/2012/07/can-bernanke-force-banks-to-lend-by.html
wow, sounds an awful lot like what i’ve learned on this site! i’m impressed, at least, with this discussion of his……. you’re making headway, Cullen!
To be fair to Mish, he has been making this argument for several years so it’s not as though he just had some ‘come to Jesus’ moment.
Nice. I didn’t know about the new tools the FED has for maintaining finer control.
With regards to interest payments inherent in credit money creation, that can go on for quite awhile. Credit money, especially in a bubble, creates a lot of velocity. Imagine a one dollar bill that could move at the speed of light into many accounts. That one dollar bill would make everybody “appear” to be one dollar richer. An economy with high velocity movement of money has a multiplier effect that can pay the interest, for awhile. Steve Keen has shown in his models that the multiplier is 3.1. However, that output derives ultimately from his models.
Since the multiplier is so fuzzy, and essentially based on people’s mood and other external factors, then control of interest rates is probably the only option in any money system.
During a crash, credit dries up, but the credit banker still requires payment. In that case, the velocity goes to near zero, while the liability column on the bank balances still demands to be paid. This double whammy explains the sawtooth nature of most credit driven economies. A slow rise then a rapid vertical fall.
If the liability column is not paid, then legal forms of justice and or force is brought into play. Government can also spend, and that money goes on to pay down the credit ledger.
In the gold days, during depressions, credit would dry up but the underlying base (gold) would be demanded instead to make the balance sheets right. If not gold, then land or some other now depressed asset would be demanded.
An explanation of the money system allows us to move on to the higher arguments. Such as, “What is the shape of the economy?” How does the money system predicate its outputs, and is that output desirable?
OK, that give some additional thoughts to consider regarding where the credit money comes from to pay the interest.
Like the old joke where the guy goes into the hotel lobby and places a deposit$100.00) on a room before going to see it.
The reception guy takes it and runs to the bar to pay his bill.
The bar tender pays the lady of the night and then the lady of the night returns the $100 to the hotel receptionist to pay her room bill.
The customer returns to the reception and decides the room is not acceptable and pockets the $100 . But all these other people have cleared their bills
So I guess velocity can account for the ability to pay interest in this sort of way
Thanks for providing some additional information on how credit money interest payments can be found.
The velocity idea reminds me of the old joke where the gentleman enters a hotel and leaves a $100.00 deposit on the counter with the reception while he goes up to look at the room. The receptionist runs across the street to pay his $100 account at the pub. the pub owner then pays the lady of the night his $100 for services provided. The lovely lady then rushes back to the hotel and returns the $100 for her room bill just in time as the gentleman comes down and decides he does not like the room. He picks up his $100 and leaves having provided the liquidity for several people to pay their debt.
Isn’t the monetary system amazing?
Exactly. Also, remember that credit can have counter parties as well as assets (e.g. your car or house) attached to the ledger. So, you can get a chain of counterparties that can fall down like dominoes, which is an additional factor helping create the rapid downward stroke of the sawtooth pattern. Joe owes Maria who owes Sam who owes you. The counterparty scheme is an inherent weakness in the system.
When credit is borrowed, it is money from the future that pops into the now. Often (usually?) it can go on to make asset inflation as the extra credit money bids up prices faster than production can adjust. For example, extra land cannot enter into the “market” as new supply of land cannot be found..it is fixed. Since most credit has land attached at the ledger, then it causes land prices to go up. When the future comes into the now, it allows prices and debt to climb simultaneously, and nets out our present day world circumstances.
The bulk of credit creation does not go for improved productivity like the textbooks say.
Keens models show it is the ROC (rate of change) of credit that drives asset inflation. So, if there is a lot of sudden loan activity, it is guaranteed to tax the future, and bring poor economics into the now via asset inflation. Ultimately we have to pay as the future is met, and you get balance sheet recessions.
Sudden loan activity usually follows some sort of irrational exuberance. The productivity gains of the 20′s (innovation), the productivity gains of the 90′s (high tech revolution), and the lean productivity methods in Japan circa 1980s.
