Some myths about modern monetary theory and its developers

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1. Note that wrt: “High levels of unemployment tell us that there is significant idle capacity in the economy. It cannot be inflationary for the government to use its fiscal power to provide a job to this labour – which has no private sector demand by definition. The government would not be competing for any resources at market prices.”

   It could be if the provision of that job competes for OTHER resources that are more scare than labour. This is one reason why a system of bids to participate as JG programs from outside the JG authority should have on-costs provided by the bidder, to bias the programs in favour of activities that are labour intensive and equipment and natural resource extensive.

2. Bill,

   The vehemence of some of the criticism is somewhat mystifying to me, but I have been observing a similar phenomenon elsewhere in discussions on topics such as whether or not there is a bubble about to burst in Australian property prices or whether or not anthropogenic global warming is occurring or not. As in the case of monetary theory, it would seem that the core of the discussion is to get at matters of fact (whatever the degree of difficulty may be). Armed with those facts, there may be politically-inspired courses of action, but that is the second step. You would almost think that we were talking about religion!

   So, it is a subject that I have been giving a fair bit of thought to of late and I am sure that there is something about the relative anonymity and lack of face to face contact in online forums that allows discussions to become more heated than would otherwise be the case. We have had flame wars as long as we have had the internet and on even less charged topics (one would have thought). For that reason, if clear messages are to be communicated, I think that tone and language are quite important. While the emails you receive may be excessively emotional, by and large cooler tempers tend to prevail here on the blog (perhaps courtesy of judicious comment moderation) and I think that this is a good thing for furthering the understanding of anyone who visits.

   There is one thing I have begun to notice only in recent months and that relates to a point of language. You have often commented on the inflammatory language often used by neo-liberal critics of monetary policy: “printing money”, “monetisation”, even “Zimbabwe”. When used in this way, language can certainly distract from the central issues under discussion by means of emotional short-circuits. What I have noticed of late is your use of the terms deficit “terrorists” and deficit “nazis”. Quite apart from the fact that I tend to appeal to Hanlon’s Razor and attribute most misunderstandings of economics to cock-up rather than conspiracy, surely here you are doing exactly what you criticize others for? Just a thought.

   Regards,
   Sean.

3. Dear Sean

   Good points. I would say the following.

   First, if my language is immoderate then I will be more careful.

   Second, I don’t attack anyone personally but always engage with the ideas that are presented. So the term deficit terrorist is generic and never said without giving a comprehensive critique of the position being presented. The criticism is only ever aimed at the ideas not the person. I never say someone is a f….n goose or whatever just because they dare to say something different. That is not similar at all to the issues I was raising in the blog where it is quite clear that the critics neither engage with the alternative ideas being presented nor understand the paradigm they are promoting sufficiently to be called informed. I also never dismiss a class of people out of hand just because they have a particular occupation.

   best wishes
   bill

4. Dear Sean

   Two other thoughts to add:

   (a) None of the vehement ones ever own up to who they are. I always take responsibility for my public position.

   (b) Terrorism is actually an appropriate descriptor – Noam Chomsky’s definition (from the US Army Manual) of a terrorist act is “the calculated use of violence or threat of violence to attain goals that are political, religious, or ideological in nature. This is done through intimidation, coercion, or instilling fear.” The deliberate creation of unemployment is in my view a violent act against a person’s human rights. The arguments used to support the deliberate creation of unemployment (via lower deficits than are necessary) are all based on fear. Further, the government and its allies uses intimidation and coercion to deal with the unemployed. And more.

   So while I will withdraw the deficit nazi terminology because that does have other connotations that I don’t want to push ever I think in this battle of ideas – that deficit terrorist is a reasonable summary of politically/ideologically assaults on human rights.

   best wishes
   bill

5. Bill,

   Thanks for giving it some thought. You make good points in response and there can be no doubt at all that you are in an entirely different league from the cowards who indulge in (usually anonymous) ad hominem attacks. There is also no doubt that, in making the comments I did, I was holding you to a far higher standard. I did that because in my by now extensive reading of your blog I have come to appreciate the integrity and discipline of your writing and thought and so I know that is the right level to put the bar for you.

   Regards,
   Sean.

6. Sean,

   I am with you to attribute misunderstanding of Economics by economists to cockup rather than conspiracy! Maybe Bill is attributing conspiracy because, if (lets say) a government expands its Employment Guarantee Scheme, people revolt without doing any analysis which is what terrorists do – become insecure and show some territorial behaviour?

7. Ramanan,

   I was thinking more broadly of misunderstandings among the general public and even politicians. It does seem harder to excuse economists.

   Sean.

8. Dear Bill and Sean,
   my interpretation of the word “violent” used to be physical violence whereby one person actively hits, injures or kills someone else. So I was quite taken by surprise when the German Constitution Law Court, back in the 1970s ruled that sitting on the tram lines thereby blocking the traffic during a demonstration was an act of violence (Gewalt) even though this to me was a passive action. But as I recall the judgement the point was based on the causing of harm to others and harm was then interpreted in a broad way, eg tram and car passengers being hindered in their right to get to work on time or whatever.
   Cheers
   Graham

9. Dear Graham

   My version of this is that losing ones job is a violent act – very harmful, very confronting and very shocking with often long-lived consequences (especially in a downturn). If unemployment arises from systemic failure (deficient spatially distributed aggregate demand) which I consider it does, then those who have the capacity to address that failure are guilty of inflicting this violence onto society and the individuals who make up that society. While clearly capital can alter things by investing they are not a united entity (despite conspiracy theories which suggest they act as one). But the government always has the capacity to employ anyone who hasn’t got a job. The fact they allow fear and harm to prevail by not reducing unemployment to its irreducible minimum (people moving between jobs on survey day) is an act of terrorism sourced in politics and ideology.

   best wishes
   bill

10. Dear Bill,
    yes, I fully agree.

    The German experience was a learning experience for me at the time and caused me to reflect quite broadly on issues of justice, fairness and a decent society. The word “Gewalt” had of course a special significance for the Germans because of the Nazi period but the lesson for me was to learn to attempt to recognise the less directly observable results of our active and PASSIVE behaviour – even if well-intentioned.

    BTW, I just heard a claim (don’t know to what extent it is true although I have met 2 people who claim they have done this) that unemployed people have been moving to a country town which is more than a certain distance from the next Centrelink office because this means they don’t have to conform to the requirements. It is not that they don’t want to work but that they have given up trying to find a job and the Centrelink requirements are just too painful and cost far too much in terms of time and money. For example there is only one bus per day from this town to the town with the next Centrelink and one return bus. So the round trip takes all day. They know their chances of getting a job are nil anyway even if they lived in the town with Centrelink.

    Cheers

    Graham

11. Dear Sean,

    Great post about Hanlons Razor. The victims families of the Hiroshima and Nagasaki bombings will be very relieved when they find out it was all just a cock-up rather than a calculated act of mass murder.

    And while we are at it lets assure the victims of the stolen generation that it was all just a simple cockup…or that the White Australia policy was just a simple cock-up rather than a blatant ploy to wipe out the Aborignial culture.

    Well done Sean – great post I’m so glad you cleared it all up for us.

12. I know this is a very old post of Bill’s but I’m always accused on here of having a very basic underlying misunderstanding of MMT and so I thought I needed to revisit the groundwork. Two things are made very clear – the desired end result Bill suports “I value people having work with an environmentally sustainable world above most other things” is the same as mine (and most peoples) and as Bill points out MMT is just a framework to understand how that aim (or any others) might be attained. Then Bill says “and so my understanding of how the economy works tells me that the only way I can achieve those political (or ideological) aspirations (full employment) is for the government to run deficits up to the level justified by non-government saving.”- This is where I feel my understanding dissolves. It is left entirely open whether “the level justified by non-government saving” is zero (if a wealth tax were to keep the amount of accumulated savings constant over time) or whether savings are to be allowed to accumulate indefinately. To me the practical consequences of having accumulating savings appear overwhelming and certain to thwart any positive efforts made by the government spending. Is it an MMT position that enlarging the global pot of savings from say £1T to say £100T will not necessarily increase the size and political influence of the FIRE sector and oligarchy and otherwise distort the economy and society? If such an increase in the global pot of savings is predicted to have no influence, am I uniquely stupid in falling into the misconception that it does and is that why MMTers do not feel the need to explain how it has no influence? If MMTers do also recognize the importance of having a limit to the global pot of savings then I don’t understand why MMTers don’t say deficit spending has dual constraints- not inducing consumer price inflation by overwhelming capacity and also not creating an undue burden of savings. I know I have asked this before and many people have made an effort to answer but the answers have all totally contradicted each other to the extent that I get the impression that the issue is the “emperors new clothes” of MMT.
    People have said- the size of the financial services sector and the power of the oligarchy is entirely uninfluenced by the scale of the wealth it has under management- I say that if true then that is one of the most amazing and counterintuative results I have ever come across in any field and deserves much more exposure.
    People have said- limiting savings is a purely political not economic issue- I say if the consequence is economic catastrophe then it is just as much an economic issue as hyperinflation is an economic issue.
    People have said- when the time comes MMTers will come up with adequate measures to constrain the financial services sector such that a small benign financial services sector will handle an ever increasing mountain of wealth and keep it from distorting the economy- I say that how can such a vague claim to be able to hold back the tide be the basis of advocating a course of action.

13. People have said- when the time comes MMTers will come up with adequate measures to constrain the financial services sector such that a small benign financial services sector will handle an ever increasing mountain of wealth and keep it from distorting the economy- I say that how can such a vague claim to be able to hold back the tide be the basis of advocating a course of action.

    stone, see Warren Mosler’s proposals for reforming the system. Also check out Michael Hudson’s extensive work on taxing economic rent, and the work of William K. Black, former federal regulator and forsenic expert on financial fraud and predation. Both Hudson and Black are professors in the economics department of the University of Missouri at Kansas City and blog at New Economic Perspectives at Kansas City. The economics department of UMKC is MMT-oriented and it represents itself as the Kansas City School, with the blog offering economic analysis and policy advice based on the operational realties of the modern fiat system.

    Marshal Auerback, who blogs at New Deal 2.0, also writes about this issue from a variety of angles. See, for instance, The Wasteful War Machine, Where Have All the Investigators Gone?, Will We Have to Blow Up a Continent (Again) Before We Stop Wall Street?, Attack the Disease, Not the Symptoms, and In the Age of Systemic Risk-A Proposal for Genuine Financial Reform.

    So I think that as you broaden your acquaintance with MMT, you will find that MMT and its close allies not only have these issues adequately covered but also are in the forefront of financial reform and operationally-based economic policy-making in the US. Their recommendations also apply generally in monetarily sovereign countries operating with modern fiat (nonconvertible floating rate) currencies.

    It appears to me that you are confusing savings in the economic sense of income not taxed or consumed with economic rent in the sense of revenue from non-productive sources, i.e., land rent, monopoly rent, and financial rent. Consumer savings are not the problem, economic rent is. As Michael Hudson notes, it must be disincentivized through appropriate legislated policy and strict regulation, oversight, and accountability.

    The political objectives of many MMT’ers that are writing on the blogs is optimal capacity utilization, full employment and price stability, distributed income, and sustainable productive investment sufficient to grow the economy proportional to population, in an environment where government allocates a portion of national resources to advancing public purpose. This involves removing inefficiencies resulting from non-productive activity that is essentially rent-seeking. Excessive executive compensation would fall into this category, for instance, as well as money shuffling instead of production. MMT’ers also take on issues like central bank independence and institutionalizing consumer debt, thereby creating what Hudson calls “debt peonage” as the driver of the economy.

14. Tom Hickey, I was referring to the sites etc you mention when I said “People have said- when the time comes MMTers will come up with adequate measures to constrain the financial services sector such that a small benign financial services sector will handle an ever increasing mountain of wealth and keep it from distorting the economy- I say that how can such a vague claim to be able to hold back the tide be the basis of advocating a course of action.” -the tide is a totally uneccessary consequence of the expanding currency mindset that comes about from being entirely subservient to the idea that the global pool of savings has to increase year on year, decade on decade. How and who can distiguish consumer savings from “economic rent”? Basically if a friend of MMTers accumulates wealth it is worthy whilst if someone else does it it is “economic rent”.

15. How and who can distiguish consumer savings from “economic rent”?

    Defining economic rent is really pretty simple in terms of productive and non-productive. Most consumers, “the little people” in neoliberal terms, would not be involved in economic rent-seeking, and they would only be taxed on land rent if subject to it. Most “consumers” would benefit because taxing economic rent would eliminate the need for much other taxation, and they would be left with more discretionary income for consumption and saving for a rainy day, retirement, anticipated expenses like their children’s education. The problem with “savings” is not consumers savings which are eventually consumed. It is funds gained from economic rent that go toward more rent-seeking. That is the province of the “the big guys,” not “the little people.” The “big guys” are what P. K. Sarker and Ravi Batra calle “the acquisitors.” Their primary motivator is wealth solely for the sake of acquiring more wealth. The “little people” would simply like to live a more commodious life and look forward to a better life (standard of living) for their children.

16. I have one major problem with MMT.

    MMTers condemn mainstream economists for relying upon monetary policy as the principle means of managing the economy by maintaining an unnecessarily high level of unemployment, whilst on the fiscal side aiming to “balance the budget” over the economic cycle. They base their critique upon moral grounds:- anything less than full employment, they say, offends against social justice and equality, benefits the rich at the expense of the poorest, and gives rise to a whole train of side-effects which damage society. They ascribe not just what they regard as stupidity to the mainstream, but deliberate inhumanity. One way and another they work up quite a head of moralistic steam.

    Well and good, so far as polemics goes – and some at least of the strictures may well be justified. But how comes it that MMTers are totally silent in regard to the fact that the private banks are permitted to create nearly all of our money, as debt, on which they collect the interest? This is a completely unjustified public subsidy which amounts, In UK for example, to some £100 billion per year added directly to the banks’ profits. Like any subsidy it is redistributive, and this particular one is from the less well-off to the most well-off. Yet we hear absolutely no discussion let alone condemnation of this within the MMT community.

    A movement is slowly gathering pace in favour of radical monetary reform, aimed at putting an end to this unwarrantable subsidy to the richest corporations in our society, as well as to its many grossly distorting effects (such as fuelling credit bubbles and speculation, particularly in the property market). But MMTers appear to have chosen to shut their eyes and ears to it. How is it possible to inveigh against the moral unacceptability of causing people willing and able to work to be denied jobs whilst at the same kind apparently finding it entirely acceptable (as not even being worth a comment) that private corporations should enjoy the privilege of creating our money, in the form of interest-bearing debt?

    The (deliberate?) blindness is all the more incongruous in light of MMT’s continually emphasizing that the sovereignty of the state is a defining feature of MMT doctrine. Yet in an allegedly sovereign state such as Britain the state in actuality creates and issues less than 3% of the country’s money, having surrendered to the banks the power to create and to profit from all the rest. And how does MMT reconcile these glaring contradictions? Simple:- by ignoring them.

    Isn’t it time MMT’s exponents started showing some interest, at least, in this crucial question? Until they do MMT will remain, for me at least, just a mildly-diverting cockshy. As a non-economist its technical aspects hold little interest for me, no more than do constant sectarian squabbles over the relative merits of rival economic dogmas. The same, I’d suggest, goes for a large majority of the informed public. Time to wake up?

17. Robert, I discovered MMT around 2003 while looking for counterarguments to “inflationista” white papers that friends were
    sending me. Let me say that you are categorically wrong in your statement MMT theorists do not recognize and have not called out the evils of rentier income, the banking sector, wall street, etc. Dr. Randal Wray has railed against it on neweconomicperspectives.blogspot.com. Warren Mosler has talked about how the financial sector needs to return to the model used in the 1970’s and I quote him “The financial sector is a brain drain.” He’s been saying this for years. Also, Warren was in favor of letting all of the banks fail during the crisis but with 100% government insured deposits.

18. Robert, historically there were two models of banking. The one that you cite is the Anglo-Saxon one which relies on short-term interest gains. There is also another model of banking which has been traditionally used in continental Europe and Japan. Well, not any more but only because Wall-Street has taken over at this point in history. This second model of banking has completely different groundings and it is enough to say here that it is based on equity cross-holdings (instead of loans) with strong participation and role of government.

19. “Like any subsidy it is redistributive, and this particular one is from the less well-off to the most well-off.”

    Really. Who owns most of the bank shares and what do they do with the dividends?

    Plus with CGT at 18% (unless you live in Monaco when its 0%) and Income Tax marginal rates over 90%, I think we have a far more pressing issue of redistribution built right into the entire UK tax system.

    I’m afraid that you’ve listened to too much of the 100% reserve propaganda people and not got enough perspective on the real issues.

    Now if you were arguing, as some do here, that 100% reserve is a better way of regulating the banks because it is simplifies their operation and makes them easier to liquidate when they burn up their capital, then I could go with that.

20. Robert and Neil Wilson, I very much think that 100% reserve banking is an essential reform.
    In answer to Neils “Really. Who owns most of the bank shares and what do they do with the dividends?” – as far as I can see pension funds hold much of the bank shares, the profits are mostly retained by the banks with only a token fraction paid out as dividends. The profits not paid out as dividends are creamed off by high frequency trading conducted by investment banks and hedge funds aka the oligarchy. Also many top bankers get pay of a level so excessive that most of it goes straight into savings (eg >£4B in city bonuses in London this year).

21. Tom Hickey-“Defining economic rent is really pretty simple in terms of productive and non-productive.”
    I really can not get my head around how you would do this in practice. Would a group of MMT officials sit in an office and vet every item of investment and make a pronouncement as to whether they considered it Kosher? How much work would that entail? Wouldn’t that give extraordinary power to that group of MMT officials? To me they would be assuming the role of soviet central planners but with the extra spin that people were making and loosing billions of dollars on the basis of the decisions they made as well as “merely” the whole functioning of the real economy resting on their decisions.

22. @stone

    Saving is the same as voluntary reversible taxation. It means that general taxation can be lower for the rest of society in normal times.

    It’s spending that causes problems.

23. Neil Wilson: Saving in a giro bank might be similar to voluntary reversible taxation. Saving in a normal bank account most certainly is not. The money that caused the 2008 crisis was fed into by the Yen carry trade that utilized savings in normal bank accounts. Anyway by “leakage to savings” I was including all of the wealth that had slipped from the pool used for consumption into the pool used purely for “building wealth”. It is that latter pool of money that whilst necessary for the economy also needs to be kept from expanding in order to retain the scarcity value of money for investment so that wise investments are made that allocate resources in the best way for the real economy. If the government ensures that the pool of savings constantly increases then that leads to an economy wide ponzi effect for asset prices and that results in a deranged economy.

24. stone,

    No it doesn’t and you’ve no evidence it does.

25. Bill’s written on 100% reserve banking and we’ve had a few discussions here as well. Can’t recall exactly when, but maybe someone can find it. Suffice it to say–and the details are provided in those discussions–that 100% reserve banking changes virtually nothing. It’s regulation and oversight that are the most important. And as Tom noted above, MMT’ers are at the forefront of research in this regard. Anyone who isn’t familiar with this literature isn’t really familiar with MMT.

26. Neil Wilson “No it doesn’t and you’ve no evidence it does.” -which bit is this about? Are you saying that in the absence of expanding currencies there could be asset price inflation or are you saying that asset price inflation does not equate to ponzi finance or are you saying that ponzi finance does not harm the working of the economy?

27. stone: I really can not get my head around how you would do this in practice. Would a group of MMT officials sit in an office and vet every item of investment and make a pronouncement as to whether they considered it Kosher? How much work would that entail? Wouldn’t that give extraordinary power to that group of MMT officials?

    Have you ever seen the IRS book of regulations? It is thick and detailed, and it takes a CPA to understand and interpret it. The tax authorities have no trouble defining what is taxable and what they say goes. All Congress has to do say, productive and non-productive with a few guidelines, and IRS will take care of the rest, just as they do now. Right now, the tax code is loaded in favor of privileging economic rent and taxing incomes, because the wealthy get the economic rent that is not taxed or taxed lightly, and workers get wage and salaries that get taxed heavily. This is the way the wealthy get around the progressive income tax.

28. Tom Hickey-So you are wanting the congress to rise above the current lobbying and instead base their decisions on their ability to forecast what amounts to economic rent? I just personally think a wealth tax would leave a lot less wriggle room and be a lot less likely to distort against beneficial investments that were not recognized as such due to prejudice or a like of foresight.

29. Neil Wilson “No it doesn’t and you’ve no evidence it does.” -which bit is this about? Are you saying that in the absence of expanding currencies there could be asset price inflation or are you saying that asset price inflation does not equate to ponzi finance or are you saying that ponzi finance does not harm the working of the economy?

    stone, the problem is not asset prices per se, it is leverage. Ponzi finance is not based on asset prices being “too high” but rather on the debt service supporting the prices being unsustainable. Prices that are “too high” eventually correct, and people who invested unwisely loose money. That doesn’t affect the economy if they are 100% invested. This happens all the time in various markets without undue disruption. But when people who are highly leveraged drive up asset prices, then the house of cards collapses and debt-deflation takes hold. If there are lot of such people, then there is a real problem.

30. Tom Hickey “the problem is not asset prices per se, it is leverage. Ponzi finance is not based on asset prices being “too high” but rather on the debt service supporting the prices being unsustainable.”- I agree that leverage makes the situation worse but I disagree about the situation being OK were it not for leverage. If it were not for currency expansion, there would not be asset price inflation- asset price inflation means that even those making entirely random investments which do not yield real returns nevertheless gain due to the ponzi process. The price corrections you talk about would bring their gains back down to zero in the long run were it not for asset price inflation. If asset price inflation is greater than consumer price inflation (and that is the way things are set up) then those who start off with the most assets get a proportional transfer of wealth courtesy of the government and at the expense of everyone else. That is the ultimate form of “economic rent” if you ask me.

31. stone: So you are wanting the congress to rise above the current lobbying and instead base their decisions on their ability to forecast what amounts to economic rent? I just personally think a wealth tax would leave a lot less wriggle room and be a lot less likely to distort against beneficial investments that were not recognized as such due to prejudice or a like of foresight.

    We are discussing optimal policy based on operational principles. Politically, there is virtually no practical possibility of either taxing economic rent or”wealth” given the present system, unless the legislature would pass effective campaign finance/lobbying reform and locking the revolving door, and even then the US Supreme Court has limited what Congress can do in this regard, so it would take a constitutional amendment. Neither taxing economic rent nor a wealth tax are going to be enacted while the wealthy retain control. And if they should lose control, then MMT’ers should be ready with a comprehensive proposal for optimal economic policy.

    The advantage of taxing economic rent rather than “wealth” is that productive investment is not taxed under this proposal, but non-productive extraction is. Presuming a capitalistic system such as the present one, then this is a reasonable solution. The objection to a wealth tax consistently is that it stifles incentive for productive investment. A proposal to tax economic rent avoids that objection, which is a reasonable one. Productive investment is necessary for incomes/employment/demand. What I am arguing is that eliminating parasitism is an ingredient of an MMT-based proposal for reform.

32. That is the ultimate form of “economic rent” if you ask me.

    I would agree that a great deal of asset appreciation falls under economic rent, since it is non-productive. That should be taxed away under this proposal. In a system that controlled leverage abuse, a lot of asset price run up would not occur. Most of the gains from leverage abuse are non-productive and would be taxed away, and this would disincentivize abusing leverage. Those who did continue to abuse it would suffer the tax consequences. Ponzi finance is an abuse of leverage by definition.

    But asset markets are not a problem in themselves and they perform useful functions when they operate to determine spot and forward prices and provide liquidity, instead of being used for wealth extraction through parasitism. Leverage is also an economic benefit when used reasonably to draw demand forward. There would not be much of a housing market without mortgages, for example.

33. Tom Hickey “The objection to a wealth tax consistently is that it stifles incentive for productive investment”- The last thing I would want would be to stifle productive investment. To my mind the true measure of whether an investment is productive is whether it pays a return. A wealth tax (ie a tax on the value of any asset such as stocks, real estate, cash etc) would mean that people would vue the value of the asset as a cost and the return it paid out as the benefit when deciding whether to buy it. To my mind that would incentivise productive rather than ponzi finance in contrast to the current system. If I think of a local example of productive investment, I think it would have been encouraged by a wealth tax system- a local start up got £1M per year for nine years to convert an invention into a £100M profitable business that was sold on to a larger company. Under a wealth tax the venture capitalist invenstors would only have had to pay tax on the value of the start up which was pretty minimal before about the 7th year of its life. When they sold it on for £100M they would have had no capital gains tax to pay. My understanding is that a wealth tax would reduce asset prices and greatly increase the yield from productive assets. It would decimate the price of non-productive assets such as gold.

34. 100-percent reserve banking and state banks

    See the comments, too. JKH weighs in extensively. This post is a gem.

35. Scott Fullwiler Suffice it to say-and the details are provided in those discussions-that 100% reserve banking changes virtually nothing.

    Well done. You just confirmed all my worst suspicions about MMTers. You’re living in cloud-cuckoo land.

    Joseph Schumpeter (is that a swear-word here btw?) among others was of the opinion that it was the single feature of modern capitalism that most clearly distinguishes it from its predecessors or any other system. If you honestly believe that the power to create money “changes virtually nothing” I really can’t begin to imagine what sort of world you’re living in.

36. bubbleRefuge Let me say that you are categorically wrong in your statement MMT theorists do not recognize and have not called out the evils of rentier income, the banking sector, wall street, etc.

    I made no such statement. Nor so far as I’m aware (but please correct me if I’m wrong) has Dr. Randall Wray been anything other than silent in regard to fractional reserve banking. Warren Mosler (as I know at first hand) has no interest in the matter – he refuses to see it as a problem.

    As I think do you, since you haven’t connected my description with what my description was actually about.

    I accuse MMTers – all of them, I’m beginning to think – of consciously shutting their eyes to a flagrant abuse. Worse than that, your writings sanction it (see Scott Fullwiler’s comment).

    So much the worse for MMT.

37. The last thing I would want would be to stifle productive investment.

    Then we likely on the same page and the kerfuffle is semantic.

    I would prefer to see an economy in which minimal consumer saving is required because social programs provide the necessities of life, including education, health care, pension, etc., and fiscal policy incentivizes productive investment and income from productive contribution, in which I would include everything related to primary use in production. Secondary use (speculation) I would tax as essentially non-productive although not all of this is necessarily parasitic. I would tax away the parasitic in order to completely disincentivize it. Most of this would apply only to the top tier. I would also use taxation/fees/fines to eliminate negative externalities and reduce negative behaviors.

    If we want to create a vibrant capitalistic economy, they we need to incentivize both productive investment/supply and productive employment/income/demand and disincentivize the non-productive. Presently, a great many if not most of the incentives are reversed, leading to chronic imbalances distributional problems, and unnecessary shocks that create disruption and make life worse for a lot innocent people, while the perps go unaccountable. This is not all that difficult to understand and change.

    According to MMT, A monetarily sovereign government as monopoly currency issuer has the sole prerogative and corresponding sole responsibility to provide the correct amount of currency to balance spending power (nominal aggregate demand) and goods for sale (real output capacity). If the government issues currency as nongovernment net financial assets in an amount that results in effective demand in excess of capacity, demand will rise relative to the goods and services that the economy can supply, and inflation will occur due to excess demand relative to supply. If the government falls short in maintaining this balance, recession and unemployment result, due to insufficient demand relative to supply. The government attempts to achieve balance through fiscal policy (currency issuance and taxation) and monetary policy (interest rates), based on analysis of data in terms of sectoral balances. Part of this involves making sure that productive investment is growing the economy proportional to population growth and distributing it demographically. Government also has to oversee banking, shadow banking, and other aspects of the financial sector in order to prevent imbalances from occurring. Congress needs to provide tools for this, and make sure they are being used properly.

    I would revisit the indexing of inflation and look at including asset inflation in addition to CPI and PPI. The GFC developed in part because the Fed under Alan Greenspan missed this, and the Fed under Ben Bernanke is trying to stoke asset prices again, prolonging the unwinding of the financial cycle at the risk of more debt bombs exploding.

38. Sergei Robert, historically there were two models of banking. The one that you cite is the Anglo-Saxon one which relies on short-term interest gains. There is also another model of banking which has been traditionally used in continental Europe and Japan.

    Thanks for that comment, and I find it interesting that you term it “the Anglo-Saxon model of banking”. That lends a bit of healthy perspective.

    But the Anglo-Saxon model was not predetermined to become what it did: there were in earlier times instances of honest models of banking before inordinate greed took over. The turning-point was the chartering of the Bank of England in 1694, for the express purpose of printing what were for all practical purposes counterfeit banknotes bearing the fraudulent words: “The Bank… promises to pay the bearer on demand the sum of —“, in the full knowledge that the promise could not be honoured if more than a certain proportion of the notes were presented for redemption at any one time. Whenever this threatened to happen the Bank suspended its promise, and was never taken to court for doing so. Maybe people were less litigious in those rumbustious times and so long as you were brazen enough you could get away with pretty-well anything – so long as you were a gentleman of course (if you were a villager you were hanged for stealing a sheep).

39. Robert,

    That was then, this is now.

    What is promised to the bearer of a government note now? The answer is : nothing other than the use of it to extinguish a tax liability.

    Fractional Reserve Banking is a canard of the recent Austrian School Renaissance. It may have had a little relevance when notes could be redeemed, but it has zero relevance now.

    The answer to the entire problem is to take bread and butter banking and turn it into something like a public utility through regulation.

40. Robert,

    Please prove via appropriate balance sheet manipulations that 100% reserves stops anything. Good luck.

41. Robert @7:19: To state it a bit differently, the point is that 100% reserves doesn’t alter whatsoever “the power to create money.” Sure, the power to create money is about as important as it gets, but it existed long before capitalism did. And I’m a big fan of Schumpeter, by the way.

42. Tom Hickey “I would revisit the indexing of inflation and look at including asset inflation in addition to CPI and PPI.”-Our objectives may be the same but there is an overwhelming difference between our positions because you (and all MMTers) want currency to expand and I am saying that for capitalism to meet your objectives it is vital that there is no expansion of the currency. If as you say, you were to adequately include asset inflation in your indexing and aimed for a zero rate of all inflation, then we would be in aggrement as that would equate to a trend towards balanced budgets followed by balanced budgets from then on.
    You say that the currency has to expand due to population growth. The population growth in the UK and USA is due to migrants forced to migrate due to the distortions caused by the expanding currency system. If it were not for expanding currencies it would not be possible to trade USD for real goods on a long term basis with the USD being hoarded by the elite. That would mean that money from international trade would have to be spent (eg by paying for higher wages, education etc). That would reduce both the economic migrations to places such as the USA and UK and also the poverty that leads to rapid population growth in impoverished nations.
    You say that adequate fiscal stimulus is dependent on having an expanding currency. I totally contest that. Current government spending is about 80% covered by taxation. If that taxation was shifted from the many different forms it is in now to a wealth tax (a tax on asset value applied equally to all assets eg stocks, real estate, cash etc), there was a modest pay cut for the highest paid public sector workers and a citizen’s dividend was paid to everyone, then a balanced budget with no increase in the burden of taxation might give a level of fiscal stimulus that filled the capacity of the economy.

43. Jeff65 “The answer to the entire problem is to take bread and butter banking and turn it into something like a public utility through regulation.”

    What does that vague phrase actually mean? Does it, for instance, mean that private corporations would no longer be legally permitted to create money in the form of debt? Does there exist somewhere in MMT-land a fully worked-out proposal for how that aim might be accomplished? If so, I’d be genuinely interested in knowing where I can read it.

    As you may or may not know, such fully worked-out proposals do exist in the outside world – several of them.

44. Scott Fullwiler “Robert @7:19: To state it a bit differently, the point is that 100% reserves doesn’t alter whatsoever “the power to create money.” Sure, the power to create money is about as important as it gets, but it existed long before capitalism did. And I’m a big fan of Schumpeter, by the way.”

    You seem not to have taken on board that the issue here is not the power to create money (which, of course, has existed since human societies started using cowrie-shells or whatever as money). The issue is who ought to have it – elected governments or privately-owned profit-seeking corporations, drawing interest from every cent of it?

    MMTers inveigh passionately against the iniquities of so-called neo-liberal (ie conservative, right-wing) governments. Yet at the same time you view with complete equanimity the privatisation of our money-supply for private profit. Beats me!

    !00% reserves mean that deposits remain the property of the depositors and are not legally permitted to be taken onto a bank’s balance-sheet and thereby be taken into and treated as part of the bank’s capital. So balance-sheets, for your information, don’t come into the argument. It also means that no loan (a credit) may be made without being balanced by an exactly equal debit elsewhere – in other words, a bank can only loan money it already has or is able to borrow. The bank is thereby deprived of the power to create one single cent out of thin air.

    And btw your characterization of FRB as a canard of the Austrian School merely confirms my suspicion that you MMters have blinded yourselves to reality. Offhand I find it difficult to think of any group more viscerally hostile to the Austrian School than the American Monetary Institute; they are in the forefront in the US of the campaign for monetary reform through abolition of FRB.

    More and more MMT seems to assume aspects of a monkish cult, to my mind.

45. Jeff65 “The answer to the entire problem is to take bread and butter banking and turn it into something like a public utility through regulation.”
    On the face of it this sounds as if it has some very serious implications. If publicly owned banks had unlimited funding and could decide who and what to fund, then what is the conceptual difference between that and a Soviet central planning set up. The problem with giving “public utilities” the power to decide what should and should not be funded is that they always seem to choose grand “best of the best” projects rather than meeting everyday needs. Think of the Concord supersonic passenger plane project we had in the UK thanks to such a system of funding, also the Appolo Moon landings and basically the whole Soviet Empire- nuclear bombs, helicopter gun ships, space exploration but a fairly crappy existence for most of the “little people”.

46. Robert . . . just as I suspected, you have no clue how deposits or banking works. Go see JKH’s comments in the link Tom provided. He demonstrates rather clearly my point.

47. stone: Our objectives may be the same but there is an overwhelming difference between our positions because you (and all MMTers) want currency to expand and I am saying that for capitalism to meet your objectives it is vital that there is no expansion of the currency.

    Agreed. As has been explained, your approach is through the quantity (stock) of money and the MMT approach is through sectoral balances of GDP (flow). What you are arguing essentially is a fixed rate monetary system and MMT is arguing a flexible rate system. The MMT literature shows amply how adhering to the former hobbles the ability of economic policy to deal with domestic problems like unemployment since it is keyed to inflation. MMT claims to be able to generate an economic policy that results in full employment (less frictional) at optimal capacity utilization, along with price stability.

    The way that MMT works is through adjusting flows through fiscal policy – currency issuance through targeted government disbursements and currency withdrawal through targeted taxation. There is also a coherent macro theory to back it up that is based on operational reality.

    I don’t see any comparable economic theory on the table that compete with this credibly.

48. stone @ 19:42

    Well, we agree on this anyway. As a libertarian of the left, the last thing I want is government controlling the economy top-down and that is what exclusive state banking would amount to. There needs to be a healthy balance of public and private to keep both in check.

49. Tom Hickey, I had to do a google search to try and work out what you meant by “What you are arguing essentially is a fixed rate monetary system and MMT is arguing a flexible rate system. The MMT literature shows amply how adhering to the former hobbles the ability of economic policy to deal with domestic problems like unemployment since it is keyed to inflation.”.-I really don’t know what you mean. I most certainly am not arguing for the exchange rates of different currencies not to be free floating if that is what you somehow thought. -All I am arguing for is for the MMT spending side of things with free floating currencies to be combined with a balancing wealth tax. As far as MMT claiming to be able to maintain price stability, it has been made very clear that you do not include asset price stability in that.

50. stone, you want to limit the quantity of money by some mechanism that establishes a standard. That is effectively a fixed rate system, since the “right” quantity is determined by an imposed standard. The domestic effect of this is comparable to a convertible fixed rate currency, where the government (consolidated treasury and cb) is constrained in issuance based on the fixed limit. This is what the balance budget advocates are advocating. The point of fixed rate systems is to control inflation ( in your case, specifically asset inflation).

    The point of MMT’ers preference for a flexible system is that controlling inflation through arbitrary standards results in unemployment or unsustainable consumer debt for countries that are not net exporters and whose citizens desire to save a portion of their incomes. An imposed standard, either internationally through fixed rates or a domestic rule mimicking this, restricts a government’s inability to adequately address unemployment through fiscal policy by running deficits. Unemployment becomes a tool to control inflation. What MMT says is that government should target both employment and inflation through altering flows, which are controlled fiscally by issuance and withdrawal (taxation). These can be tightly targeted, so that funds are put in where they are needed and taken out where they are collecting and stagnating.

    When firms take the stimulus funds to run up their income statements and balance sheets, they government has to step in and address that with, e.g., higher corporate taxes on money that is not productively invested (spent). Again, the banks were bailed out so they would start lending again, but instead, they took the money and ran off to leverage it, rebuilding their balance sheets for free and continuing to pay outsized compensation. That should also be taxed away to discourage such behavior. This is all about incentivizing productive investment, which is necessary for lifting income that generates consumer demand and permits delevering to stave of debt deflation, and disincentivizing economic rent, which is parasitical. As Bill’s post points out, business got a free lunch from the stimulus. That is basically monopoly capital resulting from earnings in excess of productive contribution.

    You assume that by establishing the correct standard for controlling quantity, an economy will run eternally at a happy equilibrium. You would have to work out the numbers to show that and also defend the assumptions on which the model is based.

51. Tom and others,

    Clarifying what I mean by “public utility”:

    Currently the government grants permission for banks to create money when they make loans, making a private – public partnership. Because this is a government granted monopoly, it should be heavily regulated whether privately or publicly owned and should be about as interesting (in terms of complexity) as the Postal Service.

    The banks’ duty is to make loans to creditworthy customers (loans that have a high likelihood of being repaid in full.) To ensure the banks fulfill their duty, the banks bear the full risk of loss on loans they make.

    In exchange for this the banks receive the interest payment, which also serves as a brake on the demand for loans.

    When viewed this way, it is easy to see where everything has run off the rails. Banks no longer bear the full risk of loss on loans they make and because of this the incentive to loan only to creditworthy customers has been lost. Enforce this one simple thing and the mess we find ourselves in now would not have happened.

52. Tom Hickey, I am disappointed that rather than facing up to the points I made you have found it more comforting to claim that I was advocating a fixed currency exchange rate and have argued against that. I agree that fixed currency exchange rates are not good and appreciate that it is very much in all of our comfort zones to argue against them.
    If any relevance to anything I have ever said can be extracted from your @6:54 comment it is “controlling inflation through arbitrary standards results in unemployment or unsustainable consumer debt for countries that are not net exporters and whose citizens desire to save a portion of their incomes.”- as I have always maintained my whole point is that it is essential that the macroeconomic set up makes no provision for “citizens desire to save a portion of their incomes” on an aggregate basis. Obviously people and corporations need to save when they can so as to cover expenses they later need to cover for- BUT in a sane world, for every person or corporation saving there will be another drawing down on savings previously accumulated. Precisely what I am arguing against is the expansion of the currency to accommodate a decade on decade, generation on generation, build up of global savings that are never spent and yet cost us dearly to manage and distort the economy.
    With regard to consumer debt- some (the wealthiest) have access to consumer debt. Unlike governments, consumer debt can not be rolled on from one generation to the next- so one set of wealthy US citizens may die off with debts BUT the level of consumer debt can not increase exponentially generation after generation. It is the long term exponential increase in savings which means that a crisis will inevitably be forced so long as the system attempts to cater for it by expanding the currency.

53. stone, savings typically come at pretty stable share of GDP. They have been stable over different time periods and in different countries. However the underlying dynamics of this process is way too complex in order to be able to say that savings should be equal to this percentage of income and nothing more. There are various factors like position in the business cycle, demographics, technological trends and fashion, etc. which can influence any particular outcome in savings. I am sorry that you do not understand this point and keep on pushing some type of fixed rule arguing that savings above this level are bad. The only result that your rule is going to achieve is to fight the private sector. It can be a viable approach but I am sure that all MMTers, despite their strong believe in the government, will stand behind private sector desires and freedom as primary sector fulfilling long-term economic growth. Government is only to support private sector and not to fight against it. If you have a believe that your approach is a better one there is no contradiction with MMT as long as you have broad consensus behind it and also make sure that you mitigate any adverse effects of such policy. Again, there is nothing that contradicts MMT here and you simply appeal to political views of different people. Political views can hardly be reconciled if they are way apart.

54. Scott Fullwiler: “Robert . . . just as I suspected, you have no clue how deposits or banking works. Go see JKH’s comments in the link Tom provided. He demonstrates rather clearly my point.”

    We may as well face the fact that we’re never going to get to the nub of this. I’m not an economist and to me JKH’s comments in that link are more or less totally impenetrable.

    However, in my trawling through some amongst Bill’s voluminous writings I did come across the following:-

    “When a bank makes a $A-denominated loan it simultaneously creates an equal $A-denominated deposit. So it buys an asset (the borrower’s IOU) and creates a deposit (bank liability). For the borrower, the IOU is a liability and the deposit is an asset (money). The bank does this in the expectation that the borrower will demand HPM (withdraw the deposit) and spend it. The act of spending then shifts reserves between banks. These bank liabilities (deposits) become “money” within the non-government sector. But you can see that nothing net has been created.”

    This is, frankly, twaddle. Or, to put it more politely, tautology.

    Of course nothing net is created when it is a self-fulfilling outcome of double-entry bookkeeping (the conventions of which like all conventions are entirely synthetic, that is to say without independent veracity external to the particular system from the operation of which they derive their sole meaning) that all entries on one side of the ledger shall be balanced by equal entries on the other. That’s bookkeeping, but it isn’t logic.

    If I take a loan from a bank to buy a car the amount of the loan is added to my current account. No other account is debited; instead (in accordance with bookkeeping conventions) the increase the bank makes in my current-account balance is booked as an added liability of the bank, while my IOU for the amount by which my current account has been increased is booked as an addition to the bank’s assets. Surprise, surprise – the two net out.

    But meanwhile, in the real world outside, I take the new money that the bank has created with key-strokes on its computer and buy a car with it. That’s logic, not bookkeeping.

    So, when this is what really happens in the real world (and am taking it that even an MMTer won’t deny that), to state as Bill does that “nothing net has been created” is pure casuistry. The amount of the loan has been created. By that amount and that amount precisely has the bank increased the amount of new money put into circulation in the economy.

    If to express that opinion is proof that I “have no clue how deposits or banking works” then you and I are not speaking the same language. From my angle it is you who clearly lack that perception.

55. Robert,

    You seem to have forgotten that you have to pay back the loan. Over the long run, the two absolutely do net out to zero. This is fact.

56. Robert, you should this paper from BIS link_http://www.bis.org/publ/cpss55.pdf Please note that this is the paper directly from the heart of monetarism and not something invented by MMT.

    The central and oft repeated MMT claim is that loans create deposits. These are deposits in the banking system. However deposits are not money. Deposits are liabilities of the private banking system. Central bank is charged with responsibility to make sure that payment system in every country operates smoothly. This implies a par conversion of commercial bank deposits into central bank money. And it is done as part of banking supervision and deposit guarantees.

    So it is not about you and Scott speaking different languages but that you are rather unaware of how the banking system actually operates.

57. Sergei I take your point about different political views and I’m not wanting to change anyone’s politics. I’m just trying to get my head around how people who have stated political views that chime so closely to mine (eg Bill, Tom Hickey and many of the people on here )- have such a divergent view of what macroeconomic adjustments would be conducive for achieving our shared political objectives. When you say that “savings typically come at pretty stable share of GDP”- I somewhat agree- However I think it is vital to appreciate that since widespread long term currency expansion (the last few decades), the growth in real GDP in the USA and UK has almost all been in the FIRE sector. If “leakage to savings” is accommodated by expanding the currency so long as the savings to GDP ratio is kept constant- then that will nevertheless still lead to an inexorable rise in the levels of savings with a consequent growth of the FIRE sector to deal with them.
    I find it ironic that you say that advocating a non-expanding currency is tantamount to siding with the government in a government-private battle. I think you should tell that to the Austrian School bunch who as well as advocating a non-expanding currency are about as extreme anti-government as you are likely to find. I’m not anti-government nor anti-private sector. They both seem to have things that they do better than the other (eg government is good at providing sanitation and the police, private sector is good at providing food)

58. “If I take a loan from a bank to buy a car the amount of the loan is added to my current account. No other account is debited; instead (in accordance with bookkeeping conventions) the increase the bank makes in my current-account balance is booked as an added liability of the bank, while my IOU for the amount by which my current account has been increased is booked as an addition to the bank’s assets. Surprise, surprise – the two net out… But meanwhile, in the real world outside, I take the new money that the bank has created with key-strokes on its computer and buy a car with it. That’s logic, not bookkeeping.”

    …

    Well, it’s hard to know where to begin with somebody who actually equates tautology with twaddle.

    But here’s an example of loan 100:

    bank books accounting:
    debit loans 100
    credit deposits 100

    personal books accounting:
    debit deposits 100
    credit loans 100

    personal books accounting for car purchase:
    debit car value 100
    credit deposits 100

    then, depreciate value of car over time:
    credit car value 10
    debit net worth 10

    That’s how the accounting actually works

    debits = credits, always

    Bookkeeping = mathematics = logic

59. Jeff65 “You seem to have forgotten that you have to pay back the loan. Over the long run, the two absolutely do net out to zero. This is fact.”- Do you have to pay off the loan? You just pay it off with a bigger loan that you got on the basis of the increased value of your assets that came about from the asset prices being pushed up thanks to all the loans. A financial crash and a mass default followed by a decade of debt deflation and a world war can wipe the slate clean (with appalling suffering) but as we all now know the government won’t let “this sucker go down” as George W Bush put it.

60. stone, your point looks to me not like a point of savings per se but the distribution of savings in the private sector. And this is the reason why FIRE sector got so big and powerful because it formed a loop with positive feedback. Is this correct?

61. Sergei, “this is the reason why FIRE sector got so big and powerful because it formed a loop with positive feedback”- yes that is what I was trying to say. I see the problem of a currency expanding to accommodate “leakage to savings” as being a double whammy of both more savings and the predictable prospect of even more savings. To my mind a global pool of £100T in savings is going to justify (in financial terms) a bigger FIRE sector than one of £1T. In addition the predictable prospect of even more savings creates the global ponzi effect. The whole point of the FIRE sector is to redistribute wealth to fewer and fewer winning hands. In a recirculating system such as a non-expanding currency with a wealth tax and fiscal stimulus, that concentration of wealth is moderated. In a system where money is put in more than it is taken out, that moderation is lacking.

62. To me whilst there is professed agnosticism towards 100% reserve banking on the part of MMTers, there seems in fact to be undeclared hostility,.

    But I think the real point is being missed (or evaded?). It is that MMTers have a built-in bias in favour of private credit creation, and it really is this that they’re defending when they’re purportedly picking holes in the case for FR banking.

    That’s right – MMTers, who yield to none in their radicalism in pursuit of “public purpose” (an ethical concept, or nothing), defend and even extol the creation of money, as interest-bearing debt, by privately-owned corporations to their own sole pecuniary benefit. Instead, they look to “regulation” to curb the bankers’ excesses. They view with complete equanimity the granting to these corporations of what is in all but name a subsidy, and a totally unwarrantable and massively large one, at the expense of the public because MMT theory takes care of all problems of distributional inequality and so will bring about perfect equity despite the subsidy. The issue of the private creation of our money (more than 97% of it in UK at present) will thus have been turned into a trivial one. They anticipate the day when enlightenment will have dawned and governments, of all political complexions, will have become converts to MMT and will unfailingly apply its precepts in their management of their economies.

    It’s pretty rich, in light of this touching faith, that Bill sees fit to mock what he chooses in his own rant on the subject to describe as Rothbard’s mad ravings.