@REN
Keen and Mish have opened a dialogue on solutions.
Keen is suggesting debt jubilee but Mish is not for this.
Mish wants to start with identifying the problem which he says is fractional reserve lending.
Would 100% reserve lending be too much “brake” for our modern economies?Would 100% reserves be just like the gold standard or would the supply just grow as productivity creates the additional capital.
As CR says, banks lend to worthy customers with only a capital constraint. Not sure what the FRL ratio to capital is now but going to 100% would limit loans quite a bit?
Ren,
Can you be more specific on how a 100% reserve system would operate?
For Joe to lend directly to Mary is not practical, so how would banks operate to provide the link between savers/lenders and borrowers? Eg. for the ordinary saver, would the vehicle for savings basically operate as a CD does now?
Is there any example of a fiat currency system operating with 100% reserve lending?
Hello Colin,
My example of counterparty risk, where Mary owes Joe, etc. is an example of today’s credit money system. For example, the Greek government issues a bond to a German commercial bank. The bank attaches the bond to their ledger and issues Euro credit money. At the same time, some sort of insurance or derivative may attach as well making the bond even more secure. The counterparty gets some of that gravy interest payment for their risk. AIG serving as counterparty to loans at American banks is another example. So if Greece doesn’t pay, then the insurance has to pay. If the insurance doesn’t pay, then somebody else is tapped. This is the domino that underlies private credit, and it is all based on “risk” assessment. But in reality, that is hard to do when credit itself is a function of future money, and the future is unknown.
I can see that you are still trying to piece together how a 100 percent system will work. In that type of system, a borrower (debtor) gets a loan from a creditor (somebody who has extra money as savings to loan out). In this case, the money already exists and does not come from the future – it came from the past. It also does not need counterparties or asset seizures to derive risk levels. This is money and not credit, and hence it is of higher power and said power is in turn a function of the law and system design.
The private banker simply matches up debtors and creditors, and said parties make a contract. This means that bankers still get between creditors and debtors, but do not make a market in new credit money. They are simply trusted go between agents. In such a system, if there is a default, then there is no Mary who owes Joe, etc. The creditor gets hosed, but there is no domino effect as it stops there.
In my opinion though, a pure 100 percent system has to have a percentage of state credit in order to work. I’m probably the only person making this case, so I feel alone. With State Credit, the Treasury would have an account at private banks. As far as the private banker is concerned, this money looks the same as savings held by private individuals. In this way, the state can provide credit as needed during disasters, or to keep monopolists at bay. Also, the direct link to the Treasury means that debts can go through a jubilee if things get out of hand. In other words, State credit of this type is of a much higher power than private debt we currently use. State Credit would be similar in power to the real money component in a 100% (now 80%) system. The private banker must be an agent for the State as well as private individuals, so they are to be high trust people. Since money is a form of law, and our money is legally issued by the treasury, the law needs to be of the highest power – constitutional without populist pressure.
There has to be a fine mechanism for controlling interest rates. That means the money supply must have a natural drain other than blunt taxes. Some state credit in the system, maybe 20 percent, would be required to make a drain, thus creating a knob for keeping inflation at bay.
“The private banker simply matches up debtors and creditors, and said parties make a contract.”
I was using ‘Joe’ as a name for the creditor, and ‘Mary’ for the debtor as in your example above. My point was that for a bank to act only as the go-between in direct contracts between small savers and borrowers would seem unworkable: for such parties, differing desired amounts and time frames; limited ability to assess risks and mobilize legal measures to enforce the contracts, etc.; it seems like the bank would have to mediate some or all of these aspects.
I’ve been thinking of an alternative version to the current Treasury/Fed system that might work similarly to your 100% reserve +
‘State Credit’: The Treasury obtains funds for any balance for Congressionally mandated spending/taxing, directly from the Fed/CB, which can also auction bonds to, or repurchase them from, the public in amounts and at set minimum bids that help it meet its various mandates.