    I don’t think I’m alone in finding MMT’s position inconsistent, if not morally questionable. Apparently it’s OK to have fought to acquire unwarrantable privilege and to hang onto it by any means, fair or foul, in order to keep on lining one’s own pockets at the expense of those less well-placed, so long as the vehicle chosen for this is fractional reserve banking. But when essentially the same self-interest is pursued on behalf of the same plutocracy by means of the artificial creation of unemployment it suddenly becomes disreputable. I happen to think too that the deliberate creation of unemployment is indefensible (when it actually is deliberate), but MMTers for their part seem precluded by their dogma from perceiving that to permit private agents to hang onto a virtual monopoly of the money-creation machinery in our society whilst siphoning into their own pockets the enormous proceeds from doing this accords no better with public policy than under-employment. The social havoc wreaked is in my opinion every bit as bad (I would say worse), yet it draws only muted condemnation (if that) from most MMT disciples. Even more startling is the realisation that this tolerance towards the privatisation of the money-supply is accompanied by emphasis upon the sovereignty of the state in regard to the issuing of a fiat currency as a defining feature of MMT doctrine. This insistence is a little hard to reconcile with the fact that less than 3% of all our money is in fact being created in the form of fiat currency by the allegedly sovereign state

    The posts from MMT regulars I’ve been scanning on this subject seem largely tangential to what those who are currently agitating for monetary reform are actually advocating. In an age of e-money it’s obsolete to talk about 100% reserves backing all deposits: the same effect can be much more simply achieved by requiring that each deposit-taking institution lodge all its deposits en masse in a separate account with the central bank. Thereby they became automatically ring-fenced and remain always available even if a bank crashes, and no need to insure them arises. By the same token they become unavailable for investment and cease to be included on any bank’s balance-sheet. All other banking activities continue but with a legal requirement that loans are matched £ for £ by the bank’s own capital (with provision for emegency injections of liquidity by the central bank to tide-over cashflow bottlenecks). New money may only be created by the consolidated government sector and may be injected into the non-government sector through a variety of different channels. I’m not personally equipped to debate the intricacies of how and to what end the central bank would manage interest-rates, but it seems clear is that deciding-upon the volume of new money to be placed at the Treasury’s disposal at any given time would need to rest with the central bank. Demand for credit for “productive” investment (however defined) might exceed the capacity or the willingness of the private banks to supply it, in which case the government sector would need to come up with an appropriate alternative or additional source of credit.

    What problems does MMT have with that?

63. axiom: “Well, it’s hard to know where to begin with somebody who actually equates tautology with twaddle.”

    I share your frustration, in reverse (and btw I was trying to tone it down a bit, but if you force me to choose I’m happy to stick with “twaddle”).

    I’m frankly not interested in bookkeeping.

    Setting aside Jeff65’s point about the loan eventually being extinguished (which I’ll come to separately), how do you account for the new money which is conjured into existence out of thin air in the form of the loan? Are you claiming that that is not a net addition to the money spent into circulation in the economy at the moment when I spend it?

64. “Are you claiming that that is not a net addition to the money spent into circulation in the economy at the moment when I spend it?”

    It’s a net addition to money.

    It’s not a net addition to net financial assets.

    Who claimed it wasn’t a net addition to money?

65. Jeff65: “You seem to have forgotten that you have to pay back the loan. Over the long run, the two absolutely do net out to zero.”

    No, I hadn’t forgotten it. In the passage of Bill’s I quoted he actually uses the phrase “The act of spending”, and the entire decription is couched in terms of a process being visualized in real time (rather as though it were being filmed, if you see what I mean).

    In the act of spending, to use Bill’s words, net new money created by the bank out of thin air is injected into the money-supply then in circulation. On that basis I hold Bill’s statement “But you can see that nothing net has been created” to be casuistical.

    Yes, true enough, in the course of time (in the case of a house 20 years or more) the loan will be repaid. Before reading some of the stuff on here and on Warren Mosler’s site I would have said that an amount exactly equalling the repayments would instantly be loaned-out again, so long as the reserve ratio hadn’t changed in the meantime. Now I’ve learned that there’s no such direct link (which has, if anything, appalled me even more): nevertheless, the effect is much the same at the end of the day as if there were. Banks exist to make money from making loans: so long as they have the capacity to go on lending that’s what they do – except when under crisis circumstances like the present ones as a consequence of their own excesses they’re forced to re-build their balance-sheets by shrinking their loan-books.

    Other than then the new money once created stays created, by one means or another. If it didn’t, how could we ever have credit bubbles?

66. axiom: “It’s not a net addition to net financial assets.”

    Playing with words.

    “Who claimed it wasn’t a net addition to money?”

    Bill. And before you respond: “Ah, but he meant ‘to net financial assets, not to money’, allow me to say ‘Fiddlesticks!’

    All I’m concerned about is that banks create our money. 97% of it, for god’s sake. Isn’t that enough for you? Why not make it 100% – all the more windfall profits for the banks and even obscener bonuses for bankers.

    You happy with that? I’m not and nor are a whole lot of other people in case you hadn’t noticed.

67. “All I’m concerned about is that banks create our money.”

    Which MMT’er said commercial banks don’t create money?

68. Jeff65: When viewed this way, it is easy to see where everything has run off the rails. Banks no longer bear the full risk of loss on loans they make and because of this the incentive to loan only to creditworthy customers has been lost. Enforce this one simple thing and the mess we find ourselves in now would not have happened.

    Jeff, the banking mess is a lot more complicated than that, however, moral hazard is a large problem that needs to be fixed. My solution is to limit the public-private partnership completely. Banks in the US have managed to convince the people that they are private enterprises, and lot of people think that the Fed is a private institution. We should make public explicitly public and private explicitly private in my view, since public-private partnership has come to mean that the public bails out the private sector when it gets in over its head. I would make retail banking entirely public, with private institutions only able to act as government agents working on contract, and end the corporate veil in investment banking by returning to the partnership model, with full responsibility for mistakes falling on the partners. I would also have a government plan in place for systemic failure in which the government would automatically put insolvent investment banks into resolution, under strict day-by-day oversight. Banking is a fiduciary responsibility. Firms that don’t want to undertake this responsibility should just be hedge funds, again functioning under the partnership model. There should be no corporations allow to operate in finance.

69. Robert: “I’m not an economist and to me JKH’s comments in that link are more or less totally impenetrable.”

    Right. You don’t understand how banking works, but see fit to criticize those that try to explain it to you. Waste of time talking with you unless you want to actually try and get at how this works.

70. axiom:

    Shall we stop playing ping-pong? It’s getting a mite tiresome.

71. stone @ 10:00. I thought we agreed that we are in basic agreement about the desired outcome but disagree over the means for getting there. You want to control the stock of money by limiting the amount of currency, and MMT is arguing that it is more efficient and effective to control the flow of money to put it where it is needed and to remove it from where it is excessive.

    There are already pretty well developed theories about controlling money stock, such as convertible fixed rates and the quantity theory of money. Bill and other MMT economists have chopped these up. What is happening here is the pitting of macro theories against each other.

72. Scott Fullwiler: “Right. You don’t understand how banking works, but see fit to criticize those that try to explain it to you. Waste of time talking with you unless you want to actually try and get at how this works.”

    I take it that’s code for “unless you’re prepared to see banking the MMT way and talk the MMT talk”. No thanks. English is still supposed to be the medium we communicate through, unless you want to retreat into the protective cover of a cult.

    MMTers aren’t going to advance their cause very far if they’re only prepared to communicate their theories in a language understood only by initiates.

    You haven’t shown me yet that you’re in any position to judge how much I do or don’t understand about banking, though I do of course realize that when you talk about “understanding banking” the only kind of “understanding” that counts is one that’s consistent with MMT dogma.

    How about you trying to show that you’re prepared to take any of the points I’ve made? What’s your critique of the means I sketched above (in plain English) whereby FRB might be replaced with a banking system that takes money creation away from privately-owned corporations and puts it where it belongs – in the hands of our governments?

73. Dear Robert and Scott and all

    Remember the comments policy and the “culture of this blog”. We respect each other but argue vehemently.

    Best wishes
    bill

74. “Shall we stop playing ping-pong? It’s getting a mite tiresome.”

    Is that what we were doing?

    I saw a couple of overhead smashes coming from your side, but nothing that hit the table on my side.

    Anyway, fine by me.

    Give the accounting a try some time. It’s quite refreshing.

    Cheers

75. Robert . . . JKH is no MMT’er. I’ve only asked you to look at his/her comments. Do you have specific disagreements or comments about the points made there?

76. As far as I could decipher JKH, in the 100-percent reserve banking thread fell back on that old chestnut of concocting a hypothetical novel form of 100-percent reserve banking and explaining how that novel set up would be stupid (I really appologize if JKH was dealing with the standard proposed 100% system and I have a misunderstanding of the standard idea of it).
    Bill on the other hand used the line of argument “I do not support a 100-percent reserve banking system. It is the work of a lobby that hates and distrusts government. ” . That seems to be following the South Park Eric Cartman method of deduction as in “drugs are bad because hippys take drugs and hippys suck” (personally I don’t like drugs but do like hippys :)).
    To my understanding there could be giro banks where you would pay an admin charge for them to store your digital money and lending banks that would sell bonds inorder to get the money to lend. If loans went bad then the lending banks capital would take the first hit with the bond holders only being at risk if the bank went bust (just like with an investment bank now). I can’t see how such a set up would be subject to the pratfalls JKH goes into. I agree that it would not create unlimited cheap money- but that is the whole point and to my mind is critical for achieving Bill’s stated objectives of “producing less and distributing it more equally”.
    In general I’m both very grateful for everyone who contributes to this great site but also somewhat saddened by much of it. It really strikes me that in comparison to a natural science, we seem to fall into adopting a somewhat disfunctional (to my eyes) attitude and approach when trying to grapple with economics. Amongst people trying to work out how cancers form or whatever, all the usual human frailties of ego and dumbness come into play as in most things but everyone involved does basically want work out what is going on and find a way through any technical impass. In economics I often get the sense it is not like that. It almost seems like people want to defend a “theory” more than they want to get to the crux of the matter and sort it out. This seems such a shame since economics has so much potential to effect peoples lives for better or worse.

77. Robert–for starters:

    “In an age of e-money it’s obsolete to talk about 100% reserves backing all deposits: the same effect can be much more simply achieved by requiring that each deposit-taking institution lodge all its deposits en masse in a separate account with the central bank. Thereby they became automatically ring-fenced and remain always available even if a bank crashes, and no need to insure them arises.”

    Yes, that’s one way to do it. Minsky made this point decades ago. MMT is agnositic here, because it’s simply one of the alternative ways of effectively creating deposit insurance. Beyond that, it doesn’t change much.

    “By the same token they become unavailable for investment and cease to be included on any bank’s balance-sheet. All other banking activities continue but with a legal requirement that loans are matched £ for £ by the bank’s own capital (with provision for emegency injections of liquidity by the central bank to tide-over cashflow bottlenecks).”

    Here’s the crux of the problem. Your proposal here is simply impossible. Your evasion of accounting leads you into a black hole. A bank doesn’t create a loan from it’s own capital. The loan creates a deposit, by accounting definition. Even if the bank could “lend its capital,” what that would mean is that the creation of a loan would REDUCE capital as the capital is reclassified as a deposit. The only alternative is to assume there is something else on the bank’s asset side as an offset to deposits created via lending, so that the qty of loans = capital. What is that other asset, in your view? Is the bank getting an injection of capital from the govt or cb, so that it now has reserve balances?

    “New money may only be created by the consolidated government sector and may be injected into the non-government sector through a variety of different channels.”

    So, the govt takes over with state banks? OK, again fairly agnostic on this point. However, I don’t really see that, say, US community banks have done such a bad job with this, particularly if they are put under MMT’ers preferred regulatory apparatus. And their employees would probably now be the loan officers in the state banks–again, fairly small change overall. The differences might be profitability (state run vs. private run for profit) and perhaps some efficiency issues (though either can turn out to be quite inefficient). Perhaps let state banks compete with community banks if one thinks the latter’s profits are too high. I should also note that Wray wrote a paper with Ronnie Phillips in the early/mid 1990s proposing community development banks designed according to Minsky’s proposals.

    Of course, none of this actually gets rid of credit creation in the non-govt sector, which is the key problem with these “govt money only” proposals. Again, JKH explained rather clearly why it couldn’t be done in Tom’s link above.

    New money may only be created by the consolidated government sector and may be injected into the non-government sector through a variety of different channels.

78. Robert,

    Just in case that cognitive dissonance of yours missed the key point, I’ll mention it again.

    Reserves don’t matter under MMT. Banks lend against their capital. Loans create deposits and reserves are obtained a posteriori to cover those deposits.

    If regulations control the amount that can be lent against an amount of capital that, by definition, controls the amount of money a bank can create.

    Under a reserve system all money created by a bank is effectively insured by the central bank. In other words they have outsourced creation and the insurance system gets rid of the need for shuffling reserves. Under a simple 100% system the insurance is really just converted into the underlying physical asset. If a bank is short of reserves it asks the central bank for them in return for a ‘Bank IOU’ and an interest payment at the Reserve Rate.

    So the issue is not really private or public created money since it is trivial to ensure that all money reserves in the banking system are created by the central bank. Since the Central bank also regulates the private banks then any loan made by the private bank is ‘within regulations’ and therefore would have to be backed with state money from the central bank.

    So that sorts your problem with private created money – move the current derivative (state reserve guarantees) to the underlying (state money issued in exchange for bank IOUs). If you think about it your problem isn’t a problem, because really there isn’t any private created money – there is only state money and money created with state backing under state regulation.

    Now if your problem is more than that, then it isn’t the ‘private creation of money’ that is the vice.

79. Scott “Here’s the crux of the problem. Your proposal here is simply impossible. Your evasion of accounting leads you into a black hole. A bank doesn’t create a loan from it’s own capital. The loan creates a deposit, by accounting definition. Even if the bank could “lend its capital,” what that would mean is that the creation of a loan would REDUCE capital as the capital is reclassified as a deposit. The only alternative is to assume there is something else on the bank’s asset side as an offset to deposits created via lending, so that the qty of loans = capital. What is that other asset, in your view?”
    The something else on the bank’s asset side as an offset to deposits created via lending would be bonds sold to provide the funds for the lending bank to make loans.

80. OK, Stone, but how did they get the bonds?

81. Scott, by bonds I meant bank bonds created by the bank to sell in exchange for cash. The cash could then be lent on as a loan. The bank would not be creating money, as the amount lent would equal the amount tied up in the bond. The point of the lending bank would be as an intermediary between investors and those needing loans. Am I missing something?

82. Those bonds would be liabilities, not assets.

83. So let’s look at what we have thus far. We have banks that get reserve balances by issuing time deposits or bonds, while their lending must be equal to capital. Again, though, the problem is that the balance sheet doesn’t balance as soon as the bank makes a loan and delivers reserve balances to the borrower’s account at the Fed (using Robert’s set up). Assuming the loans are equal to capital, reducing reserve balances reduces assets. The only way to square this is to reduce the bank’s capital. But if bank capital started out the same size as the loan portfolio, now capital is smaller than the loan portfolio just by settling the initial loan transaction. Even if capital is greater than the loan portfolio to start, the act of settling the initial loan transaction reduces the bank’s capital and severely restricts lending to the amount of capital that can be raised. And how much capital can banks raise when the expected return on such an investment in a bank would be so small?

84. Neil @ 3:59–very well said. I would just add that it’s not MMT that says reserves don’t matter; that’s just how it works, and many even neoclassicals are figuring that out finally.

85. stone: It almost seems like people want to defend a “theory” more than they want to get to the crux of the matter and sort it out. This seems such a shame since economics has so much potential to effect peoples lives for better or worse.

    That is not what is happening here. The general macro problem in volves juggling a lot of heavy balls at once, and everyone of of these balls can turn into a knife if the wrong move is made. The objective is a dynamic (relative) equilibrium condition in which society as a whole prospers in a sustainable way. This is what the history of economics is about and there are a number of theories about this, not only based in free market capitalism. We are discussing the present monetary and political system, and the optimal economic policy for managing it.

    As you may have figured out, the parameters that Bill and other MMT’ers regard as key are employment and price stability. The theory that is determining present policy holds that these are irreconcilable other than through a buffer of unemployed. MMT contests that.

    You seem to think that the MMT solution leads to asset inflation through excess money creation. MMT’ers have addressed that. I have also.

    Why don’t you lay out your macro theory, or point us to one, so we can compare it side by side with MMT in order to see how the two balance the various factors that need to be dealt with to formulate an economic policy that generates distributed prosperity.

86. Stone,

    The core point in JKH’s argument is the following:

    “In summary, the intention of 100 per cent reserve requirements is to ensure credit and liquidity protection for bank deposits and government liabilities. The maturity matching motivation is a discipline imposed on the credit banking side of the framework. Banks are not permitted to create money from credit. They must have money before they lend it, and they do this by issuing liabilities prior to lending. This requirement combined with maturity matching and capital discipline should make liquidity risk a non-issue. But a fundamental problem gets in the way of this objective. Credit banks in a bifurcated framework cannot avoid liquidity risk. Credit banks require accounts with the depository institutional framework in order to make and receive payments. In particular, they require such an account to make payment to holders of maturing liabilities. If a maturity matched liability coincides with a bad loan maturity, there will be no matching funds to make payment. The fact that capital is available to absorb the loan loss has no effect on operational liquidity. Liquidity and capital are distinct. The bank in that situation has two choices. It can fail on the payment and go bankrupt (or some other form of wind-up). Or it can go overdraft on its deposit account at the Fed. In order to make the second choice, it must have a pre-existing privilege to do so. If such a credit facility is in place, it means that the principle of pre-existing funding has been broken. In either case, the bank has definitely experienced liquidity risk, notwithstanding matched funding. The bottom line is that the combination of 100 per cent reserves and maturity matching provides no ultimate protection against liquidity risk. Liquidity risk is a function of perceived solvency risk. At the same time, the ex post balance sheet impacts of liquidity risk and solvency risk are operationally separate – because those impacts are recorded through entirely different accounts. It is that account separation that precludes capital from protecting realized liquidity exposure at the operational level. Finally, real world extrapolations of the “pristine” Austrian type model may add an element of buffer protection afforded by a self-imposed reserve of excess liabilities and corresponding deposits at the Fed. But the solvency/liquidity dynamic still operates, and will prevail according to the duration of the liquidity crisis and the time protection offered by such a liquidity buffer.”

    I have not yet seen anyone in favor of 100% reserves counter this in a way consistent with how accounting really works and an understanding of how the payments system actually works. If you can do this, then more power to you and I would change my view. And, again, JKH is NOT an MMT’er, so we can get rid of the silly red herring being thrown around here by multiple people that only the MMT view is considered valid or even entertained.

87. Tom said:

    “Jeff, the banking mess is a lot more complicated than that, however, moral hazard is a large problem that needs to be fixed. ”

    I don’t disagree with you at all, but I think this one prescription plus one more (treat CDS as insurance) would fix a lot of problems if not most of them. I’d back the notion of forcing investment banks back to the partnership model, too.

    I see securitization as the root of the problem. It took time to build up the edifice that allowed the recent fraud, but once the primary incentive to write loans only to creditworthy borrowers was removed it was only a matter of time.

88. Neil @ 3:59 – Thank you. That is exactly my understanding and it is why I have said FRB is a canard, but I find it difficult to put into words without making a misstep.

89. And in terms of maturity matching ‘pure’ credit creation, such a vehicle already exists in the UK. It’s called Zopa.

    http://uk.zopa.com/ZopaWeb/public/about-zopa/about-zopa-home.html

    Here the depositor takes the credit risk directly, but spread across lots of borrowers. It’s 100% reserve and maturity matched loans directly by computer. Peer to Peer banking.

90. Scott, as I understood it the private banking system would be disconected from the state. There would be giro banks that could not lend and charged a service fee to store digital money.
    There would also be lending banks that got their money in the same way that regular non-financial corporations do now. An IPO, retained profits etc would provide a pool of cash for such a lending bank. The lending banks would also issue bonds to get extra cash. The bonds would be mainly bought by institutional investors such as insurance companies, pension funds and mutual funds. A retail investor who wanted to store money in a way that paid interest rather than just being subject to a service charge would invest in a mutual fund that held the bonds from lending banks. The mutual fund would also generally have a small cash holding to provide liquidity but investing in such mutual funds would explicitly be a risk investment and customers would be making a choice to take that risk rather than just suffering the giro bank service charge.
    As now, someone needing funding for a high risk start up company would need to go to a venture capital trust that gave loans in return for an equity stake rather than fixed interest.
    My point in advocating such a system is not to try and create a world free of financial risk. I realise real life has risks and the financial system should reflect that. My point was to prevent the banks from creating money.

91. Tom Hickey, sorry if I’ve not been clear as to what I thought would be an alternative to an expanding currency system. What I meant was to have each nation having a fixed stock of currency (say one trillion units). Private banking would be set up as in the comment I put above. The state would recirculate the fixed stock of money by exerting a flat wealth tax where inorder to legally own anything (cash, real estate, stocks etc) you had to demonstrate that you were up to date on the tax paid. There would be a fixed ceiling on the amount of wealth that anyone could inherit. I realise that inheritance tax is an emotive issue. Personnally I’d choose a low ceiling (say £10k) but so long as there is a ceiling (even £1B)- that would be OK. The money taken out as tax would be put back in as a citizens’ dividend (say £10k per year) payable to every citizen and also as government spending on things such as the police, roads, schools etc. International trade would use a SDR type system with the basket of currencies being weighted in proportion to the population of the countries. Currencies would be free floating with no fixed exchange rates. In order to join the WTO group of nations taking part in international trade, a nation would have to have a free floating non-expanding currency.

92. Now this is starting to get interesting!

    Please excuse me while I take a little time out to digest these points – in a spirit (may I make it clear) of genuine desire to learn.

    But, meanwhile, may I please make (again) the point that no one really seems to want to discuss? I don’t see that it matters a damn whether reserves are put in place a posteriore to achieve the specified ratio of lending to reserves – or in whatever way you want to express that if my crude layman’s phrasing offends anyone’s exquisite sensibilities. Essentially – which is all that matters – the effect is the same, and it would be rather strange (considered logically) if it weren’t, since what we are discussing is after all FRACTIONAL RESERVE banking (I don’t mean to shout, since I’m well aware that it isn’t called-for – it’s just that I haven’t figured-out how to make this software type italics or in bold, purely for needed emphasis).

    FRB, I repeat – and no one denies – enables banks to create money. I believe that not only is it monstrously inequitable that in our society privately-owned corporations should be allowed that privilege, but that it is also an offence against any notion of the sovereignty of the people, exercised through parliament, to whom and only to whom should that power belong. I can’t find words to express it more clearly or strongly than that – but many others (among them eminent bankers) have said the same thing, only better. There is absolutely no chance that you here don’t know what it is I’m talking about.

    If you don’t agree with that – fine. Then we will know where we stand and – in my own mind at least – I’ll judge the relevance and value of MMT (as I have understood its basic tenets, shared with other closely-aligned theories, such as functional finance, chartalism, etc) to society’s needs – as I perceive them – accordingly. And MMTers will of course do (or have already done) the same for their own part. Our respective judgments as to that might turn out to be opposed and if they do it won’t be because I haven’t understood the intricacies of banking or MMT’s finer points – it will be because we differ as to what social; and political outcomes ought to be being striven for.

93. Stone,

    You said “My point was to prevent the banks from creating money.”

    I haven’t followed the discussion here but in a demand-constrained world in which we live in, such ideas take us back into the neoclassical world where there is money scarcity etc which further restricts demand and is bad for employment, inventions, breakthroughs and revolutions.

    If you look at the banking behaviour of the United States over the years, you will find that banks have been successful in avoiding all kinds of restrictions on them and its simply a waste of time to prevent money from being endogenous.

    However, this advantage to economies (the powers of the banking system) has the tendency to be abused and that is what the banking system has actually done. A direct approach is to regulate lending rather forcing institutions to behave in a neoclassical way.

    There is an approach called “Institutional Economics” and Scott (Fullwiler) is a leading figure in that. You may want to find out about this approach.

94. Ramanan “such ideas take us back into the neoclassical world where there is money scarcity etc which further restricts demand and is bad for employment, inventions, breakthroughs and revolutions.” -you are correct that the set up I’m proposing would cause money scarcity. What I think needs more examination is whether that need be “bad for employment, inventions, breakthroughs and revolutions”. As far as I can see all “inventions, breakthroughs and revolutions” are currently funded not by bank loans but by venture capital money where the money is put down and spent in exchange for an equity stake if and when the venture works out. The current banking system does not aid that process. In fact it crowds it out by providing a lucrative alternative that has little social purpose.
    In terms of money scarcity leading to a loss of demand for goods and services and so to unemployment- I think it is critical to distinguish scarcity of money fro investment and scarcity of money for consumers. To my mind if a wealth tax recirculated money and paid it out as a citizens dividend to everyone then that would provide plenty of money in the hands of consumers.

95. Robert and others,

    Disclaimer: apologies but the following is going to sound wonkish, I’m super tired.

    Sorry but I don’t have time to participate in this discussion. But I’d just like to emphasis Ramanan’s point:

    its simply a waste of time to prevent money from being endogenous.

    As I understand it, most Post Keynesians are of the view that the money supply is always and everywhere 1) a credit-debt relationship and 2) endogenous (which is derived from the first). The point is that any one can potentially create credit/money* the restriction is in when trying to make it acceptable. Acceptance can come about through a variety of means, but mainly social relations (credit relationships in a giro sense) or by stating that your liabilities (credit) is convertible into another good or credit. Within a market institutional framework credit performs the function of overcoming constraints – e.g.. providing the means for a producer to finance production prior to the production period. . . because of credit/money have the features 1) and 2) it is simply not possible to restrict its creation. Unless massive institutional changes are made, such as, complete elimination of market institutions.

    Randall Wray in his 1990s book** – I don’t have the book with me, so going from memory, if the debate is still going by the end of next week I’ll borrow the book and provide references – makes the point that throughout history restrictions on the ability of various institutions to constrain their ability to create credit have been tried. These attempts have always failed because regulators have a misconception of money/credit and its creation. I feel this is the same issue being discussed here. Robert et al have a different conception of money to that of Scott et al.

    /end wonkisk post.

    *I’ve used these interchangeably but obviously there is a significant difference between the two. All money is credit, but only some credit is money. What makes credit money is its ability to cancel various forms of debt, with State money being at the top due to the states ability to impose that which is necessary to pay taxes.

    **As I understand it Wray’s views have changed, but I don’t believe they have changed re the historical origins and development of money.

96. Scott Fullwiler:

    “‘By the same token they become unavailable for investment and cease to be included on any bank’s balance-sheet. All other banking activities continue but with a legal requirement that loans are matched £ for £ by the bank’s own capital (with provision for emegency injections of liquidity by the central bank to tide-over cashflow bottlenecks).’

    “Here’s the crux of the problem. Your proposal here is simply impossible. Your evasion of accounting leads you into a black hole. A bank doesn’t create a loan from it’s own capital. The loan creates a deposit, by accounting definition. Even if the bank could “lend its capital,” what that would mean is that the creation of a loan would REDUCE capital as the capital is reclassified as a deposit. The only alternative is to assume there is something else on the bank’s asset side as an offset to deposits created via lending, so that the qty of loans = capital. What is that other asset, in your view? Is the bank getting an injection of capital from the govt or cb, so that it now has reserve balances?”

    You’re right that my far from perfect understanding of accountancy is causing me to fail to put across successfully the ideas (advanced not by me but by people far better-versed in such matters) as to how this scheme would work, in detail. I frankly just don’t possess that competence, nor have I claimed to.

    So – since you obviously do – can I turn it around the other way? Why don’t you play devil’s advocate (it’s good for the soul, I’m told), by explaining to me in simple terms how my desired objective – namely, that no more money is to be lent than the lender actually has legal ownership of – could be legislated-for? Since, as we both know, this has been done, historically, to my simple mind it can’t be impossible to do it again.

    For the avoidance of doubt, can I say that I simply don’t understand this:- “A bank doesn’t create a loan from it’s own capital. The loan creates a deposit, by accounting definition. Even if the bank could “lend its capital,” what that would mean is that the creation of a loan would REDUCE capital as the capital is reclassified as a deposit. The only alternative is to assume there is something else on the bank’s asset side as an offset to deposits created via lending, so that the qty of loans = capital.” Once upon a time, men who had accumulated money through whatever means (in mediaeval England for instance they might be wool-merchants) which was lying idle lent it out to others who had need of capital, and were paid interest on those loans – which made them even richer but served an economic and socially-productive purpose in the process. That process, quite simply, is the analogue for what I’m describing. Why does it need to be any more complicated than that?

    “‘New money may only be created by the consolidated government sector and may be injected into the non-government sector through a variety of different channels.’

    “So, the govt takes over with state banks? OK, again fairly agnostic on this point.”

    Why does that follow? Personally I had not seen that as a corollary, but I’d be interested in why you do.

    “Of course, none of this actually gets rid of credit creation in the non-govt sector, which is the key problem with these ‘govt money only’ proposals. Again, JKH explained rather clearly why it couldn’t be done in Tom’s link above.”

    It seems clear that we’re not talking about the same thing. If you’re interested in understanding the sort of thing I’m talking about (as distinct from what JKH was), you could do worse than take a look at this:-
    http://www.bendyson.com/
    or at the AMI’s website (assuming you’re not already familiar with that), or at James Robertson’s at:-
    http://www.jamesrobertson.com/subject-guide.htm#money
    (specially the booklet “Creating New Money” downloadable as a .pdf file).

    Meanwhile, suffice to say that to “get rid of credit creation in the non-govt sector” is not an aim of this proposal. The aim is that loans come only out of existing stocks of money (for every credit a corresponding debit) instead of being created as new money out of thin air. As much credit can be advanced as funds exist to provide.

    The passage in my sketch where I did refer explicitly to a possible role for the state was at the end where I wrote:- “Demand for credit for “productive” investment (however defined) might exceed the capacity or the willingness of the private banks to supply it, in which case the government sector would need to come up with an appropriate alternative or additional source of credit.” That “appropriate alternative source” might or might not include state-owned banks – I simply don’t know.

97. Neil Wilson: “Reserves don’t matter under MMT. Banks lend against their capital. Loans create deposits and reserves are obtained a posteriori to cover those deposits.”
    To say that “reserves don’t matter under MMT” doesn’t (it seems to me) advance the argument one jot so far as it relates to the shortcomings (in terms of social utility, not to mention ethics) of fractional reserve banking. FRB relies upon the existence of reserves, in some approved form, serving as the basis, in some approved ratio, of what a bank is permitted to loan. Whether the ratio is achieved ex post facto by some jiggery-pokery is, in plain langage, neither here nor there. The purpose of the system is quite simply that more money shall at all times be on loan than a bank possesses.

    Where does that money come from? It is created ex nihilo by means of the bank’s computer keyboard. As you say:- “If regulations control the amount that can be lent against an amount of capital that, by definition, controls the amount of money a bank can create.” Just so, but you seem unaware that it’s the fact that a bank can create any amount of money at all, even if it’s only 1 cent, that is precisely what I’m inveighing against. The existence or non-existence of regulations is beside the point so far as I’m concerned.

    “Under a reserve system all money created by a bank is effectively insured by the central bank. In other words they have outsourced creation and the insurance system gets rid of the need for shuffling reserves. Under a simple 100% system the insurance is really just converted into the underlying physical asset.”
    You seem here to be seeing the issue entirely in terms of deposit insurance, and the difference between FR as opposed to 100% as resolving merely into a difference in the respective forms that that insurance takes. The difference is a whole lot lot more than just that!

    “So the issue is not really private or public created money since it is trivial to ensure that all money reserves in the banking system are created by the central bank. Since the Central bank also regulates the private banks then any loan made by the private bank is ‘within regulations’ and therefore would have to be backed with state money from the central bank.”
    You put up a straw man (a requirement that all money reserves in the banking system be created by the central bank) then knock it down (by asserting that it’s trivial to ensure that this shall happen); and then another one (that any loan would have to be backed with state money from the central bank) which you in turn knock down (by saying that this is implicit in central bank regulation). But what relevance does any of this have to the merits or otherwise of FRB?

    “So that sorts your problem with private created money – move the current derivative (state reserve guarantees) to the underlying (state money issued in exchange for bank IOUs). If you think about it your problem isn’t a problem, because really there isn’t any private created money – there is only state money and money created with state backing under state regulation.”

    So far as I understand that argument, it’s a complete non sequitur.

    What you seem to be trying to do is to conjure away to your own evident satisfaction the actual problem that I posed by re-packaging it in words of your own choice which I for one don’t recognize as having any connection with how I defined it. I won’t repeat here how I defined it but you’ll find that (if you’re interested) in my latest posting to Scott.

98. Robert, the problem with state money created by the state only with no other medium of exchange is that it gives the state total control of the economy, hence, society. Similarly, allowing for private banking only, gives the business/finance sector total control over the economy and society. Having a healthy balance of public and private reduces the possibility of either, both of which are non-democratic and potentially totalitarian. I believe there is a way to navigate this Scylla and Charybdis without getting crushed by either.

99. stone, fixing quantity is potentially deflationary, while flexible quantity is potentially inflationary. MMT shows how to eliminate the inflationary challenge inherent in a flexible system based on a credible model. What is your solution to address the deflationary challenge of a fixed system? What happens when a deflationary episode arises, and it cannot be addressed fiscally? Or, are you presuming an equilibrium state. If so, have you a credible model worked out?

100. Robert: FRB relies upon the existence of reserves, in some approved form, serving as the basis, in some approved ratio, of what a bank is permitted to loan. Whether the ratio is achieved ex post facto by some jiggery-pokery is, in plain langage, neither here nor there. The purpose of the system is quite simply that more money shall at all times be on loan than a bank possesses.

     The purpose of reserves is for settlement of accounts. What the reserve requirement does in effect is affect the price of lending. In the present system, the higher the reserve requirement, the more reserves that the lending bank has to borrow from the interbank market if it does not have the reserves itself, e.g., from its time deposits. That increases the cost of lending and is reflected in the spread.

     Under the present system, a principal function of the FRS is settlement. Interbank settlement is accomplished through reserves. If a bank doesn’t have sufficient reserves for settlement, one of two things happens. The first is that the Fed loans the funds at a penalty rate. This is all ways true in the case of a solvent bank. Secondly, in the case of insolvency the bank is put into resolution immediately and the government steps in.

     What you are saying is that banks must always hold reserves hence there is no need for an interbank market for reserves. The central bank does not set the overnight interest rate since there is no reserve lending. Therefore, loans are going to be more expensive, and this is going to curtail demand. Moreover, loan defaults must immediately be covered by converting bank capital to reserves to cover the loan in order to avoid insolvency. I assume there is no FDIC, and no government guarantee of deposits. This is going to make banking a lot riskier for both banker and customers. Lending is going to be tight with credit requirements high. Depositors can conceivably lose.

     This will translate into much tighter and more expensive credit, with a reduced tendency to borrow, which is deflationary. Are you OK with a lower standard of living, and if a business person, with lower demand for your products?

     The American Dream was built on credit: 1) looser credit after WWII with government programs, and 2) more available credit since the ’70’s due to the introduction of credit cards. JIggling with this is going to have profound effects. I wonder if there are any models constructed by the people proposing these changes that show what they expect to see.

101. stone, To my mind if a wealth tax recirculated money and paid it out as a citizens dividend to everyone then that would provide plenty of money in the hands of consumers.

     BTW stone, I am not being “cute” asking for a model. My cousin (engineer and MBA) and I have been involved in several entrepreneurial endeavors. On a number of occasions I have had ideas that he agreed were promising. However, when we worked up the numbers on spreadsheet, it became evident that the idea was not promising financially. My conclusion is that you have to do the numbers. If you can’t do them yourself, then you either have to learn how or link up with someone who can. Jus’ sayin’.

102. Scott Fullwiler:
     “So let’s look at what we have thus far. We have banks that get reserve balances by issuing time deposits or bonds, while their lending must be equal to capital. Again, though, the problem is that the balance sheet doesn’t balance as soon as the bank makes a loan and delivers reserve balances to the borrower’s account at the Fed (using Robert’s set up). Assuming the loans are equal to capital, reducing reserve balances reduces assets. The only way to square this is to reduce the bank’s capital. But if bank capital started out the same size as the loan portfolio, now capital is smaller than the loan portfolio just by settling the initial loan transaction. Even if capital is greater than the loan portfolio to start, the act of settling the initial loan transaction reduces the bank’s capital and severely restricts lending to the amount of capital that can be raised. And how much capital can banks raise when the expected return on such an investment in a bank would be so small?”

     (You’re using “capital” and “reserves” interchangeably here – right?)

     Not to be guilty of plagiarism I must make clear that I’m relying on Rothbard’s description of loan banking in “The Mystery of Banking”.

     As soon as the bank makes a loan that amount of its assets is replaced by an IOU (including the interest to be charged). Total assets thereupon increase by the amount of the interest charge; liabilities increase by the amount of the loan, whilst owners’ equity increases by the amount of the interest charge. The balance-sheet balances. This can be repeated as many times as the capital available for loaning (ie minus a prudent cash reserve) permits. There can never be an excess of loans made over capital.

     Where’s the problem?

103. Scott Fullwiler
     @Saturday, October 16, 2010 at 9:10

     Thanks for that very clear paraphrase of JHK’s argument, which I think even I have managed to follow. If I’ve understood correctly the distinction being drawn is between what I’ve elsewhere seen dubbed “cashflow insolvency” as opposed to “balance-sheet insolvency”.

     I don’t believe the exponents of 100% banking are under any illusion that “credit banks in a bifurcated framework cannot avoid liquidity risk.” Nor that for a central bank to supply (emergency) liquidity to such a bank which is temporarily cashflow insolvent – so long as it is balance-sheet solvent – may be to temper strict purity to the dictates of pragmatism.

     So, yes, you make a fair point when you say “I have not yet seen anyone in favor of 100% reserves counter this in a way consistent with how accounting really works and an understanding of how the payments system actually works.” How crucial for the concept’s viability that departure from strict purity would be has to be a subjective judgment I suppose.

     “JKH is NOT an MMT’er, so we can get rid of the silly red herring being thrown around here by multiple people that only the MMT view is considered valid or even entertained.”

     Being a guilty party, may I hereby withdraw that canard and promise not to repeat it?

104. “(You’re using “capital” and “reserves” interchangeably here – right?)”

     Absolutely not. Never. Reserves are a bank asset, capital is on the bank liability/equity side of the balance sheet. Completely different.

105. Robert . . . when the loan is actually settled initially–that is, the borrower receives the funds it has borrowed–what happens on the balance sheet in your framework? From what you said above, it sounded like the bank’s reserves at the Fed (on the asset side of its balance sheet) were drawn down.

106. stone:
     @Saturday, October 16, 2010 at 17:43

     Your enviably succinct description of a desired system accords exactly with what I would wish to see.

     I’ve yet to understand where are the technical flaws it is being said to contain. (Its palatability is of course another matter entirely, but I’m not talking about that).

107. Robert . . . didn’t see the latest since it went onto another page (and almost re-posted my own when they didn’t show up–duh!)

     The point about the CB providing “emergency” liquidity is that this must happen EVERY day. There are about $3 trillion in payments settled DAILY via bank reserve accounts, and a far larger $ volume than that is settled in private clearing systems that then settle on a netted basis via reserve accounts. You simply cannot have a disruption to that, even on a very typical day. The Fed, prior to Lehman, was providing peak daylight overdrafts (i.e., lines of credit that are repaid by the end of the day, either by overnight borrowing from others in money markets or collateralized overnight borrowing from the Fed) to banks at around $150 billion, daily. And once you start providing overdrafts to avoid a payments system crisis, the requirement that banks must pre-fund their lending is obliterated (if it even could have actually existed), as JKH explained. The alternative is to not provide such overdrafts at all, which sets you up for the liquidity crisis–even simple disruptions to the payments system caused by, say, bad weather, could create a crisis in the gold standard era.

     No worries on the MMT-thing–I hate to say Bill was right, but I guess he was, at least in my case.

108. Stone @Saturday, October 16, 2010 at 17:43

     You’ve basically set up the exact system there that JKH demolished in a very detailed way–for whatever reason, you and Robert find yourselves completely unable to offer any sort of critique of that point and just keep repeating the same mistakes pointed out.

109. Scott Fullwiler: “Robert . . . when the loan is actually settled initially-that is, the borrower receives the funds it has borrowed-what happens on the balance sheet in your framework? From what you said above, it sounded like the bank’s reserves at the Fed (on the asset side of its balance sheet) were drawn down.”

     Yes, that’s so. Of course if any part of the monies loaned was spent with another account-holder (say, a car-dealer) who happened to bank with the same bank its reserves at the Fed would be correspondingly increased.

     Is that a problem?

110. “The purpose of the system is quite simply that more money shall at all times be on loan than a bank possesses.”

     The system I described, where the bank makes a loan in principle, asks the state to create the required money and pass it over (in return for an IOU) and then advances the loan ensures that a private bank always has as much reserves as it has lent. At that point the bank has not created any private money (which apparently is your problem) and you have 100% Reserve Banking.

     It it trivial to do that for any bank, since it is functionally equivalent to the central bank authority and deposit insurance they have now. One is using the underlying (state cash) and the other a derivative of state cash (the insurance).

     At any point in this chain the state can refuse to advance the money which would prevent the loan – let’s say because they are lending more than their capital ratio allows. That again is functionally equivalent to the oversight rules that are in place now.

     The money that banks create under the current systems is by licence from the state. The state has delegated them limited powers to do that so that it doesn’t have to bother with the fine detail itself. The control mechanism is the fractional reserve regulations that the state imposes on banks.

     The state does this delegation to private businesses on a regular basis. It’s called outsourcing and is incredibly popular. Your bins get emptied by private companies under state authority and monitoring. Police cars are maintained by outsourced companies under authority and monitoring. Even the paper money in your wallet is printed by De La Rue – which is listed on the London Stock Exchange – again to a set standard and under monitoring.

     So why not electronic money? Why is it so vitally important that the state does that bit entirely in house, but nothing else?

111. Scott,

     Off topic, partly:

     Been following here, but not that closely, and certainly not closely enough to add at this point.

     But here’s something I thought you might find interesting/amusing, perhaps for later consumption.

     It’s a comment I just left for Nick Rowe, about a general theme, not entirely divorced from your subject matter here.

     My comment there may be a bit over the top, but I feel strongly about it.

     Comment October 16, 2010 at 02:55 PM , at –

     http:

     //worthwhile.typepad.com/worthwhile_canadian_initi/2010/10/currency-wars-and-forced-dissaving.html?cid=6a00d83451688169e20134883e87cc970c#comment-6a00d83451688169e20134883e87cc970c

112. Scott:

     The balance sheet stone & Robert might have in mind would look like this. Assume zero bank capital for simplicity.

     ‘A’ buys 1year bond with 100 cash:

     A: $100
     L: 100_1YB(owed to A)

     ‘B’ borrows 1Y loan:

     A: $100 + 1YL
     L: 100_1YB (owed to A)+100D(owed to B)

     ‘B’ can take $100 elsewhere, without the bank needing to use the CB or the interbank market borrowing, in which case the sheet would look:

     A: 1YL
     L: 100_1YB

     I think that the the point they are trying to make: no money creation, no CB involvement, no IBM borrowing Not sure if the above helps 😉

113. VJK . . . thanks! That would make sense. But Robert said that loans couldn’t exceed capital. That’s what I’m having particular difficulty understanding, unless he means something besides capital.

114. Scott, “That would make sense. But Robert said that loans couldn’t exceed capital. That’s what I’m having particular difficulty understanding, unless he means something besides capital.”

     – I can’t speak for Robert, I can only speak for myself. The hypothetical “lending banks” I described would have no prescribed capital requirement and no connection to a central bank. They would never take deposits and would only lend cash that they already held and so there would be no need for them to be subject to any banking regulations. I should have called them “loan companies” rather than “lending banks” as perhaps the word “bank” created unneccessary confusion. All their cash would come from institutional investors and from retained profits. The same pool of cash would be tapped into to pay bond holders when bonds matured and when bond holders received interest, to pay out as loans to customers and to pay out as dividends to share holders. The size of pool of cash held in relation to the bond liabilities would be a commercial descision of the “loan company”. If a loan company had only made very low risk loans such as 25% mortgages to people earning 50% the value of their house per year, then the loan company would be able to issue bonds at a low rate of interest despite having a small pool of cash. On the other hand, if the loan company was in the buisiness of making loans to people who might not be able to repay, then there would need to be a big pool of cash in order for the bonds to be taken up for a reasonable rate of interest. It would be up to the institutional investors who bought the bonds – If a loan company went bust, the share holders and then the bond holders would take the loss just as with any other type of company.
     I think the crucial overall point is that deposits and loans need to be delt with by entirely seperate institutions (giro banks and loan companies respectively) if we are to have a system where banks are not able to create money. Someone on here said that money creation is impossible to prevent. I’m struggling to get my head around that idea. As Robert says, credit creation of money is entirely dependent on the legal enforcability of receiving repayment of a loan made by someone who didn’t have the money to lend. If people only accepted payment in the form of cowerie shells or whatever then there could be no creation of money by credit. I don’t see why there could not be a digital equivalent of cowerie shells. If anyone was stupid enough to accept an IOU as payment then it would be on the understanding that if they were not repaid, they would have no legal redress. I realise that it is not just banks that create money currently. I guess when I buy materials and the supplier gets paid 30 days after delivery, I am creating money. My employer stipulates that that is what I must do. I think it is just as important to prevent money creation at that level as by the banks. I hope I’m not in too much of a muddle about this.

115. Scott Fullwiller:
     @ October 17, 2010 at 3:43

     The “emergency” liquidity I was envisaging was on nothing like the scale or continuous nature you describe. Little as I know about it, I don’t see that the necessity for a continuance at anything like that level of activity would be called-for when banks would not be loaning out more than their own capital. Tom correctly filled-out my assumption when he wrote:- “What you are saying is that banks must always hold reserves hence there is no need for an interbank market for reserves. The central bank does not set the overnight interest rate since there is no reserve lending.”

     What I had in mind was more along the lines of what in your paraphrase of JKH’s argument is described as an “overdraft on (a bank’s) deposit account at the Fed” to cover liquidity risks (provided the bank is balance-sheet solvent).

     However I have a shrewd suspicion that you (and others here) would be perfectly capable of overcoming the objections which you yourselves are advancing, were you by some miracle to undergo a sudden conversion which caused you to become motivated so to do. In other words (and this is I freely admit a profession of faith) I don’t believe that, given the right motivation, those objections are technically insuperable. I think it all depends on what objectives are being aimed at. If the end willed were the abolition of fractional reserve banking (for the kinds of societal reasons I’ve previously advanced), the means to achieve that end would undoubtedly be found.

     What we are debating here is ends, and the reasons for preferring some against others (amongst the others being perpetuation of the status quo). But many posts are concerned only with means, which is a second-order problem.

     May I again point out that MMT’s prescriptions are shaped in order to combat what its proponents judge to be undesirable societal outcomes, and to promote policies judged to produce desirable ones. So (quite properly) it is far from being ethically neutral. I happen to think that you are targeting the symptoms rather than the agent. I also suspect that some here have been seduced by the sheer diabolical intricacy of the present financial system and by their own ability to understand how it works (no mean achievement), and have lost sight of what it is for:- to perpetuate the hegemony of one tiny minority over our entire society. It is indeed a remarkable creation, beautiful even – if you can ignore the harm it does. Its product is the overwhelmingly powerful, bloated, predatory financial sector of the modern Western world (alongside a productive sector more and more starved of capital and at the mercy of financial freebooters), under the hegemony of a shameless and conscienceless plutocracy which has bought and sold our legislators. It’s a world which runs on exponentially-increasing debt which can never be repaid. It’s a world in which a financier who “earns” 53.4 million USD in a single year, mainly by screwing his unfortunate investors, is held up for our admiration. And it’s a world which will before long inevitably implode because it can’t be sustained in the medium, let alone the long, term. If that’s what MMTers want to see perpetuated, you’re welcome to it. I for one don’t.