One could combine this with a high reserve requirement for bank lending (perhaps as high as 50% or more). These reserves could then be used to buy treasuries, or essentially equivalently, put in an interest-bearing account at the Fed. They could then only be used for settling payments (not for speculating, or in direct or indirect support for additional credit creation, etc).
Something like this would be more flexible; would it not also limit private credit creation, and provide the state a ‘drain/fine mechanism for controlling interest rates’, while not relying on banks to act as ‘agents of the state’ as well as for profit?
Collin, the way I read it is you are worried about debtor power. The debtor doesn’t make good on their contract, and now the creditor gets it in the shorts. Then the relatively “toothless” banker does not have the legal or money power to solve the contract. Yes?
It’s an interesting point, but one that could be addressed in a 80% system. Legal structures could be put in place to address the problem. A whole host of legal systems and safeguards could be unlocked in stages to mediate between creditor and debtor, essentially escalating it outside of the banker’s purview and to a higher legal authority. Lawyers would have to become conversant with the money system, a new branch of the law.
My starting framework is from what money is: A simple definition is that money mediates between credit and debt. When credit and debt get together they annihilate each other into nothingness. For example, I give you a chicken and you immediately are in debt to me, and I’m the creditor. You give it back, and annihilation takes place. If there is a time element involved, then some sort of fees are collected, say some eggs. The usury in this case could be more eggs, and egg interest is not outside the bounds of nature. Money is sterile and cannot reproduce itself naturally, so usury growth is outside of nature, and must be accounted for in the system design.
If the debtor doesn’t pay back the Chicken – then if you are the Creditor, you could go bash his head; or if civil society has arisen, the authorities could deal with it. Therefore money has a law and force and time element to it. Any system has to deal with money contracts in a law and force manner.
When private bankers create credit money, they make a market in money. Creating a market for money deviates from what money is, and hence unleashes all kinds of disturbances. The market gets between Credit and Debt annihilation. See my previous comment to LRM on the circle of illogic in private credit money creation. My position is that the private credit system should not be tinkered with any more. We do a fix with Greenbacks, and then we undo it with a recall. We try to do a free banking system, then we undo with a Federal Reserve system. We do a Glass Steagall, then we undo it with Graham Leach Blily. Today we have a private credit system, with Government as a rump to provide reserves on demand. Private money power is the funding tap root for parasites to host our elected government.
Public money, some public credit, with private banking means that the money power has one headwater source, the treasury. It can then be surrounded with fire extinguishers and legal watchdogs to make sure it doesn’t get out of its cage. Our double source of money; base money and credit doppelganger as money, continues to allow all kinds of games to go on that are not good for humanity, and may ultimately be our undoing. Already neo feudalism is on the march, witness banker caretaker governments in Greece.
I understand though that you are trying to make credit behave more like money, and I applaud the sentiment. A half loaf is better usually better than no loaf, but if we could go to a real system, that would be ideal.
Ren,
You’ve addressed some of my concerns. The added element would just be the cumbersomeness of a system of myriad direct contractual links between small lenders and borrowers (matching amounts and timeframes, etc).
I would also have concerns on adding a layer of lawyers (and lawsuits), similar to my concerns about expecting private banks to act partly as agents for the government.
However, I strongly sympathize with your goal of ‘public money’ such that “the money power has one headwater source, the treasury”.
Cullen, and Brett Fiebiger seem to see a danger in such concentration of the money power. I agree that vigilance would be needed, but as you say, I think it would be easier to surround it “with fire extinguishers and legal watchdogs” if it was kept in one, transparent and public, place and everyone knew it.
With the current ‘double system’, even the experts and those elected to bear ultimate responsibility for the system don’t seem to understand how it works, allowing insiders to ‘game’ it for private gain at public expense.
Thanks for your responses.
Colin,
Please consider that if there were a public credit component, it would be like a ring in a Bull’s nose. Whatever the credit component did, the fully reserved component (savers) would follow. Also municiple fund type arrangements would bundle savers moneys for large contracts. The public would see no difference as their savings are loaned out, which is how they think it is done now anyway.