     I’m not so foolish as to suppose that if the current FRB system were replaced by what in my opinion would be a far better and fundamentally more honest system all corruption and greed would miraculously be banished. I just don’t see the point of putting into the hands of those with the most rapacious and selfish instincts – who under any conditions will still become wealthy – a tool designed for the express purpose of permitting those instincts the freest possible rein at the expense of the rest of us. The oft-quoted words of one of them – who at least was without the sickening sanctimony of a Lloyd Blankfein who claims to be “doing God’s work” – deserve in my view be kept always in mind:-
     “Bankers own the Earth. Take it away from them, but leave them the power to create money, and with the flick of the pen they will create enough money to buy it back again…

     “Take this great power away from them and all great fortunes like mine will disappear, and they ought to disappear, for then this would be a happier and better world to live in.

     “But if you want to continue to be slaves to the banks and pay the cost of your own slavery, then let bankers continue to create money and control credit.”
     (Sir Josiah Stamp, Director, Bank of England, 1928-41 and reputed to be the second-richest man in England at the time)

     We can’t say we weren’t warned!

116. stone: “I can’t speak for Robert, I can only speak for myself.”

     Can I say that, yes, I concur in your explanation.

     I’m not sure though if you’re right to equate the non-instantaneous payment of debt (in the form of a supplier’s invoice) with “creating money”, for the length of time by which payment is delayed. I would have thought that that was in a different, and much more trivial, category altogether.

117. Scott Fullwiler: “VJK . . . thanks! That would make sense. But Robert said that loans couldn’t exceed capital. That’s what I’m having particular difficulty understanding, unless he means something besides capital.”

     It seems we’ve got at cross-purposes somewhere, and I think that may be because you aren’t making sufficient allowance for the abysmally low level of my knowledge of the technicalities and terminology of accounting. You probably find it difficult to imagine that any adult could be that unsophisticated 🙂

     Can I shock you by saying that such is my ignorance that I don’t actually follow the (highly-simplified) illustration which VJK provided? Though I was grateful that he sought to help me out by providing it and I imagine that if he believes it to represent my view, it probably does! (I also go along with Stone’s exposition).

     Does that help, or is there something else I need to add or to modify in what I’ve said?

118. Robert, I personally think it is important to include government created high powered money in your critical examination of what interests monetry expansion is serving. Once governments have been captured by the plutocracy (as they have been), then governments will create extra money so as to satisfy “leakage to savings”- in other words to feed a positive feedback loop expanding the financial sector. This high powered money is the base that limits the rate at which banks can create money.

     Tom Hickey, you suggest that I need to provide a numerical model to show that a non-expanding currency would be less prone to causing runaway financialization than an expanding currency. I can see that numerical models could potentially throw up unexpected results and so be helpful. My issue is that presumably the MMT models of an expanding currency just have “leakage to savings ” as leakage to some giro bank like entity that has little impact on GDP or whatever even if it has zillions of dollars in it. The reality seems to be that leakage to savings creates essentially all of the GDP growth and the currency expands as fast as GDP growth so as to accomodate it leading to positive feedback and a destructive exponential crisis. To me that just shows that numerical models are only as good as the thoughts that choose what variables to include in them. I’m sure the set up I described would lead to a reversal of financialization and also a reversal of the growing rates of inequality both within and between nations. Are you skeptical about either of those points?

119. Robert “I’m not sure though if you’re right to equate the non-instantaneous payment of debt (in the form of a supplier’s invoice) with “creating money”, for the length of time by which payment is delayed. I would have thought that that was in a different, and much more trivial, category altogether.”

     – I’m not entirely sure either but if a large institution such as my employer has say £10M of yet to be paid off invoices, then isn’t that £10M created out of nothing?

120. Neil Wilson:
     @Sunday, October 17, 2010 at 6:12

     I think I’ve now understood where you’re coming from and I’m sorry I failed to grasp it first time ’round.

     What you’re describing seems to me to be an alternative system, based on retaining FRB whilst nominally reserving to the state (by means of outsourcing) the creation of money. Have I understood correctly this time?

     Fine, if that’s what you want. But it’s not what I want.

     Under the system I’m describing the creation of money is not outsourced because no need for that to happen is acklnowledged to exist. Instead it remains entirely within the government sector and the new money thus created (or money subtracted should that be necessary) is “injected” or “withdrawn” (I’m deliberately using vague terms, to allow for every sort of means) into the non-govt sector.

     You may (as does Tom) have a horror of the state having a monopoly over the creation of money, and wish that power to be mitigated or mediated in some way by private agencies, presumably because (like Tom) you don’t trust the state not to abuse such a power for nefarious ends. Indeed Tom raised the spectre of totalitarianism, but I don’t know if you share his fear.

     I accept that that might have to accepted to be a danger (although to me it seems a trifle far-fetched). Personally I prefer to take the optimistic view. Firstly, it ought not to be impossible to put in place robust safeguards against any but the most ruthless would-be dictators (another Lenin for instance, or another Hitler). Secondly, I prefer to put my faith in democratically-representative institutions, because I see no acceptable alternative. What we have now is not democracy but a financial oligarchy – aka a plutocracy. For me it’s a matter of fundamental principle that in a democracy the power to create money belongs to the people, and at present they don’t have it – the private bankers do. Unless one is an uncritical admirer of free-market capitalism of the neo-liberal sort I don’t see it as possible to hold up the results of the private sector having been given free rein during the last four decades as having in any way demonstrated the superiority of private agencies over the state in exercising that power. The exact opposite in fact.

     And if I’m not mistaken MMT accords to the government sector a significantly enlarged (indeed very powerful) role via a far more radical part to be played by fiscal policy, whilst not going (as I would see it) the whole hog, because MMT is deeply conservative in regard to the continuation of private credit (=money) creation (as a lynch-pin of this marvellous game of monetary management which MMTers so much enjoy playing).

     Your scheme seems to me to be a way of preserving that monetary management system intact at any cost whilst – through the device of designating private banks as being nominally “licensed” by the CB to make their loans (ie to go on creating money exactly as they do now in the form of interest-bearing debt) – you pay lip-service to money-creation being the state’s prerogative but fundamentally change absolutely nothing. Ingenious, but I’m sorry I don’t buy it: I’m not interested in fig-leaves.

121. Robert: It seems we’ve got at cross-purposes somewhere, and I think that may be because you aren’t making sufficient allowance for the abysmally low level of my knowledge of the technicalities and terminology of accounting. You probably find it difficult to imagine that any adult could be that unsophisticated

     When I first started getting interested in this I wrote some comments on another economist’s blog. He kindly informed me that I wasn’t speaking the language and that I should just sit down and read a basic economics text to get the terminology straight, which I did, since I hadn’t been involved in economic discourse since I took Econ 101 fifty odd years ago. I still remember that it was Samuelson’s text though. I am still working on picking up the terminology and honing. I have found that if you can’t speak the language you can’t be understood and you can’r really understand what’s being said, and if you aren’t fluent, you can’t be precise or even think clearly about the subject. Jus sayin’.

122. stone: To me that just shows that numerical models are only as good as the thoughts that choose what variables to include in them. I’m sure the set up I described would lead to a reversal of financialization and also a reversal of the growing rates of inequality both within and between nations. Are you skeptical about either of those points?

     The macro problem is essentially an engineering problem. One is constructing a model of an economy and testing it not only for efficiency and effectiveness under ideal or even normal conditions, but also stress and shock. The problem is one of balancing factors under conditions of internal stress and external shock that disrupt normal functioning. The engineering challenge is controls. Are these controls automatic and or ad hoc, for example. What happens in inflationary situations, and deflationary ones? How about unemployment? These are some of the questions that a macro theory has to deal with. Money, banking and finance are in service of the real economy and the welfare of society through production, distribution, and consumption of real resources in a sustainable fashion.

     So we can agree about objectives but the trick is securing them in terms of a comprehensive theory that can be expected to work based on evidence. Bill’s posts make this point quite clearly.

     What you and Robert are arguing is toward a goal that I agree with in principle. However, I am not convinced that the means proposed are the way to get there. Secondly, you complain that MMT leaves most of the present system in place. That I regard as a practical advantage. It makes it doable practically. As it is right now, we can’t get even the most basic reforms in place, and crime is becoming institutionalized.

     I would personally prefer to go to a much more socialistic system than is presently in place in the US and world, because I don’t think it is possible to institute a liberal system that works through perfect markets. I agree that independent central banking is anti-capitalistic and anti-democratic and should be ended. I also agree that the state should have complete and explicit control over state money, ending the so-called public-private partnership arrangement, and elected representatives should be responsible for their decisions with respect to use of it.

     The idea that it is possible to harness the power of government through “small” or “limited” government is politically naive. The problem is who controls the state through government. Economics plays a key part in this.

     The challenge is to create a polity that is harmoniously balanced socially, politically, and economically between public and private, so that neither can get the upper hand and dominate. This requires a comprehensive macroeconomic theory to provide the economic foundation for such a polity, with adequate controls for internal stress and external shock. Obviously, this has to be done acknowledging the hysteresis of existing structure and different countries will have different opportunities and limitations. However, all economies must mesh with a global economy also. The opportunity now is that the global economy is just forming, and there is the opportunity to craft something at that works for humanity.

     So what I am saying is that MMT provides what I would regard as an interim solution that improves the present system by making operational opportunities available. Just doing this is a monumental task. However, I don’t think that the present system is sufficient for the global economy, and humanity really needs to be developing a global macro and global politics in service of the emerging global society that acknowledges the human family and the global village.

123. Well said, Tom. Don’t make the perfect the enemy of the good.

124. @stone,

     “The hypothetical “lending banks” I described would have no prescribed capital requirement and no connection to a central bank.”

     Sounds to me like you’re describing Zopa – which already exists. With Zopa the depositor takes the bad loan risk – the ‘bank’ just does the match-making and skims the interest rate charged by the depositor for the match making service.

     If the bank takes the credit risk, then it needs capital as a buffer – and then you’re back into how many loans is the bank allowed to make and who insures the depositor against loss if a double-six comes up on the dice and the bank burns all its capital.

125. “Instead it remains entirely within the government sector and the new money thus created (or money subtracted should that be necessary) is “injected” or “withdrawn” (I’m deliberately using vague terms, to allow for every sort of means) into the non-govt sector.”

     And given that banks don’t lend on reserves, how does that alter things? I’ve already shown you how it is trivial to alter the current system to use 100% central bank money. The bank makes a loan in principle, gets the nod and the state created money from the central bank in return for a bank IOU and then it pays out the loan. How is that any better than what we have now just because the money is directly state created?

     Are the banks barred from obtaining reserves from the central bank – in which case you’re into maturity matching and homing bad debt to the depositor, ie a Zopa like match making service.

     Or are you about fully nationalising the private banks, British Rail style?

     Our current system gives depositors capital security and an interest on their savings, because as the state regulates the banks the state should insure that regulation should it fail – which is what happened during the Financial Crisis. That is an extremely useful facility which we would lose under maturity matching.

126. Neil Wilson, “if the bank takes the credit risk, then it needs capital as a buffer – and then you’re back into how many loans is the bank allowed to make and who insures the depositor against loss if a double-six comes up on the dice and the bank burns all its capital.”- I have to reiterate that the “loan companies” I was proposing would not take deposits. They would get money from selling bonds etc as I described. There would be no more call to protect the bond holders than there is to protect holders of other commercial bonds issued by say manufacturing companies. If you wanted to prevent any retail investors from being at risk of being tempted to invest in commercial bonds you could have a rule stipulating that each bond had to cost >£1M or whatever. Deposits would only be held in giro banks. Retail investors could invest in mutual funds that held diverse commercial bonds and the mutual fund managers would be professionals exerting due diligence to ensure that the lending practices of the “loan companies” were appropriate for the yield their bonds paid out.

     “Our current system gives depositors capital security and an interest on their savings, because as the state regulates the banks the state should insure that regulation should it fail – which is what happened during the Financial Crisis.”
     Our current system is a blank check offered on a plate to the financial sector. The financial sector is consequently growing at 10% of GDP per decade or whatever it is -as is its power to thwart any future attempt at regulating it. The clock is ticking.

127. Scott Fullwiler “Well said, Tom. Don’t make the perfect the enemy of the good.”
     -To me this whole debate is about what macroeconomic direction is the right direction to be heading in if we want to be heading towards an improving rather than a worsening situation. To me the “Don’t make the perfect the enemy of the good” phrase is about as apt as it would be in a conversation between a car full of people trying to drive towards New York and arguing whether they should be driving North or South 🙂 . After all MMT is advocating an increasingly rapid expansion of the currency and I’m arguing for a recirculating totally fixed pool of money.

     Tom Hickey- “I would personally prefer to go to a much more socialistic system than is presently in place in the US and world, because I don’t think it is possible to institute a liberal system that works through perfect markets.”- Wikipedia (boo hiss) says “Socialism is an economic and political theory
     advocating public or common ownership and cooperative management of the means of production and allocation of resources”- I’m not such a fan of increasing socialism. I feel that it often ends up running very counter to what to me is an egalitarian ideal of everone only having limited power to boss other people around (financial power, political power, military power etc).

     Tom Hickey- “The engineering challenge is controls. Are these controls automatic and or ad hoc, for example. What happens in inflationary situations, and deflationary ones? How about unemployment? These are some of the questions that a macro theory has to deal with.”-To my understanding the best defense against inflation and deflation is to have a totally fixed money supply. The private banking set up I described would mean that horizontal money creation would be curtailed as much as possible. Consequently business cycles would be very much attenuated. Any inflation or deflation would largely reflect genuine changes is scarcity and would be better regarded as price corrections. If there was a credit fueled speculative bubble it would be by way of increased velocity of the money held in giro banks (loan companies awarding loans to purchase a bubble “investment” on the basis of the asset price being constantly bid up). When such a bubble burst, there would be no debt deflation. All that would have happened in effect is that say one million idiot investors would have each transfered £10k from their giro bank accounts to the giro bank accounts of a handful of cunning speculators who had sold at the peak. The total flat wealth tax paid to the government would stay the same. The citizens dividend paid out to everyone would be the same. The amount of money in the system would not change at all. All that would change would be that the stupid investors would no longer be in the position to make investment decisions and the loan companies that were diligent and prudent would no longer have competition from the ones that had collapsed.

128. Neil Wilson@ 7:18:
     “If the bank takes the credit risk, then it needs capital as a buffer – and then you’re back into how many loans is the bank allowed to make and who insures the depositor against loss if a double-six comes up on the dice and the bank burns all its capital.”

     It seems we may have a conceptual mismatch here. Under this scheme what you are calling “deposits” are not insured. They are intrinsically at risk, although the degree of risk will for the great majority (numerically-speaking, not necessarily of funds invested) be slight under “normal” circumstances whilst paying out a correspondingly low rate of interest. So yes, the bank does as you say need capital as a buffer, but how much capital is a business judgment supported by appropriate risk management assessment.

     Unlike Zopa (which I’m not familiar with but taking your description as given) the depositor doesn’t take all the risk – the bank’s shareholders, the sellers to it of bonds, and creditors of any kind would all be exposed to the risk of the bank’s folding. No different in principle from any other joint stock company so far as I can see.

     “How is that any better than what we have now just because the money is directly state created?”

     It wouldn’t be. But that’s not what’s being proposed. 97% of our money is currently created by the private banks in the form of interest-bearing debt – the interest on which flows in an unending stream into the coffers of the banks. The proposal is that all of that private money/debt creation be ended.

     “Are the banks barred from obtaining reserves from the central bank”
     Yes, except under certain extraordinary circumstances as a temporary expedient. It is accepted (see earlier posts) that this is a concession to pragmatism and in strict purity offends against the “100% reserves” principle. Too bad.

     “- in which case you’re into maturity matching”
     Yes, as part of risk management I presume

     “and homing bad debt to the depositor, ie a Zopa like match making service.”
     No, as explained above.

     “Or are you about fully nationalising the private banks, British Rail style?”

     No, and I’m puzzled why you think that may be implied by this proposal. It says nothing one way or the other about whether banks ought to be nationalized, which is an entirely separate issue. You seem to be reading something into this which isn’t actually there, but I can’t figure out what that “something” is.

     “Our current system gives depositors capital security and an interest on their savings”
     The proposal would also give savers interest on their savings, in inverse proportion to the riskiness of the investment vehicle chosen by the saver

     “because as the state regulates the banks the state should insure that regulation should it fail – which is what happened during the Financial Crisis.”
     But the state would no longer be regulating the banks (in the sense in which you mean that, and in the way they do now; there would of course still have to be regulation – “consumer protection” etc – but its form would be different) and so there would be no moral obligation of the kind you’re implying on the state to provide deposit insurance, in respect of citizens’ private investment choices. The banks’ customers would have to rely upon due diligence being exercised by their banks’ managements. Most importantly of all, there would no longer be any bank that could be deemed “too big to fail”.

     “That is an extremely useful facility which we would lose under maturity matching.”
     How useful is a matter of opinion. And anyway in the other scale need to be weighed the disadvantages of the present system (which I won’t elaborate again here).

129. Tom Hickey: “Money, banking and finance are in service of the real economy and the welfare of society through production, distribution, and consumption of real resources in a sustainable fashion.”

     I think that’s an admirable formulation, if I may say so. It is also, I suggest, an idealized encapsulation of liberal capitalism’s aspirations. Anyone who believes that capitalism is the best (or maybe “least worst”) economic system so far invented – provided only that it is intelligently and justly administered – would no doubt concur.

     The question of course is how far short is our present version of capitalism of achieving that idealized goal and, following from the fact that the answer is inevitably going to be “by quite a long way”, what is it that ought to be changed to get a bit closer?

     You have your own (very persuasive) analysis of present performance and desirable improvements. Although, clearly, we have similar ends in view mine is a little different.

     Where we part company most obviously is in regard to the present financial system which, to me, is almost entirely dysfunctional when measured against your ideal specification quoted above. MMT, putting it crudely, whilst leaving the functioning of that system undisturbed seeks to offset its most pernicious socio-political outcomes, by deploying to the fullest extent necessary (as a result of bringing to bear a sophisticated understanding of what the possibilities actually are) the fiscal weapons available under a fiat money system to governments.

     I on the other hand (making no claims to originality, having picked up these ideas from others with far more original minds than me) am of the opinion that – since the current financial and banking system not only spectacularly fails to measure-up to your prescription (that it serve the real economy and the welfare of society) but also that it continues unrepentantly to set itself against the achievement of any such aim – it must first of all be reformed root and branch in such a way as to force it to conform to or, at the very minimum cease to be the biggest obstacle to, the achievement of your ideal prescription for it. I don’t believe that anything short of this will be able to deliver the outcomes you seek. The current system is, I believe, a corrupt and corrupting incubus which has been permitted to fasten itself upon and to pollute our body politic and our civic values, and until it can be forced to stop bleeding us there’s little point in applying palliatives.

130. stone:
     Sunday, October 17, 2010 at 19:54

     “Robert, I personally think it is important to include government created high powered money in your critical examination of what interests monetry expansion is serving. Once governments have been captured by the plutocracy (as they have been), then governments will create extra money so as to satisfy “leakage to savings”- in other words to feed a positive feedback loop expanding the financial sector. This high powered money is the base that limits the rate at which banks can create money.”

     Have been pondering this, and I think you make a valid point – in regard to the present system’s operation.

     However, my view would be that the temptation for governments to employ HPM for this purpose would disappear as an automatic corollary of the elimination of private money-creation. I take it that would be your view too.

     The question has thus far in this debate been begged as to the means by which, and the criteria according to which, HPM (which then in fact would have become the same as “all money”) would be created by the non-govt sector post-reform. But since you advocate a fixed (and unchanging?) volume of money I imagine that not will be a pressing concern for you.

131. Robert “my view would be that the temptation for governments to employ HPM for this purpose would disappear as an automatic corollary of the elimination of private money-creation. I take it that would be your view too.”
     -Actually that isn’t really my view. I get the impression that government (and society) is completely addicted to having an expanding currency as a kind of phoney illusion of increasing prosperity. Also if one currency expands faster than another, then the nation with the faster expanding currency gains a financial advantage over the nation with the slower expanding currency (even though both would be better off if neither currency were expanding in my view). Even if all of the monetary expansion were conducted by a government with socialist leanings it nevertheless transfers relative wealth to those with the most assets as global monetary expansion acts as a force to push up global asset prices (though in a very jerky way and with no geographic borders). All of this conspires together to make for a collusion between the financial elites and governments to expand the money supply in all ways they can. The governments get the greatest possible resources (whether for invading Iraq or for great things like sure start programs or whatever) seemingly for free and the financial elite get to control and own a larger and larger proportion of everything. Of course the collateral damage is an entirely deranged economic system heading for the abyss :). To me the shrillest wake up call was the 2008 wheat price spike. http://www.wdm.org.uk/food-speculation/great-hunger-lottery

132. stone, regarding capitalism v. socialism, the dictionary definitions don’t apply absolutely because there are different forms of both. The US is considered capitalistic and the Scandinavian countries are considered socialistic, for example. The US does not have a free market capitalism because capitalism has run its course long enough for monopoly capital to have emerged as dominant and captured the state. The Scandinavian countries are not purely socialistic either since the state doesn’t own all means of production. I would prefer to live in a state in which the elected representatives are largely in control of the economy instead of unelected and unaccountable oligarchs. My preference, maybe because I see the US headed over the cliff and Scandinavia doing pretty well.

     To my understanding the best defense against inflation and deflation is to have a totally fixed money supply.

     Inherently deflationary. What is the control for rising unemployment in case of internal stress or external schock?

133. Robert @21:00

     I agree with what you say, and I prefer liberal democracy, too, but founded on an economic infrastructure that supports it. The problem as I see it is that free market capitalism has failed for the reason that Marx gave (tendency toward monopoly capital) and also the related reason that Sergei mentions, namely, that it encourages ruthless competition and this favors the ultimate success of the psychopathic fringe. This is where we are presently in the US. As a consequence, the whole country has gone bonkers and is becoming a rogue state. The US is now the most feared nation on earth. This is capitalism run amok.

     The political problem is that socialism tends toward totalitarian statism, capitalism tends toward state capture by monopoly capital, and feudalism engenders a hereditary landed oligarchy. Socialism, capitalism and feudalism represent the three factors of production, labor, capital and land, respectively. There has to be a harmony among the factors of production and this has to be reflected politically.

     One means of accomplishing this is taxing away economic rent.

134. Tom hickey, I take your point about there being different forms of socialism and capitalism. I guess what I was meaning was that my priority is to get the capitalist aspect of our economy back on the right track rather than shifting the balance between capitalism and socialism. I think the current mix between capitalism and socialism probably has about the correct proportions but much of the capitalist part is rotten and that has corrupted the government part.
     When you say about a recirculating fixed stock of money- “Inherently deflationary. What is the control for rising unemployment in case of internal stress or external shock?”-Please elaborate your position especially what type of deflation you consider bad. As I described in the @19:18 post, if there was a banking system without the capacity for horizontal money creation, then there would not be debt deflation. To prevent unemployment, I am proposing having just as much of a citizens dividend or JG with government spending as the MMTers. The only difference is that I’m proposing funding it by a wealth tax rather than by currency expansion. That would initially cause an asset price correction but I don’t see how there could be long term deflation in the classic way where all the money becomes sequestered in savings rather than circulating. The fact that all taxation would be in the form of a wealth tax (a tax on assets including tax) and that there would be a fixed inheritance ceiling would prevent the stock of savings from accumulating. Are you still sceptical about that?

135. “97% of our money is currently created by the private banks in the form of interest-bearing debt – the interest on which flows in an unending stream into the coffers of the banks.”

     The money multiplier is a myth, so that’s a propaganda line you’ve got from somewhere.

     OK. Under your scheme what is to stop money that was loaned out by the bank on loan #1 from being reinvested back in the same bank as reserves for loan #2?