With regards to the extra legal layer, we have that now, but it will change slightly. Bankruptcy courts and the like, along with other mechanisms for handling defaults. There is less complexity as it becomes transparent, not more complexity.
As long as there is a way to game the system, there will be clever people who are able to do it.
Cullen is wrong, money is not debt. Money mediates between credit and debt, allowing them to extinguish. Sorry Cullen, you have to get a handle on this.
If money is not credit, then what is it? You claim money is a creature of law, but that’s only true for specific kinds of money. So clearly, not all money is a creature of law. Only certain forms of money are a creature of law. I think the one universal truth with money is that it is something that allows us to extinguish liabilities within society. Even in the most finite of transactions this is true.
Money exists in that space between Credit and Debt. In that same space exists law and force.
In the old days people would keep credit and debts as talleys in their heads. They would instinctively know how much they owed each other. It then evolved to making marks on paper or clay. These marks served as a “marker” that conveyed information, such as one chicken and three eggs, along with a time stamp. Therefore Tallys are high information, but do not allow credit and debts to extinguish immediately.
Money on the other hand, allows credits and debts to extinguish in the here and now. When I buy a Chicken at the supermarket, the debt is extinguished immediately and the creditor is satisfied with the money. We don’t have to go to a fair at the end of the year and settle all of our debts and credits.
So, the real answer is that Money is a medium that has many properties, namely a time element, and information element, and it mediates between credit and debt. If we could look at it with x ray glasses, it would be a long accounting identity and would be something more than a simple number.
Poor economists call money debt when there is a malformed legal system. In that case, money becomes debt as the money power devolves to bankers and the concurrent double entry policy of commandeering real assets. Bankers also make a market in money, which is contrary to what it is. So, the banking cohorts will always try to define money as debt, and muddy the issue to their benefit.
I don’t say money is debt. Most money is credit. Credit is the trust between two parties that extinguishes a debt. Maybe it’s a bit imprecise of me to say that “all money is credit”. Okay, I’ll give you that.
When money is credit it moves toward the Creditor in that space between credit and debt. Therefore credit money has credit power. Generally the issuer of credit is over the debtor in the case. For example, in private banking credit money, the issuer of the credit money is over the debtor. Payment of debts point back to the issuer of money, or those who have money.
If money is debt, then the law framework shifts toward the persons hold the debt. For example, England had debtor power after WW2 and they could have used it to make markets for their goods.
The legal framework decides which way the money power shifts. The ideal money exactly arbitrates between credit and debt, meaning that each party has a fair shake. Only fiat money in the proper legal and system arrangement can do this.
Rome grew quickly from 790BC until the second Punic war by knowing this, and having good legal structures. They then devolved to a lower form of gold money and soon the dark ages were upon them. Banker money came into being after the fourth crusades and the return of the Templars, and we’ve been learning about it ever sense.
Sorry, my bad. Banker money is CREDIT money, but sometimes I call it debt money. I do this subconsciously because banker money comes into being with debt attached. That debt drags around behind it, and has a cost in every transaction.
If the creators of money are taking out a slice of the productive for themselves, then they are stealing. But, you cannot see the theft because money is not a long accounting identity and does not tell us about its past.
You need system frameworks for limiting the variables and holding money into the proper form. Otherwise, civilization looses trust, a basic building block. Fiat is faith, and the money system should not steal. Simple numbers on a ledger are one of the reasons people are so confused. They assume that the system is working magically.
OK, I have to be very careful with the definitions. When a banker creates money on a ledger it attaches an asset and then goes out into the marketplace. This is not money, but acts as money. It can still mediate between credit and debt. If I give you a coke and you pay me back with another identical coke, then credits and debts extinguished. We didn’t use money did we?
This bank money can also mediate between credit and debt transactions. However, the bank money, when examined closely takes wealth for its right to exist.