136. Neil Wilson, “OK. Under your scheme what is to stop money that was loaned out by the bank on loan #1 from being reinvested back in the same bank as reserves for loan #2?” – If this is about the loan companies I was proposing, they would not take reserves, they would only sell bonds. If a loan was taken out and used to buy a bond, then the person who did that would say pay 6% interest on the loan and receive 4% interest on the bond. If they had any sense they would sell the bond to someone else and use the money to pay off the loan early before they lost too much money.

137. Neil Wilson- further to my comment above, sorry I meant to say the loan companies would not take deposits, they would only sell bonds. The loan someone took out would have to be put in a giro bank. Giro banks would be the only institutions that could take deposits and those would not be able to make any loans.

138. stone, economics is about the production, distribution, and consumption of real resources. The basic rule of a market economy is that what is underpriced is over-consumed (hence over-produced), and what is over-priced is under-consumed (hence underproduced). Real goods and services are rationed based on price differentials. Price is nominal and depends on the availability of funding for effective demand. In an economy in which incomes are used to consumer the entire productive capacity of the economy, everything is hunky dory. But that is an ideal situation that doesn’t exist in the real world. In the first place, as soon as government is introduced, the equation changes to the macro equation, Y= C + I + G, and in an open economy the complete equation is Y = C + I + G + (X-M). Sectoral balance come into play, and MMT, following Wynne Godley’s monetary economics, describes how this works. The trick is to keep the nominal values in the equation in balance through appropriate economic policy, so that the real economy operates at optimal capacity and full employment, along with price stability. MMT is advising to use fiscal policy under the existing system (including needed reforms), while you are advocating changing the present system substantially.

     With a fixed quantity of money, when government enters the market place, it competes with the private sector and withdraws real resources for public purpose, and under a fixed system government has to tax to spend, drawing down incomes, or else government must finance spending with actual borrowing, crowding out private credit for investment. This greatly constricts the flexibility of government to address economic stress, as well as it ability to craft economic policy for public purpose.

     Again, unless there is a zero trade balance, the country will be either importing funds from net exports or exporting funds from net imports. Government and trade immediately changes the simple model of income directly purchasing all potential output. The macro equation requires that the quantity of money be continually adjusted to its fixed level based on changes in sectoral balances. How do you propose to to do this overall and, in particular, in the face of internal stress or external shock?

     Why is a fixed system deflationary? It’s specifically designed to prevent inflation by limiting money creation. This is the purpose of fixed systems. Unless they are in equilibrium, which modern economies aren’t over time, then there will be disinflationary and deflationary periods, in which there won’t be enough effective demand to purchase potential output, so an output gap will open and unemployment will rise.

     What a fixed system does is to reduce the flexibility of government to respond to changes in domestic demand through fiscal means, which, I understand, is your intent to preclude asset inflation. What mechanism do you suggest for addressing issues that arise, or don’t you anticipate any? As far as I can tell, you are assuming an equilibrium state in which effective demand always equals total potential output.

     There is another potential problem with the system you propose. Effective demand is based on income. There are three classes of income, 1) present, past (savings) and future (credit). Saving accumulate present income for future consumption, and debt draws future income forward for spending in the present. You are proposing a great reduction in debt, and it seems reduction in savings, too. There is no appreciable asset accumulation to sell or borrow against for pressent consumption, either. This places the brunt of effective demand on present income. That is going to result in a large constriction in lifestyle and living standard, and it will also constrict productive investment and innovation, as a result.

     There are always tradeoffs, whatever system one constructs. It is a political question as to what kind of system a people wants to live under. Economic policy is about the tradeoffs.

139. @stone

     What’s to stop somebody buying bonds with borrowed money?

140. That borrowed money having been borrowed by person A, spent with person B who then buys a bond with it.

141. Neil Wilson, they could buy bonds with borrowed money (and would loose money to the loan company if they did) but as I said above doing so would not create money.
     Say some one gets a £100 loan and buys a £100 bond with it. The bank’s pool of cash would have decreased by £100 and then been replenished. The “investor” would then have a bond- they would not have cash. They would not be able to exchange the bond for anything other than to sell it on for cash which would just mean someone else would have a bond and have less cash.- No money would have been created.
     About the Zopa link- cheers for pointing that out. Personally I would invest in a hypothetical “mutual fund of loan company bonds” but I’m too scared to put any money in Zopa. I’ve no banking acumen , I don’t want to bid for interest rates and unlike a mutual fund share that can be sold at any time, the Zopa set up locks your money in and is nothing like as spread out across many loans as a mutual fund of bonds would be (perhaps I didn’t read about Zopa enough though).

142. Neil Wilson:
     “‘97% of our money is currently created by the private banks in the form of interest-bearing debt – the interest on which flows in an unending stream into the coffers of the banks.’

     “The money multiplier is a myth, so that’s a propaganda line you’ve got from somewhere.”

     What, exactly, is “a myth”? That banks create money? – I think not. That the proportion they create is more than 97% (in the case of the UK) – or, to put that another way, that the amount created interest-free by government in the form of notes and coin is less than 3%? A “propaganda line”? – I think not. I think you’ll find that if you believe the proportions are otherwise it’s you who have swallowed a propaganda line.

     Our mutual failure to understand each other continues as before. It seems evident we’re speaking different languages, and that both of us would benefit from the good offices of a translator because, this way. we’re not making progress (just going round and round in circles).

     If what divided us were a difference of opinion or of philosophy that would be one thing. But if it’s mutual incomprehension I’m not sure how we deal with that. Somehow I’ve evidently failed to convey to you the nature of what I’m describing.

     Could that perhaps be because you’re unwilling to think outside the box you’re in? For my part. I believe I have honestly tried to see the problem through your eyes but clearly haven’t succeeded.

143. Stone:

     my post @Sunday, October 17, 2010 at 19:54

     Sorry, a howler I’m afraid! In the penultimate line “non-govt sector” should have been “govt sector”.

144. Tom Hickey says:
     Tuesday, October 19, 2010 at 1:56

     “One means of accomplishing this is taxing away economic rent.”

     I’d buy that. But I’d still like to radically reform the banking system anyhow because I don’t trust the banking interests as far as I can throw them. Unless and until they’re disarmed they’ll find a way to screw the rest of us: it’s in the nature of the beast. Predators predate – they don’t know anything else.

145. Robert,

     I’ve been looking at your comments, and the feedback you’ve been getting, and think I’ve got a reasonably good idea of what you’re talking about. It looks operationally feasible to me, including the accounting, at least in theory.

     This whole thread is very interesting. I’m going to try and post something here in the next couple of days, maybe connecting your idea to some MMT concepts and to some of my comments in the link provided by Tom Hickey earlier.

146. “No money would have been created.”

     Yes it would there are two loans outstanding and two cars bought with the same £100 injected by the central bank. How is that not money creation?

147. But I’d still like to radically reform the banking system anyhow because I don’t trust the banking interests as far as I can throw them. Unless and until they’re disarmed they’ll find a way to screw the rest of us: it’s in the nature of the beast. Predators predate – they don’t know anything else.

     Have you looked at Warren Mosler’s proposals?

148. “That banks create money? – I think not.”

     They still ‘create money’ in your terms under 100% reserve.

     £100 social security cheque from government recieved
     £100 bond bought with social security cheque
     £100 loan created for Person A – marginal rate 0.5%
     £100 TV bought with cash by Person A from TV vendor
     TV vendor invests £100 in £100 bond with bank
     £100 loan created for Person B – marginal rate 0.5%
     £100 TV bought with cash by Person B from TV vendor
     TV vendor invests £100 in £100 bond with bank
     £100 loan created for person C – marginal rate 0.5%
     £100 TV bought with cash by Person C from TV vendor

     There are no net-financial assets created there, but I make that three TVs bought with the same £100 of ‘state money’. Three lots of margin on the same money. And no end in sight unless there is taxation of the purchase transaction.

     It would be the same under fractional reserve, except that regulation would terminate the sequence instead based on capital adequacy.

     The difference is that the lending meltdown risk is privatised in your proposed model and socialised in the current model.

     The mainstream misguided view is that somehow the state guarantee is limited due to borrowing requirements from foreigners. And that’s what a lot of people are getting excited about. Isn’t it terrible that we’ve had to ‘borrow’ so much to ‘bail out’ the banks.

     But of course with MMT we know the state guarantee of deposits does not need to be limited in a sovereign currency issuing state and there is no need to borrow to cover any bank liquidity issue. The government can easily cover all calls on the deposit insurance where essentially failed banks assets end up on the balance sheet of the central bank.

     State insurance of bank deposits is not a financial problem.

     The failure of banking as we have seen over the last few years is essentially the failure of the control rods in a nuclear reactor. A Financial Chernobyl if you like. And the state insurance should cover that since it went down on their watch.

     The state insurance can ensure that depositors can have 100% capital assurance, can earn a reasonable interest rate and have free banking on their current accounts, while loans can be made easily and cheaply without a load of functionally pointless ideological intermediate work.

     The downside is that the regulation has to be a lot tighter than it has been over the last ten years and the banks should be restricted to just offering loans for a turn within their capital adequacy ratios. It should be easier for the central bank to put a bank into administration. All those reforms limit the moral hazard sufficiently to stop further problems. Banks are largely agents of the state and should be made to act as such.

     “Somehow I’ve evidently failed to convey to you the nature of what I’m describing.”

     No, I know exactly what you are describing.

     This two layer maturity matched model is just pure privatised banking as generally put forward by the extreme right wing along with abolishing legal tender and state currencies. Ralph has a 750 page opus linked on his blog with their recommendations in it.

     Like Bill I can’t see any advantage to it and quite a few disadvantages.

149. Neil Wilson, I totally agree with you that whilst the “loan company” concept would prevent the stock of money from increasing, there would still be variations in the velocity of the money that would potentially lead to inflations and deflations (I hope my terminology is OK). The aim of the whole reform would be to have a constantly circulating fixed pool of money that could buy TVs or whatever for perpetuity just as you describe. If some extreme right wing types also favour such a system then we should bear in mind that fiscal stimulus was put to very effective use by the Nazis building autobahns and such like. Keynes was apparently somewhat gutted that it was the Nazis who made best use of his insights. Just because a set of people have evil views about somethings does not mean that they do about everything. Anyway isn’t Ralph himself an ultra right wing politician as well as being an MMTer or am I mixing him up with a different Ralph Musgrave.

150. Neil Wilson “The state insurance can ensure that depositors can have 100% capital assurance, can earn a reasonable interest rate and have free banking on their current accounts, while loans can be made easily and cheaply without a load of functionally pointless ideological intermediate work.”- I just see this as the recipe for the great financial crisis mark 2. The only people to genuinely suffer in the 2008 crisis were the urban poor in the third world who starved to death. I’m sure such people will also be the first to feel the cost of our folly in future if we continue to pander to the expanding money mindset.

151. Tom Hickey, cheers for the detailed comments.
     About “under a fixed system government has to tax to spend, drawing down incomes,”- that is why I was saying that the only tax should be one on assets (eg cash, real estate, stocks, bonds) and all other taxes should be abolished.

     “Again, unless there is a zero trade balance, the country will be either importing funds from net exports or exporting funds from net imports.” ” The macro equation requires that the quantity of money be continually adjusted to its fixed level based on changes in sectoral balances. How do you propose to to do this overall and, in particular, in the face of internal stress or external shock?”
     – Much of my motivation for wanting non-expanding currencies is to force a zero-trade balance. With free floating currencies, the exchange rate would take an immediate and hard hit if a trade “imbalance started. That would prevent trade imbalances from developing. Currently say China and Germany and Saudi Arabia export goods to us in return for USD that are hoarded by the elite in those exporting nations. With non-expanding currencies, we would have to work out ways of creating goods or services that were of value to the people in those countries and the elites in those countries would have to distribute the profits of the trade to the “little people” in those countries. The elite already send their children to the best universities, use the best health care etc etc. For the elite, USD to hoard are what is wanted. Medicines and places at US or UK universities can not be hoarded in a hedge fund by the elite- they have to be distributed to the “little people”. I think that the trade imbalances facilitated by expanding currencies are a major cause of global injustice, poverty and strife. I was shocked that when I mentioned to a friend that I was worried that we had invaded Iraq because they were not accepting USD for oil, his response was along the lines of, “no shit Sherlock, no one in the Islamic world has ever thought otherwise”- (he’s Turkish).

     “there will be disinflationary and deflationary periods, in which there won’t be enough effective demand to purchase potential output, so an output gap will open and unemployment will rise.”-The system I suggested would have a fairly large citizen’s dividend paid out to everyone. Wouldn’t that mean that everyone had plenty of money to pay for what they wanted so if there was unemployment it would only be because all the work that was wanted was already being provided? The citizens dividend would mean that workers could be relaxed about bargaining for reduced working hours if that was what they wanted. To me it seems inane that we work such long hours when if there is any point at all in having had any technological progress over the last 10000 years it surely has to be that we would have more freedom to spend time how we wish rather than meeting essential demands.

     “What mechanism do you suggest for addressing issues that arise, or don’t you anticipate any?”- I guess the classic “issue that arises” is war. I think it is essential that the financial cost of war is felt as an immediate hit to the wallet by everyone. If invading Iraq had entailed a cut in the citizens dividend and a hike in the wealth tax then I don’t believe Tony Blair would be the toast of Wall Street as he is now. In more general terms if more government spending is needed for any disaster (say a major earthquake reconstruction) then the citizens dividend would be cut and the wealth tax increased so as to allow the government to directly finance the reconstruction if that was deemed necessary.

     “There is no appreciable asset accumulation to sell or borrow against for present consumption, either. This places the brunt of effective demand on present income. That is going to result in a large constriction in lifestyle and living standard, and it will also constrict productive investment and innovation, as a result.”- There would be much lower asset prices, that means that a £100 of stock or farmland or whatever will be earning >£10 per year in dividends. That will be a much more stable and reliable form of investment appreciation than the current bubble chasing, crash dodging game that inevitably results in a massive transfer of wealth from the “dumb money” to elite speculators. Currently innovations are funded not by bank loans but by venture capitalist who spend money in return for a share of the company should the company actually work out. Under a wealth tax system, such venture capitalist activity would avoid much of the tax because whilst the company was starting it would have little financial value as an asset and so would not be subject to much tax. Also when the venture capitalists sold on a successful company their would be no capital gains tax to pay. The current financial system actually crowds out such productive investment by offering a lucrative alternative with no social purpose in the form of asset price inflation.

     “That is going to result in a large constriction in lifestyle and living standard”- when we assess the current expanding currency set up we must include all the people in the world who are subject to its effects. Currently those nations that expertly expand their currencies are able to profit at the expense of those that do not. The poverty of the least well off 10% of people in the world has got more and more severe over the last few decades. The currency system can only act to allocate resources and guide people into doing the work that needs doing. From what I can see most of what we currently do in order to get financial reward is actually counter productive by any sane assessment of worth. The FIRE sector is largely a moronic artifact of the currency set up. A lot of consumption is pointless “keep up with the Jones’s” flaunting etc etc.

152. Tom Hickey, I just feel the need to re-state that I totally see that MMT with an expanding currency could work initially. My problem is that the “leakage to savings” is an ongoing process with no check or balance and with a positive feedback loop to a growing FIRE sector. It is that source of heading towards an inevitable crisis that means that I think an alternative to expanding currencies needs to be implemented ASAP.

153. stone,

     How does your theoretical non-expandable currency account for the empirical evidence that expandable currencies favour those you purport to be helping? See the gold – silver – greenbacks debate in the USA during the 19th century. A scarcity of money always hurts those at the bottom.

     How would a non-expandable currency deal with a capital strike? It seems to me that taxing stocks of savings (rather than flows) would be necessary.

     Once I have an accumulation of money in a non-expandable currency, what is the incentive not to hoard it so it can be used by others? Would others have to pay whatever price I ask for its use?

     I see inflation as a feature not a bug. It’s an incentive to spend and invest.

     Your characterisation of private banks as being uncontrollable is odd given what would be required to implement your proposal. Why would someone with an accumulation of wealth be any more controllable than a bank? I don’t get it.

     The same energy put into the legislation you must enact to control accumulations of capital and stop a glut of savings from arising could be put into controlling the banks lending practices. The government could revoke a bank charter if it chose to do so.

154. Tom Hickey:
     “Have you looked at Warren Mosler’s proposals?”

     Yes, I have. And found them very attractive.

     I even went so far as to wish Warren the best of luck in his campaign for election to the US Senate!

155. Neil Wilson:
     “I know exactly what you are describing.”

     You still don’t, I’m afraid. You’ve completely failed to understand it and, instead of what I’ve actually described, you persist in foisting on me some other completely different animal which you’re carrying around inside your head. Namely:-

     “This two layer maturity matched model is just pure privatised banking as generally put forward by the extreme right wing along with abolishing legal tender and state currencies. Ralph has a 750 page opus linked on his blog with their recommendations in it.”

     I frankly have no idea what you’re talking about. And I don’t believe I’m any stupider than the next man.

156. Jeff 65-“How would a non-expandable currency deal with a capital strike? It seems to me that taxing stocks of savings (rather than flows) would be necessary. Once I have an accumulation of money in a non-expandable currency, what is the incentive not to hoard it so it can be used by others? Would others have to pay whatever price I ask for its use?”
     -I totally agree that avoiding capital strike needs to be the absolute critical focus if a non-expanding currency is adopted. That is why the system would depend on all of the tax being in the form of a wealth tax. Such a wealth tax would be a flat % of all asset values (eg cash, stocks, real estate etc) and to have legal ownership of anything you would need to be up to date on the tax. There would also need to be a fixed ceiling to inherited wealth. Although personally I’d favour a low ceiling, so long as there was a ceiling (even £1B) it would be OK.

     “How does your theoretical non-expandable currency account for the empirical evidence that expandable currencies favour those you purport to be helping? See the gold – silver – greenbacks debate in the USA during the 19th century. A scarcity of money always hurts those at the bottom.”
     -This is because the non-expanding currencies were not previously combined with a large wealth tax and a large citizen’s dividend paid out to everyone. Those are essential add ons if it is to work.

     “I see inflation as a feature not a bug. It’s an incentive to spend and invest.”- That is what creates consumerism and that is what is destroying our planet. It also drives gross inequalities. The losers may be out of sight from us. People who have to work on construction sites in >40oC heat in Dubai for 4years in order to pay back the cost of their passage from Bangladesh, unemployed in third world cities etc etc. Bill says we need to produce less and distribute it more equally- I agree. Also by “invest” to avoid inflation people often mean to buy useless assets as a store of value as asset price inflation outstrips consumer price inflation. The system I’m proposing would induce people to invest in investments that actually earned a yield so that they could pay the wealth tax rather than having to liquidate the asset to pay off the wealth tax.

157. Jeff 65″The same energy put into the legislation you must enact to control accumulations of capital and stop a glut of savings from arising could be put into controlling the banks lending practices. The government could revoke a bank charter if it chose to do so.”-
     -The problem with expanding currencies is that the expansion is an ongoing process. You might be able to get in place legislation that was able to control damaging financial vested interests at the current level of savings (I don’t see any evidence of that happening though- do you). However in a decades time, the level of savings will have doubled again and so a whole new raft of even more unlikely legislation would be needed to keep a lid on things and so on for perpetuity.

158. stone, two issues come up.

     First, what is the incentive for productive investment? The argument of the have’s against this arrangement would be based on that. i.e., why invest if the gains from risk-taking are going to be confiscated by taxes? This hampers job creation and innovation. In fact, this has been the persistent argument in the US for across the board tax cuts.

     Secondly, if one country were to adopt this plan, then capital flight is virtually assured (instead of a capital strike). It would have to be imposed on the global economy in some fashion, e.g., eliminating capital flows or a single non-expanding global currency like a return to the gold standard, or some such. Wall Street has already warned Washington that if it imposed too tight controls, it will just move somewhere more agreeable, like Dubai.

     Also, it looks to me that you are pretty much presuming an equilibrium state and don’t have a clear plan for addressing stress and shock.

159. I just feel the need to re-state that I totally see that MMT with an expanding currency could work initially. My problem is that the “leakage to savings” is an ongoing process with no check or balance and with a positive feedback loop to a growing FIRE sector. It is that source of heading towards an inevitable crisis that means that I think an alternative to expanding currencies needs to be implemented ASAP.

     Then you haven’t careully examined the writings of Warren Mosler, Randy Wray, Marshall Auerback, and others on reforming the present system. MMT’ers are Minskians. They understand full well the implications of the financial instability hypothesis and the long financial cycle that ends in Ponzi finance.

     MMT’ers’ fully recognize the necessity of reforming FIRE and reducing the role of economic rent in the economy, while encouraging productive investment. This can be handled a lot simpler using the operational potential of the existing system than going to an entirely different system. Moreover, MMT’ers would say that one is giving up too much in switching from a flexible to a fixed system, since government is too constrained when faced with internal stress or external shock.

160. OK, still doing my level best to follow your argument 🙂

     “£100 social security cheque from government recieved
     £100 bond bought with social security cheque”
     So £100 of new fiat currency has been created by the govt sector and vertically transmitted to the non-govt sector, where the recipient loans it to a bank in exchange for a bond, redeemable at some future date at par plus interest; meantime he gives up to the bank the use of the new money.

     “£100 loan created for Person A – marginal rate 0.5%
     £100 TV bought with cash by Person A from TV vendor
     TV vendor invests £100 in £100 bond with bank
     £100 loan created for Person B – marginal rate 0.5%
     £100 TV bought with cash by Person B from TV vendor
     TV vendor invests £100 in £100 bond with bank
     £100 loan created for person C – marginal rate 0.5%
     £100 TV bought with cash by Person C from TV vendor”
     (TV vendor invests £100 in £100 bond with bank?)

     The bank loans out this borrowed new money at interest, whereupon it instantly resumes monetary form and may be used to purchase goods. Instead of consuming this money (the proceeds of the sale) himself or saving it or distributing it as dividends the TV vendor chooses to loan it – to the same bank but that is incidental – in exchange for a bond, redeemable at some future date at par plus interest; meantime he gives up to the bank the use of the money. This process is repeated three times (or n times, it makes no difference how many)

     The new money in this example is created (as already stated) exclusively by the govt sector and transmitted to the non-govt sector. It is then put into circulation and goes through successive metamorphoses, alternately as money and as savings. To redeem the first bond when it matures and pay the interest due on it the bank must draw upon its capital, likewise the second and the nth.

     So how can you say:-
     “They (banks) still ‘create money’ in your terms under 100% reserve.”

     Where, exactly, is the money you say the banks create under this system?

     “Three lots of margin on the same money.”
     Is there anything wrong with that?
     – “And no end in sight unless there is taxation of the purchase transaction.”
     There is, indirect, taxation (VAT) borne by the consumer, and there may be profits tax due from the vendor on his markup.

     I’m sorry but I’m unable to see the point you’re making in the rest of your argument or – more importantly – to see any connection between it and the proposal I’ve advanced. To me it all seems tangential.

161. Tom Hickey
     “First, what is the incentive for productive investment? The argument of the have’s against this arrangement would be based on that. i.e., why invest if the gains from risk-taking are going to be confiscated by taxes? This hampers job creation and innovation.”-someone has some money in excess of what they want to spend- if they don’t invest it productively, it will get taxed away incrementally. Just as now it will be lost incrementally to inflation. The difference is that with a non-expanding currency it would need to be invested in a way that earned a yield rather than just in a non-productive asset.

     “if one country were to adopt this plan, then capital flight is virtually assured (instead of a capital strike). It would have to be imposed on the global economy in some fashion, e.g., eliminating capital flows or a single non-expanding global currency like a return to the gold standard, or some such. Wall Street has already warned Washington that if it imposed too tight controls, it will just move somewhere more agreeable, like Dubai.”
     -I totally agree with this. It would have to be a WTO rule that to participate in free trade a participating country would need to have a non-expanding currency. International trade would use a SDR type basket of currencies with each currency weighted in proportion to the population of that country.
     There would not need to be all countries taking part. I guess it would be fine to have a group of participants spanning a variety of types of countries so long as trade and currency exchange was just inside or outside the group. To be honest all the rich people could leave and it wouldn’t cause any problem so long as they no longer had a means of exerting financial power on the nation they had abandoned. There would be no income tax or capital gains tax or VAT. That would encourage people who were wanting to earn a living.

     I heard I think it was Nigel Lawson talking on the radio about when he had relaxed all regulation for the City of London in the 1980s. He said that at the time there was a race to the bottom between him and whoever it was who was deregulating Wall Street. He amazingly said that with hindsight he could see that it had been a mistake. Basically Wall Street and the City is one entity that has a foot in each country to play one regulator off against the other.

     I think stress and shock are best addressed immediately by making the necessary reallocations of resources (such as increasing direct government spending at the expense of an increased wealth tax and decreased citizens dividend. You could say that the government could have a “war chest” of state savings that it topped up and drew down as needed. I’d be keen to minimize that as sometimes it can lead to problems being swept under the carpet rather than being faced up to. Basically I think we have had a few decades of sweeping under the carpet economics.

162. Tom Hickey “They understand full well the implications of the financial instability hypothesis and the long financial cycle that ends in Ponzi finance.”- that is just it- I don’t believe they have faced up to the super cycle that starts when a currency starts expanding and doesn’t end until the system is fully rebooted by something like a world war or some other total apocalypse. That is why I think we can’t afford to just let this run its course. Like I said the proposed financial regulations (that we can’t manage to get implemented now) will not be adequate in a decade’s time once the pool of savings has undergone an additional doubling.

163. Tom Hickey, what I do not get is how everyone doesn’t see a glaring disconnect between allowing wealth to grow in a compounding way and our finite world. Just get your calculator out and do 1.2 to the power of 100 then 1.2 to the power of 200 :). Am I missing some crucial bit of understanding?

164. It seems to me that postings in this blog concerning FRB fall into two broad categories:- 1) those which acknowledge that it would be feasible in theory to replace it with 100% reserve banking but which are opposed to that happening, either because the poster sees positive virtue in FRB or questions the necessity for such a fundamental reform; 2) those in which the poster is in denial, in one way or another.

     Clearly there’s no reasoning with someone in the latter group.

     I continue to be puzzled by the first group though. One motive I had in posting here in the first place was to seek to elicit what might be some compelling reason why MMTers (and kindred spirits like Mosler and others) despite very clearly being in what might be called “the radical wing” of economic thought nevertheless usually maintain a deafening silence where FRB is concerned or – when they do refer to it – downplay criticism of it or simply refuse to see anything wrong with it.

     Since I very definitely do see something wrong – indeed, see nothing right – with it, I naturally find this outlook saddening, especially coming from radical critics and debunkers of mainstream orthodoxy. And I have to say that I haven’r so far discerned what I regard as any compelling reason for it. It seems to me to be little more than an attachment to the familiar.

     But anyway the debate has been interesting, and I have learned something. Quite clearly it would be a waste of time for any of the various groups campaigning for complete reform of the banking system to look for any support from MMTers. Opposition rather. Won’t it cause you any twinge of doubt, I wonder, to find yourselves making common cause with some of the most rapacious forces in our society in defence of maintaining their entrenched privileges against encroachment from below?

     Ah well…

165. stone: what I do not get is how everyone doesn’t see a glaring disconnect between allowing wealth to grow in a compounding way and our finite world. Just get your calculator out and do 1.2 to the power of 100 then 1.2 to the power of 200

     You seem to have admitted that wealth acquired through gains accruing from sustainable production is no problem. The problem is other wealth accruing from non-productive sources. That is the economic rent that needs to be taxed away. I am for incentivizing productive investment for the simple reason that I believe that technological innovation is the sine qua non of sustainability. In my view any obstacle to this is dangerous in real terms. I also see demand failure as the basis for global economic underperformance. It seems to me that it is more practical to stimulate demand through the MMT agenda than a rule-based system.

     From what I can tell you would recommend global adoption of a fixed system where governments are monetarily and fiscally constrained operationally, whereas MMT’ers prefer a flexible system where governments are neither monetarily or fiscally constrained operationally, putting more reliance on the political system to make proper decisions regarding economic policy. Basically, one is the decision to make constraints operational, whereas the second removes operational constraints and relies on coordination.

166. Robert,

     2 quick points–

     1. Mosler IS MMT. He’s as MMT as you can be.

     2. MMT’ers have said many, many times that they see little purpose in the FRB whatsoever besides clearing/settling payments, so I’m puzzled why you think MMT’ers “maintain a deafening silence where FRB is concerned or – when they do refer to it – downplay criticism of it or simply refuse to see anything wrong with it.”

167. Neil Wilson:
     Addendum to mine @t 1:56

     ‘”Three lots of margin on the same money.”
     Is there anything wrong with that?’

     Is it the bank’s profit from the spread (0.5% in your example, repeated three times) that you’re choosing to describe as “creating money”, by any chance?

     If so, I would have thought that that was rather a peculiar way of regarding the paying of interest. I thought interest was normally regarded as the price offered to the lender for foregoing the use of his money for the period of the loan. I don’t see how that could be described as “creating money”.

     Furthermore that payment to the lender’s account is matched by an equal debit to the borrower’s (the bank’s) account so no net money is created in any case.

     I’m afraid your assertion that banks create money under my proposal just doesn’t stand up to examination so, rather than keep on repeating it regardless, you might as well concede the point gracefully – as others here have already done.

168. Robert, the MMT’ers I have encountered treat the Fed and Treasury as implicitly a consolidated government agency. Some would like to see that made explicit, ending cb independence from political authority, because it puts monetary policy in the hand of a small group of unelected and unaccountable technocrats allied with the financial sector. MMT’ers have further said that they are agnostic toward 100% reserve banking because banks don’t lend reserves. The real issues lie elsewhere. What is the problem here?

     BTW you might want to look at this from Cullen Roche over at Pragmatic Capitalism.

     THE N.Y. FED EXPLAINS HOW THE GOVERNMENT SPENDS FIRST AND ISSUES BONDS LATER

169. Scott:

     Your points reinforce my view.

     In a brief E-mail exchange with Warren it immediately became apparent that he saw absolutely nothing wrong with banks creating money. I didn’t pursue the matter further because in light of that it seemed pointless to do so, and I’m sure he’s got more important things on his mind at the moment.

     That experience was a large part of my reason for making the statement I did. Another large part was Bill’s blog on 100% reserve banking in which (among other arrogant put-downs) appeared this one:-
     “Anyway, I am happy for these characters to spend their time debating among themselves – sort of running around in circles chasing their tails as they get increasingly agitated about which scheme best promotes freedom. This way they reduce the time they have left to bother the rest of us.”

     Another was the views strongly defending FRB expressed by the great majority of posters on this blog.

     So I have to say I’m puzzled why you’re puzzled. I wouldn’t expect in light of this experience to get any support whatever from any MMTers for the abolition of FRB.

170. Stone,

     Yes you are missing something: financial wealth is not real wealth. Whether there is a lot of money or a little money, the limits on the goods and services available are the same. Making the financial unit of account (dollars) worth more relative to those goods and services by enforcing scarcity is not going to solve the problem you believe it will. A scarcity of money is what causes depressions!

171. Thanks, Robert. Just trying to understand, not criticize, so that’s helpful. Regarding FRB, MMT prefers to just set a rate target (preferably near 0), then keep it there. Other than monitoring the payments system and avoiding liquidity crises, there’s not much else for them to do. We’ve held that position for many, many years.

172. 100% reserve clearly works as a banking system but its a lot of effort for no real gain AFAICT. Properly regulated standard banking gets loans to people who want them, interest on deposits and banks make a reasonable turn on matching the two. So there has to be a good reason to change that.

     MMT shows that the state is not financially constrained and therefore the state guarantee on those deposits is literally as good as money in the bank. You don’t have to go to all the bother of actually doing it – particularly when you only have to call on the guarantee in depth once every 140 years or so. That, to me at least, is the key MMT difference with mainstream economics – the central bank guarantee is not constrained by the foreign borrowing myth and it can return all the deposits even if all the private banks collapsed at once.

     And that fulfils the contract criteria for standard banking that the Austrians put forward, viz: “The implementation of the contract depends on a government mandate (privilege) and the support of a central bank that nationalizes money, imposes legal-tender regulations and creates liquidity.”

     FRB works because banks worked out that the majority of demand deposits are really virtual bonds. Only a small percentage of that is going to be ‘demanded’ and converted into flows in any period. So the rest can be treated as stocks.

     So the fundamental difference between somebody who think FRB is ok and somebody who doesn’t is down to their view of the economic nature of demand deposits (or unmatched maturities to generalise). An FRB person will consider the majority of demand deposits in aggregate is a stock of currency (ie a virtual bond) and not part of money flow. A non-FRB advocate will consider all that demand deposit is part of the money flow of the depositor and therefore it seems that when the bank loans any of the demand deposit that ‘economic money’ is created. The FRB person doesn’t see any money being created – as everything sums nicely to zero.

     And that’s the sticking point. FRB people consider most of a demand deposit is ‘not economic money’ – all of it except for the fractional reserve. As far as they are concerned they have made a loan on the capital of the bank. That creates a new deposit fulfilled by converting some ‘not economic money’ back into ‘economic money’ – for which they charge an interest rate. What’s the problem, we have a state guarantee?

     Whereas non-FRB people think all the original demand deposit is still ‘economic money’ and accuse the bank of creating more ‘economic money’ when they fulfil the loan. That’s simply not cricket!

     It’s a really boils down to a viewpoint thing and apparently the argument has raged since practically Roman times. So I doubt it’ll be resolved here.

173. Robert,

     I’ve read “The Mystery of Banking”. I’ve read “The Creature From Jekyll Island”. It all sounded perfectly reasonable and I jabbered about FRB to my friends for about a year.

     I know exactly what you are talking about.

     I changed my mind when I read Mosler’s not yet completed “7 Deadly Innocent Frauds”. It took about a month or so to sink in, but after it did I realised that FRB wasn’t the crime.

174. Robert,

     Continuing on that theme, my realisation was that the government is the source of all money that is created NOW. You and I can’t create money out of thin air, nor can we start up a business that does so without the permission of the government. If we were granted this permission, it would be under the condition that we follow the government’s rules when we create money. If the government didn’t like how we created money, it could stop us.

     The government could write laws around money creation that were somewhat vague as it does for many other things (think anti-terrorism laws being used against environmental activists for an obvious example), so as to allow courts to punish those seen as deliberately pushing the boundaries.

     The main problem is not the overall system, although I’m sure a better one could be devised. The problem is the government removed or failed to enforce its own rules.

175. Neil Wilson @7:14 :

     Thanks Neil, I found that a very clear exposition indeed and you put your finger on what you correctly call “the sticking point” between our different approaches. You also gave me the succinctest (is there such a word?) definition of MMT’s reasoning for favouring continuation of FRB I’ve so far encountered.

     “Whereas non-FRB people think all the original demand deposit is still ‘economic money’ and accuse the bank of creating more ‘economic money’ when they fulfil the loan. That’s simply not cricket!”

     Exactly. Well put! And cricket, as we all know, epitomises the spirit of “fair play” (or, rather, it used to in “the good old days” – and still does in village cricket).

     Seriously yes, as a simple chap I don’t recognize the distinction which you sophisticated (or should that be sophistical?) types employ between different sorts of money. For me, any medium of exchange which I can buy something with, or pay my taxes with, is money. All the money (in my terms) that appears as a credit in my current account is equally available to me to spend. That part of it which got there by having been loaned to me by the bank was created by the bank by means of keystrokes on a computer keyboard, but that doesn’t make it any less acceptable to a car dealer or to the taxman. It’s all just – money; no portion of it is in any way distinguishable from any other portion by virtue of having originated from my bank.

     “It’s a really boils down to a viewpoint thing and apparently the argument has raged since practically Roman times. So I doubt it’ll be resolved here.”

     I agree that it’s unlikely to be resolved here – or at all so long as, as you say, the disagreement revolves around two opposed definitions of what counts as money. To resolve that dispute one of the parties would have to agree to accept the other’s definition in place of his own. For my part, I continue to believe that any definition of money which excludes 97% of what is actually used by people to buy things with and pay their taxes with can justly be viewed by an ordinary person as, to put it mildly, an eccentric definition – if not actually a perverse one.

     But, as I believe I’ve made clear, it’s not semantics I’m concerned about (although as an aid to clarity it would certainly be helpful to get that out of the way) so much as the malign social and political consequences which FRB has.

176. Jeff65: “I changed my mind when I read Mosler’s not yet completed “7 Deadly Innocent Frauds”. It took about a month or so to sink in, but after it did I realised that FRB wasn’t the crime.”

     “…my realisation was that the government is the source of all money that is created NOW. ”

     OK, but I’m afraid I can’t see how the government can be said to be the source of all the money that’s created. If that’s really so I’m obviously still missing something.

     “The government could write laws around money creation that were somewhat vague as it does for many other things (think anti-terrorism laws being used against environmental activists for an obvious example), so as to allow courts to punish those seen as deliberately pushing the boundaries.”

     Frankly that idea scares me stiff! It sounds like a recipe for bad law.

     “The main problem is not the overall system, although I’m sure a better one could be devised. The problem is the government removed or failed to enforce its own rules.”

     I’d already decided before reading your post that it was time I re-read “7 Deadly Innocent Frauds”, so I’ll see if this time it changes my mind the way it has yours (it didn’t the first time I read it).

177. Guys, I am really amazed that you still keep on 🙂

     With or without 100% reserve banking private sector can and will always create financial assets (e.g. bank deposits, shares or bonds). The only issue here is the acceptability of these private financial assets in the broad economy. A less than 100% reserve banking just makes our life easier. It says that a big chunk of these assets (i.e. all bank deposits) is as good as government money. What a 100% reserve banking wants to achieve is to blow up to heaven the financial system where various bank deposits will get a price in terms of government money and be traded on bank deposit exchange with all accompanying gymnastics and leaks (suckers). Now, Robert, you have to go to your grandma and explain her how she should manage all this stuff and make sure she still has some money to live in the end. No way. So she will stick with the cash (savings) she accumulated over her whole life to live a happy retired time. And she will hide this cash under her mattress. So what FRB does is to help your grandma to get rid of headaches of holding at home zillions of MONEY while at the same time making sure that we (broad economy) do not collapse into a barter economy with zillions of different kind-of private money. I am sure Austrians would die to get such an opportunity.

     We should really understand and measure benefits and costs. Our financial system is already way too complex and I see little reason to make it even more complex with 100% reserve banking.

178. Sergei “With or without 100% reserve banking private sector can and will always create financial assets (e.g. bank deposits, shares or bonds). The only issue here is the acceptability of these private financial assets in the broad economy.”- That is exactly why a key part of the reform is that only payment with cash will be legally enforcible. It all come down to commercial law. I buy everything I use at work using Purchase Order Numbers. I guess they are a type of money created by me. They are accepted because after thirty days our finance department pays the supplier in cash and the PO is then annulled. If our finance department defaulted on the payment, then the supplier would be able to take us to court and force us to pay. Under the proposed reform commercial law would only back up cash payments. Any other type of payment would be worthless.

179. Jeff 65;-“Yes you are missing something: financial wealth is not real wealth. Whether there is a lot of money or a little money, the limits on the goods and services available are the same.”- If there is a situation where the real economy (non FIRE sector) GDP is say $1T and there the elite group of 10000 people with the highest net worth each have $10M, then the economy and politics of that nation will be entirely different from a situation where there is a real economy GDP of $1T and the elite group of 10000 people with the highest net worth each have $1T. What expanding currency systems are all about is the evolution from the first of those to situations to the second.

180. Sergei, to clarify my @21:29 comment, you could buy a bond for cash, then sell it cash and use the cash to buy a share and the whole process would have the backing of commercial law. In the reformed system if you bought a bond for cash and then tried to swap the bond for a share you would not have obtained legal ownership of the share and the other party would not have obtained legal ownership of the bond. In the eyes of the law you would still be the bondholder and the other party would still be the share holder.

181. Tom Hickey, I’ve pondered what you have been saying about equilibrium. To me economics could do well to look to biology for inspiration. Life has been around for 4B years with no regulatory legislation. Just like an investment, living things will increase in an exponential way if given a chance. It would only take a couple of days for a bacterium to grow to a colony the size of the earth if it were provided with enough air and nutrients. The key point is that they do not get the chance to do that. They are in a deadlocked struggle with each other and need to run to stay still. In so doing they create an increasingly rich biosphere that can support more and more life. It is that process of things trying to grow exponentially but being continuously constrained that I think we need to mirror with economics.

182. Jeff65 @ 8:32:

     More on this:- “my realisation was that the government is the source of all money that is created NOW.”

     What does the word “money” mean in that sentence?

     If (as I suspect) it means what Neal Wilson is referring to in his phrase “The FRB person doesn’t see any money being created – as everything sums nicely to zero” – ie as excluding what he refers to in his post @ 7.14 as “not economic money”, then you and I are on a collision course from square one.

     If that is your meaning then Mosler has converted you from an ordinary user of the English language into a user of a special language spoken only by initiates, in which although I can buy something with it and it’s completely indistinguishable from any other money in my possession, “non-economic money” isn’t money but something else (what else exactly I’m not sure).

     I hope I’m wrong and there’s another explanation for your (to me) extraordinary assertion. But, if not, I can tell you now that no amount of reading of Mosler is going to cause me to stop using common English words to mean what they’ve always meant, and what they mean in ordinary speech.

183. Robert (et al, if interested),

     As I understand it, your proposal would effectively split the banking world into two sub-systems. The first is a 100 per cent reservable deposit system that is “ring fenced” and segregated away from other banking assets and liabilities. The remaining part is the lending bank system. I referred to these two types of sub systems generically (in the comments earlier linked by Tom Hickey and quoted by Scott Fullwiler) as the deposit bank system and the credit bank system. I’ll use those terms here in application to your designated arrangement. I believe you’ve also allowed for the possibility/preference that the deposit bank system can be embedded institutionally within the credit bank system while being functionally segregated. For simplicity, I’m going to assume away the issue of institutional configuration, since functionality is the critical factor. I’ll describe it in terms of “the deposit bank system” or “deposit banks” and “the credit bank system” or “credit banks”, so that functionality is clear and institutional configuration is optional. (It may read like institutional separation.)

     A critical aspect you’ve specified is that the credit banks are funded only by capital. I see there was some discussion between Scott Fullwiler and yourself about the operational feasibility of that. I’ll assume that the credit bank funding structure contains no deposit liabilities or debt liabilities. The funding is taken to be common equity capital in its entirety. Assume it’s a competitive lending system as we have now. As per your specifications, the credit banks are just not allowed to create money the way they do now.

     The deposit bank system is designated as 100 per cent deposits and 100 per cent reserves. The deposits correspond to the money the credit banks are prohibited from creating. Assume these deposits are basically in the form of checking accounts. The assumed nature of the reserves hasn’t been talked about in the comments as far as I can tell. Assume fiat government debt, and leave things like gold for another time. In summary, the deposit banking system is 100 per cent reserved on a risk free basis, and the credit banking system is 100 per cent equity capitalized.

     Now, consider a new loan issued by a/the credit bank.

     Suppose the credit bank has a starting balance sheet of 1000 in loans and 1000 in equity capital. It wants to make a new loan of 100.

     Suppose the deposit bank holds 1000 in reserves and 1000 in deposits.

     The key point of your proposal I think is that the credit bank is prohibited from creating new money with the loan. Given the starting balance sheet, this constraint manifests itself in two ways.

     First, the credit bank can’t just credit the customer with a 100 deposit merely as a result of having granted the loan (which is how it is done now, and recognized correctly as such by MMT). The first reason it can’t do so is that this would increase the amount of deposits in the system, with an additional 100 deposit having been created by the credit bank, which is prohibited. The second reason it can’t do so is that neither the credit bank nor the system as a whole has the reserves to match up against that new deposit. Thus, the money creation process is constrained by the specified restriction on deposit creation and the requirement for 100 per cent reserves against any deposit. Neither of those conditions is met if, in this example, the credit bank simply credits the borrower with funds in his deposit account. I believe that constitutes an air tight prohibition on the creation of money by the private banking system, which is what you are seeking.

     So how does the credit bank to proceed to lend, given these binding constraints?

     By trial and error, it can be found that the only way in which this can be done is for the credit bank to attract reserves from the deposit bank. This is because reserves are required not only to match deposits, but to make payments in this system, just as in the existing system. Note the fact that the credit bank is prohibited from directly crediting a borrower deposit account also translates to a constraint for the customer. It means that the customer can’t get value directly from the credit bank, and instead must go to a deposit bank in order to negotiate the value of the funds it has received from the credit bank. This means that the credit bank must pay the borrower with funds that the deposit bank will accept as negotiable in reserves payable by the credit bank. This means that the credit bank must attract reserves in order to make the loan. And under the assumptions of our example, the only place to get those reserves is the deposit bank.

     Thus, the credit bank requires reserves in order to make payment to the borrower.

     How exactly does the credit bank attract reserves from the deposit bank?

     There are two dimensions to the answer.

     The first is timing. The second is the balance sheet channel.

     In terms of timing, it is clear now that the credit bank requires reserves on hand or immediately accessible in order to make payment for the loan. So it can either attract reserves before lending, or attract them coincident with lending. Coincident here means coincident timing in the sense that the payment of reserves flowing out is no later than the receipt of reserves flowing in, according to the clearing system frequency. This timing constraint is actually no different than the system actually in place today. Therefore, the MMT view of reserve timing applies to this proposed system as well. Credit banks can attract the reserves they need to make payment on loans as they make the loans. There is no necessary requirement for pre-stocking of reserve funds. That’s the same as now, as is regularly observed by MMT’s normal course and correct debunking of the textbook money multiplier timing and causality myth. So the important point here is that the MMT view of reserves actually still applies here.

     The balance sheet channel for attracting reserves is either asset based or funding based. If the credit bank has a maturing loan, it can attract reserves from repayment of that loan. Otherwise, reserves must be sourced from the equity funding side. That can occur either by issuing new equity externally, or by having accumulated equity through retained earnings. Either way, the restriction of funding sources exclusively to the equity channel would seem to impose some constraints on flexibility compared to the existing banking system with its variety of deposit, debt and equity channels.

     It is necessary that the credit bank be able to make payment to the borrowing customer in some form that is generally acceptable as a medium of exchange. It can do that it the same way it does now in many cases when it doesn’t credit a customer deposit account – cut a check. That check needs to be negotiable. Specifically, it needs to be accepted by payees that the borrowing customer may deal with further on in the transaction channel, including other banks. That automatically requires that the credit bank must have a reserve account, so that it can clear funds to some payee bank at which the check ends up being negotiated. That will inevitably be a deposit bank in this simple bifurcated banking system, because the deposit banks have all the deposits. And because it must clear reserve funds out, the credit bank obviously needs a reserve account to hold the reserves. In summary, it needs reserves because it needs the means to make payment in advancing the loan to the customer. And it needs a reserve account in which to hold reserves and from which to make payments. Finally, assume as always that the central bank is the issuer of reserves – for both the ongoing requirements of the deposit banks and the transaction requirements of the credit banks.

     Now, here is an example of the credit bank using the equity channel to attract reserves:

     Assume the credit bank issues new equity of 100.

     Assume it sells the equity to somebody holding a bank deposit of 100.

     The credit bank issues equity of 100 and gets credited with 100 in reserves.

     The credit bank now has 1000 in loans, 100 in reserves, and 1100 in equity.

     The deposit bank now has 900 in reserves and 900 in deposits.

     Assume the credit bank now makes the loan of 100.

     The credit bank now has 1100 in loans, 100 in reserves, 1100 in equity and 100 in reserves due.*

     * Reserves due is a temporary item, pending clearing of reserves to the payee bank.

     (This type of item used to be referred to as “credit float”. It’s useful here to show how balance sheets have to balance.)

     The borrower deposits the proceeds of the loan with the deposit Bank.

     After reserve clearing, the credit bank has 1100 in loans and 1100 in equity.

     The deposit Bank now has 1000 in reserves and 1000 in deposits.

     There has been no private money creation.

     That’s the basic accounting for a transaction example for a 100 loan.

     Some others commenters have presented their versions of the accounting, which I haven’t focused too closely on for comparison. I don’t know if they are similar to this or not.