But, I will agree with you. Real money mediates fairly between credit and debt and does not take unfairly. Lets say, non bank money is saved up and loaned out. Then the “creditor” of real money in this case deserves some gain due to the time element.
The definitions matter. Money is defined by its system framework, which in turn is a function of the law. If I allow bank created credit to be the dominant form of money, then yes, there is an element of fraud. The creators of money in our banking system take little risk, especially if they can attach an asset. If they engage in asset inflation and then socialize the risk, even better.
So, some definitions: 1) Token money; something that stands in for something else. 2) Private credit money; stands in for money and mediates between credit and debt. Private credit money makes a market in money and in turn informs markets. Markets define asset values which in turn inform the ledger in an illogical feedback loop. In other words, the creation of money can make the asset appear to go up in value. 3) Public Money; issued within a legal framework, thus the system variables can be held more constant. The history of public money is well behaved. 4)State Bank money; this credit money can drag debt behind it like private credit. But, if the State bank re-spends the usury back into the economy to offset taxes, it behaves as money, not stealing for its right to exist.
As Mosler says, we put our labor and goods and services on the Grocery shelf of life and hope to trade them. We need to be able to trade them fairly with an agent i.e. money. We can only trade what we produce and not more, otherwise we are borrowing.
Money allows debts and credits to cancel in the here and now. When you transacted for the coke, the store creditor was satisfied. Barter also allows debts and credits to cancel immediately, but does not easily allow specialization. Barter also does not need developed law.
The higher the law formation, the higher the money system should evolve. We are evolved enough now to move beyond private credit, a lower form of money.
So money mediates between credit and debt. Credits and debts are not money. When someone says credit money, that defines the usury flow as pointing toward the issuer of credit, usually a bank, and hence the term credit money.
Hello LRM,
100% reserves is not like the Gold system. Gold systems have credit riding on top of the Gold base. Private credit in a gold system is somewhat limited in issuance “volume” but still has the credit defect. The Gold bugs never mention the credit that rides on top of Gold. Remember credit has a circular illogic to it. Credit money volumes/velocities serves as information which informs markets. Markets in turn inform the asset side of the ledger, which created the credit to begin with. This illogical feedback loop makes credit/gold systems not work. Our money system was built up ad-hoc, especially with gold bankers engaging in fraud, as they issued credit in 10:1 ratios in excess of their gold deposit base. Gold systems also ignore the fact that money is a creature of the law and they turn the money power over to private unelected individuals.
With regards to your question about limited loan activity. If the private savers don’t want to make loans, then State Credit can slam their heads against the wall. The Treasury simply tells the private banker, they are willing to loan at X amount. See my comments to Colin above about State Credit. Savers in a 100% system can be cavaliers too, rushing in to make loans when times are good and retrenching when times are bad. Our private credit making banks today are cavaliers, as loan activity dries up when there are bad times, but they rush in when there is easy money. This defect in us humans cannot be ignored in money system design.
I love REN’s concept of ‘annihilation’ when a debt is settled. Could this be why deleveraging is such a shock to the fiat economy? When I pay back the bank, that’s good for me, but bad for the bank (and, apparantly, bad for the economy.) The current system wants me to keep on owing the bank. It actually wants me to borrow more and create more money.
Since deleveraging is so damaging, is to print enough money to retire everyone’s debt … and isn’t this what the Fed is really doing by buying up bad debt and putting it on its balance sheet. But wouldn’t it be more fair for them to just pay off student loan and credit card debt at the same time?
That would be a type of debt jubilee.
And then let’s go back to a system in which all loans have to be secured.
That is why the bank of Canada, as state bank, was attacked in 1974. The Canadians had enough government fiat money in circulation that people stopped taking out loans. They were borrowing from each other. Businesses became self financing. The Bank of Canada also ran roughshod over the private banks, keeping them from being predatory.
That said, a state bank itself can become predatory; but we can learn money lessons from history.
By the way, they had little debt, free education, free medical and a healthy society. Not vectoring wealth to financial oligarchs, and allowing money to be a fair arbiter between credit and debts has a profound impact.