     ———————————

     I believe your objective was to have no private money creation, which means by default that the government must have complete control over money creation. Such control can actually be achieved in your model via a process that is MMT friendly, at least in an operational sense – which is that the government deficit spends money into creation. Deficit spending recipients deposit their money in the deposit bank. The government channels some deficit spending into a desired quantity of money creation, and drains away the rest away with bond issuance. Control over the quantity is absolute. MMT’ers may think of this control procedure as a tightly calibrated variation of “no bonds”. It lies somewhere between the current system and the pure “no bonds” proposal. (“No bond” leaves all deficit spending as reserves and matching bank deposit liabilities.) Note that “control” over money creation refers to both the origination of money and the supply of money.

     I suspect your purpose may include the aspect of tight control over the quantity of money created by such a process. That particular control setting may well not be MMT friendly, even though the operational mechanism is – more on that later.

     Since the reserves backing money are fiat in nature (government bond holdings of the deposit banks), there is no credit or liquidity risk associated with money per se in this proposal.

     There was some discussion in the comments about a 100 per cent reserve system being an underlying cash equivalent for what is currently in effect a derivative market (i.e. FDIC insurance) for the protection of depositors. The 100 per cent system in that sense is a pure cash market version of FDIC insurance – fully collateralized insurance protection for deposits, so to speak.

     At one point you opined that 100 per cent reserves as an idea was a bit more than an FDIC or derivative equivalent, and in a sense I would agree. The difference is that the taxpayer can be subject to losses in the FDIC system. In this proposed system, the taxpayer incurs no contingent cost in respect of bank deposit risk per se. The deposits have been extracted from the funding structure of the credit banking system, whereas the FDIC in the existing system remains exposed to the “tail risk” of commercial banking credit exposure. FDIC insurance exposes the taxpayer to losses on wound up banks. That tail risk no longer exists in the proposed 100 per cent deposit bank – at least in respect of deposits per se.

     However, this does not necessarily mean that the taxpayer doesn’t face certain kinds of contingent risks back in the credit bank. It depends on funding structure there.

     So the question remains about risk in the proposed credit bank system and whether the taxpayer is exposed there. This is the point at which the funding structure of the credit bank becomes critical. You have proposed a particular funding structure that I have translated as equity capital funding exclusively. This assumption turns out to be very important.

     If you refer back to your discussion with Scott Fullwiler, and his references to my linked comments including the quotation he provided, my interpretation there of risk in a 100 per cent reserve system also assumed “matched funding” in the credit bank. So this assumed the existence of non-equity liabilities in the credit bank. This is a huge difference in terms of implications for risks of various types, and this is largely why I was interested in developing the analysis here – to compare that with your pure equity funding case.

     For reference purposes again, here is Scott from the earlier comments, with the embedded quote from myself:

     ……….”The core point in JKH’s argument is the following: ………

     (JKH) “In summary, the intention of 100 per cent reserve requirements is to ensure credit and liquidity protection for bank deposits and government liabilities. The maturity matching motivation is a discipline imposed on the credit banking side of the framework. Banks are not permitted to create money from credit. They must have money before they lend it, and they do this by issuing liabilities prior to lending. This requirement combined with maturity matching and capital discipline should make liquidity risk a non-issue. But a fundamental problem gets in the way of this objective. Credit banks in a bifurcated framework cannot avoid liquidity risk. Credit banks require accounts with the depository institutional framework in order to make and receive payments. In particular, they require such an account to make payment to holders of maturing liabilities. If a maturity matched liability coincides with a bad loan maturity, there will be no matching funds to make payment. The fact that capital is available to absorb the loan loss has no effect on operational liquidity. Liquidity and capital are distinct. The bank in that situation has two choices. It can fail on the payment and go bankrupt (or some other form of wind-up). Or it can go overdraft on its deposit account at the Fed. In order to make the second choice, it must have a pre-existing privilege to do so. If such a credit facility is in place, it means that the principle of pre-existing funding has been broken. In either case, the bank has definitely experienced liquidity risk, notwithstanding matched funding. The bottom line is that the combination of 100 per cent reserves and maturity matching provides no ultimate protection against liquidity risk. Liquidity risk is a function of perceived solvency risk. At the same time, the ex post balance sheet impacts of liquidity risk and solvency risk are operationally separate – because those impacts are recorded through entirely different accounts. It is that account separation that precludes capital from protecting realized liquidity exposure at the operational level. Finally, real world extrapolations of the “pristine” Austrian type model may add an element of buffer protection afforded by a self-imposed reserve of excess liabilities and corresponding deposits at the Fed. But the solvency/liquidity dynamic still operates, and will prevail according to the duration of the liquidity crisis and the time protection offered by such a liquidity buffer”

     ………. I have not yet seen anyone in favour of 100% reserves counter this in a way consistent with how accounting really works and an understanding of how the payments system actually works. If you can do this, then more power to you and I would change my view”……… (Scott)

     It’s important to compare the analysis in that paragraph with what is being discussed in your type of proposal here, because the difference explains why I referred earlier to your proposal as “feasible”. To explain, we need to look closely at the risks in the proposed credit bank system.

     In the most general terms, the most important risks in banking are credit and liquidity risk. Market risks such as interest rate risk and foreign exchange risk are present in both the structural and trading books of commercial banks, and they are also important, but I’ll leave those aside for now. Credit and liquidity exposure are at the core of banking risk.

     Those risks are supported operationally by the bank’s funding structure, including capital. We usually interpret bank capital in the sense of Basel type capital – i.e. predominantly equity capital that is designed to absorb first losses. We can also consider capital more broadly as encompassing the entire right hand side of the balance sheet – including equity, debt, and deposits. This broad version of capital is the one that Miller-Modigliani theory would use to calculate WACC – the weighted average cost of capital – in the case of banks. The point of this broader view is to acknowledge that severe bank losses can potentially spread beyond the Basel capital position to the non-equity liability structure of the balance sheet. The Basel type capital position is designed to capture most if not all of the risk, and the non-equity liability piece is theoretically available to absorb “tail risk” in the event of severe bank losses. Part of that tail risk – deposits – in the modern system is covered by FDIC insurance. The mid section of non-deposit liabilities has become very controversial in the context of the “moral hazard” it presents and how that risk piece has been handled by the government over the course of the credit crisis.

     I would describe your idea for capital funded credit banks (at least the way I’ve translated it) as the “extreme” case in this broader conception of capital, in that credit bank funding is exclusively equity capital. There are no liabilities. This pure equity funding case is the strongest possible structure in terms of supporting credit risk. It also has an important bearing on bank liquidity risk.

     My comment as quoted by Scott suggested that a 100 per cent reserve system doesn’t provide full protection against liquidity risk and the potential for required support from the central bank. The reasoning was that in the case of “matched funding”, where say a 1 year loan is matched to a 1 year liability in the credit bank, the credit risk on the loan means that the liability can’t be repaid if losses actually occur. And in the face of such joint credit and liquidity risk, the central bank must make a choice about whether to let the institution go down, or provide what amounts to overdraft funding. And so 100 per cent reserves does not prevent the type of “moral hazard” risk that might still be present with a matched maturity funding regime, as I believe tends to be promoted by those of the Austrian school persuasion.

     Your proposal, at least in the way I have translated it to pure equity funding, is dramatically different from the typical Austrian “matched maturity” proposal. That’s because the extreme case of pure equity capitalization changes everything in the relationship between credit risk and liquidity risk. The liquidity risk of a financial institution balance sheet depends in part on its funding structure – specifically on its maturity structure. As noted above, even matched maturity funding can’t rid the balance sheet of liquidity risk, because matched funding on an asset with credit losses can’t be paid off fully by that asset. However, it is still the case in a relative sense that the term structure of liabilities is important for liquidity risk protection. The longer the term of liabilities, the more liquidity risk protection there is.

     An entirely equity funded balance sheet provides the greatest possible liquidity risk protection of any funding structure. In fact, there is no liquidity risk per se directly in respect of a funding structure that consists exclusively of permanent equity – because there is no obligatory maturity to redeem. Hence, equity is the strongest form of funding liquidity. Moreover, the type of funding liquidity risk that is contingent on credit risk doesn’t exist. There is no requirement to pay off liabilities because there are no liabilities. Credit risk is fully absorbed by the equity capital structure, without liquidity risk to the funding provided by the capital structure.

     Therefore, the credit bank as described has no need of reserve back up or overdraft protection from the central bank – at least in relation to its funding exposure. Credit risk and credit losses are absorbed by equity as they occur, without any risk to the sustainability of a liability funding structure. It is in this sense that I said earlier that I thought your proposal was operationally “feasible”, without contradicting anything I’d said in my earlier linked comments.

     However, that’s not to say there is no liquidity risk at all with a 100 per cent equity funded credit bank. Liquidity risk in that case transmits through the asset structure rather than the funding structure. The risk in question however is effectively put from the bank to potential borrowers. This is because a credit bank that conforms to “no money creation” as well as being funded with pure equity capital must source reserves either from maturing assets (or assets sold) or attract new equity funding. That equity funding might come from either the retention of earnings over time, or from a new external equity issue. In any of these cases, the concentrated equity funding structure becomes a somewhat awkward impediment to the operational liquidity that can easily be made available to potential borrowers. E.g. such a bank by definition doesn’t issue short debt to tide over interruptions to the continuity of equity funding. There is a trade-off between the rigidity of the capital protection and the ease of liquidity provision to customers. It is evident then that liquidity pressures on the bank’s asset operations have the potential to create liquidity risk for borrowing customers in the sense that the bank may not always be able to produce the reserves it requires to make the loan at the desired time.

     So although I suggested the proposal examined here was feasible, the extreme nature of its operational rigidity raises a material concern about practicability. It also points to the larger issue of striking a balance between the benefits of banking functionality and the tendency to cast a wide net on the identification of banking abuse in the form of “rentier income” or “financial capitalism”. The general point I would make here is that there are important concerns about banking functionality that should be considered carefully before stripping credit banking down to the bare bones case such as equity funded banks – because the restriction of the funding structure, while providing maximum liquidity protection to the credit bank, greatly restricts its flexibility in responding to the liquidity needs of the real economy.

     Fractional reserve banking or FRB is a term with frequent pejorative context. I think the primary issue driving this attitude is the perception of deposit risk associated with FRB, although potential runaway money creation is a correlated concern. Conversely, the notion that deposits should be fully backed by reserves is associated with safety and quantity control – safety that might be at risk if deposits are the result of money created by credit banks.

     MMT has a very specific view on the process by which money is created from credit and it is anathema to the textbook description of the money multiplier. The multiplier debate is relevant to those who want to understand the existing system, including the correct interpretation of FRB in that context. However, the mechanism of the money multiplier is not that relevant to the debate that contrasts FRB with fully reserved banking, something I believe you pointed out in the comments. The issue between FRB and fully reserved banking is that of safety and quantity. Fully reserved banking achieves a primary safety objective while offering a powerful lever for quantity control in the same mechanism.

     Your proposal includes the requirement that private banks should not be able to create money. It is interesting to see how this restriction intersects with the requirement of 100 per cent reserves. In fact, the notion that deposits should be backed with 100 per cent reserves pretty well rules out the possibility that they can even be created by private banks operating in a functionally sustainable reserve system. Just consider the possible effect of attempting to institute a 100 per cent reserve feature in today’s monetary system, where banks are allowed to create deposits from loans. A moment’s thought will convince you that the result could be a potentially infinite series of reserve injections by the central bank, as each injection of reserves designed to provide the system requirement for the most recent deposits created would simultaneously result in the creation of further deposits due to the new money required to create those reserves. Such a process would seem to be inherently unstable and self-destructive. Moreover, it would seem therefore that the stability of money in any FRB system for privately created money depends on a sufficiently low overall reserve ratio – in order to stabilize the system propagation of money creation merely due to required reserve injections.

     The upshot of that is that your proposal for 100 per cent reserves pretty much forces the elimination of private money creation as a structural feature, which suits your purpose entirely I would think. I have no idea how that stacks up against boiler plate 100 per cent reserve architecture, if such a thing exists. I noticed somebody in the comments alluded to the existence of such a standard.

     Consider the existing system. Private or commercial banks clearly have the power to create money. MMT interprets FRB in that context. The quantitative setting of the specific FRB fraction at play is one issue. Canada has a zero reserve requirement. The US has a different fractional requirements depend on deposit category (zero or ten), such that the effective requirement as a fraction of total bank checking and time deposits is around one per cent. Whatever the fraction, the MMT interpretation of FRB recognizes that the central bank always supplies required reserves after the fact – after the deposits are created that give rise to the reserve requirement. Accordingly, the requirement itself is not a constraint on the capacity of the banking system to expand its deposit base. Deposit expansion is determined instead by customer demand for the loans that create deposits, self-initiated asset acquisition by banks, and bank management strategy for allocating bank capital to different risk areas. Reserve requirements generated by deposit expansion are supplied as a matter of course, and excess reserves are supplied in quantities at least sufficient to stabilize the trading range for the central bank’s policy target interest rate. As a corollary to this view of bank reserves, MMT views the textbook money multiplier theory as an entirely incorrect view of actual banking operations in the modern monetary system, in that the textbook description of reserve and deposit causality is essentially and literally backwards. Moreover, it is an operational fact that banks do not lend reserves to non-banks, meaning to almost all of their customers. Furthermore, the real purpose of reserves in today’s monetary system is to enable banks to make payments to each other in settling net funds owed to each other in respect of net positions exchanged as a result of non-reserve asset and liability transactions. Changes in bank reserve levels are a shadow of all other activity – a net accounting for the actual paper stuff of transactions. They are not the paper stuff that is loaned to or deposited by customers of banks. In short, the purpose of reserves is to effect settlement for interbank payments – not to sit as a stock of inventory to be “loaned out” to new customers.

     The fact that mainstream economics does not understand this correct interpretation of reserves in the modern banking system has led to great confusion in the case of the excess reserves now sitting at the Federal Reserve, as a result of the banking crisis. Those reserves will never be “loaned out”, as so many commentators like to fret over, including apparently most of the universe of monetarist economists. Those reserves are the result of the central bank having swapped money it creates in exchange for longer duration and in some cases higher risk financial assets. The excess reserves created merely shadow the corresponding deposit liabilities that have been put to the commercial banks as a result of the central bank’s acquisition of financial assets. From the commercial bank perspective, this bloated reserve position is redundant and mostly useless for purposes of the normal transaction and settlement function of reserves. One way to think about these reserves is as special version treasury bills that can only be held by banks and that the banks as a whole are forced to hold – until the central bank decides to withdraw them. The non-bank public can’t acquire these special version bills and the banks can’t sell them to the non-bank public, because they are trapped in the interface between central bank and commercial bank balance sheets.

     I mention the case of extraordinary excess reserves in today’s system because the 100 per cent reserve system described here bears some loose functional similarity to the risk transformation function that these excess reserves are providing to the banking system now. At the margin of these excess reserves, bank balance sheets have become less risky, and the deposits created along with them more protected from the “tail risk” I spoke of earlier. Mainstream economics could do worse in trying to comprehend today’s excess reserve phenomenon than thinking about this sort of risk comparison (and it has done worse). It’s by no means a perfect comparison, but I think it’s superior to the desperate interpretations of “the multiplier” that the mainstream still clings to.

     The point of the comparison is that these excess reserves today are not there to provide the transaction capability and settlement functionality for banks that is normally the actual reason for reserves, as explained by MMT. Instead, they are providing a massive risk transformation function that is vaguely similar at the margin to the protection offered by 100 per cent reserves against deposits in your proposed system. The difference of course is that the Fed fully intends to withdraw these reserves when the economy and the banking system return to more regular functioning (a long way away). Your 100 per cent reserve idea has some similar characteristics to these excess reserves that are currently trapped in the banking system, although the comparison again is very loose and I don’t intend it to be exact. But both of these reserve forms serve to reduce asset risk on the balance sheets of the banks. Your system is a deliberate permanent structured approach. The current system is a crisis response. Of course, the existing system continues along with the power of private banks to create money, which is not what you want in the proposed system at all. Your system is essentially a 100 per cent allocation of bank deposits to zero risk assets, combined with a outright prohibition on the private creation of money.

     As noted, a 100 per cent reserve system effectively forces the condition that private banks are prohibited from creating deposits. In examining your system, we can ask the question more directly: to what extent are the characteristics of 100 per cent reserves and the power of money creation separable? Can private banks even create money in a 100 per cent reserve system? Could that loan for 100 have been made, a new money deposit created as is currently done, and then been reserved 100 per cent? On the surface, it appears plausible. But for that to happen, the credit bank would have to be able to create money by making a loan and thereby provoke the central bank’s creation of matching reserves. That could be done as easily as it is today at the operational level. The central bank simply injects the required reserves by purchasing assets. But in doing so, it increases deposits further. So the private creation of deposits in a 100 per cent reserve system would force an additional matching injection of liquidity in the form of reserves. Due to the extreme nature of the 100 per cent requirement, it would appear that successive reserve injections would take on a life of their own, becoming an explosive series of spiralling deposit and reserve creation. It becomes an infinite deposit multiplier, not according to the erroneous causality of textbook theory, but according to the MTM recognized causality of loans creating deposits and central banks supplying reserves as required after the fact of the deposit creation that generates the requirement.

     Thus, MMT faces conceptual challenges on two fronts – the misinterpretation of FRB in the context of the existing monetary system, and the positioning of FRB as correctly understood compared for example to the alternative of 100 per cent reserve requirements. I think the latter comparison is your major focus here, but you should at least be aware that MMT has the other one to deal with as well.

     It seems to me that the primary concerns driving the argument for full reserves are the issues of risk and quantity. These two aspects should be considered also in light of your question as to why MMT continues to sponsor private bank money creation.

     First, with regard to risk, Warren Mosler has documented a number of proposals that amount to a massive transformation of the banking system risk profile. You are free to explore those. Bill Mitchell’s views as I understand them are similar in a number of instances. My instinct is that the net risk effect of your 100 per cent reserve proposal would probably be overtaken in the totality of the risk effect by the scope of the kinds of changes that Mosler and Mitchell propose for the banking system. The segregation of deposits with full reserves is interesting from a risk perspective, but other changes are as well. As one example, the proposal favoured by both Mosler and Mitchell for bondless deficit financing would have the effect of embedding $ trillions in risk free reserves in the US banking system, corresponding to bank deposits originally created by the government. The banking system as a result of this proposal would become less risky and the average nominal asset lower risk weighted as a result of the large quantity of reserves that would be held permanently as a result of bondless deficit financing.

     Second, with regard to the issue of the control over the origination and quantity of money, my impression is that full reserve banking fully embraces the option for strict quantity control. In this sense, I think full reserve banking has a robust connection with the quantity theory of money. At the same time, my strong impression also is that MMT is generally dismissive of the quantity theory of money. This fault line may be a significant factor explaining why MMT does not necessarily reject the private creation of money per se. Again, the bank de-risking proposals favoured by MMT are what it supports instead. As to the rationale for rejecting the quantity theory, that is evident throughout numerous posts from Bill Mitchell and I leave it to you to research that if you desire to do so. But it should be noted that bondless money creation is an MMT policy option that is consistent with manifest rejection of the quantity theory of money – or at least its usefulness.

     P.S.

     Hope some of this was of interest to you. In the event you did attempt to wade through it, you may have noticed that Scott’s “very clear paraphrase” of my earlier “impenetrable” argument was in fact a direct quote from my earlier impenetrable argument.

     🙂

184. Jeff65: Continuing from that:-

     I suspect you’re echoing Mosler, p.20:-
     “Yes, that means that the government has to spend first, to ultimately provide us with the funds we need to pay our taxes. The government, in this case, is just like the parents who have to spend their coupons frst, before they can start actually collecting them from their children. And, neither the government, nor the parents, from inception, can collect more of their own currency than they spend. Where else could it possibly come from?³”
     “³…So in any case, the funds to make payments to the federal government can only come from the federal government.”

     Am I right?

     But, if so, I presume you’re fully aware that what’s being referred to in this passage is HPM? It has no applicability to loans made by banks creating deposits, all of which “non-economic money” is additional to the money Mosler is dealing with here and about which he asks the rhetorical question “where else could it come from (than government)”? Obviously, it cannot by definition come from anywhere else. But the argument is circular.

185. Robert: Seriously yes, as a simple chap I don’t recognize the distinction which you sophisticated (or should that be sophistical?) types employ between different sorts of money. For me, any medium of exchange which I can buy something with, or pay my taxes with, is money.

     Robert, I was confused about this when I first encountered this terminology, also. I soon learned that MMT economists generally do not use the term “money” because it is ambiguous, hence confusing. They use the proper technical terms to obviate conflation of distinct meanings that are important to keep straight. Without learning the operational definitions, it is not possible to understand clearly how the system works. It really isn’t a proper criticism to say to experts that you don’t get what they are saying and it’s all their fault, when you insist on imposing your own loose definitions on a field of study that is highly nuanced.

186. stone: If there is a situation where the real economy (non FIRE sector) GDP is say $1T and there the elite group of 10000 people with the highest net worth each have $10M, then the economy and politics of that nation will be entirely different from a situation where there is a real economy GDP of $1T and the elite group of 10000 people with the highest net worth each have $1T. What expanding currency systems are all about is the evolution from the first of those to situations to the second.

     I doubt that you have the causality correct here. It is more likely that the cause of the increase in wealth at the top is due to economic rent rather than simply the increase in quantity. In every system historically, the wealthy have garnered the major portion of wealth unless it is taxed away. You want to tax wealth as whole, I want to tax just economic rent. You want a fixed quantity, I want the quantity to vary based on optimal capacity, full employment, and price stability.

     BTW, by excluding FIRE, you are not covering all sources of economic rent. A lot of gains from so-called productive investment are owing to monopoly rent, as well as cheating of one form or another. Monopoly rent needs to be taxed away, and cheating needs to be eliminated through enforcement.

187. Tom Hickey “You want a fixed quantity, I want the quantity to vary based on optimal capacity, full employment, and price stability.”-
     -Are you saying that you do not consider the MMT position to advocate vastly more deficits than surpluses over the next 50 years? If you are saying that there should be vastly more deficit (as Bill always argues for except in the case of Norway or Norway like oil states) then you are saying that the purchasing power of the total savings pool should inexorably increase. That is what accommodating “leakage to savings” is all about. If you are proposing to stop that by your targeted confiscations from those you deem rentiers (in contrast to the flat wealth tax) then you will no longer be running deficits and so deviating greatly from what Bill advocates.

188. JKH – “As to the rationale for rejecting the quantity theory, that is evident throughout numerous posts from Bill Mitchell and I leave it to you to research that if you desire to do so. But it should be noted that bondless money creation is an MMT policy option that is consistent with manifest rejection of the quantity theory of money – or at least its usefulness.”-
     -I came to this site as MMT seemed to make sense about how money is created etc but I’ve always found Bill’s rejection of the quantity theory of money with regard to asset prices or the size of the financial sector required to manage it- seemingly plain stupid. From what I can work out, many of the MMters who comment on here seem to largely accept that the quantity theory of money does apply on a global basis to long term asset price inflation. Bill always just provides a link to a post of his saying that the massive creation of zero rate money in Japan had no effect on asset prices (he conveniently draws a veil over the effect on global asset prices). That has always seemed to me to be down right negligence on his part (sorry but that is my feeling) in failing to face up to the Yen carry trade phenomenon and its consequencies in the lead up to the 2008 crisis.

189. JKH:

     I’m frankly overawed by the intellectuaI power you bring to bear. a scholarly performance which I can’t hope to approach.

     I have to say that I’m all too conscious that I’m hardly the best-qualified person to act as advocate for 100% reserve banking but, having been so brash as to kick this off, I’m honour-bound to rise to the challenge to the best of my ability, and I will. But I hope that my efforts won’t be taken as typifying the level of scolarship at the command of the opponents of FRB as a whole; there are others far better-qualified than me to debate this in depth, as I’ve no doubt people here will be aware.

     First a few general descriptive remarks, the relevance of which I leave to you to judge.

     1. The thinking I’m most familiar with proposes that the deposit bank is provided with an account at the CB to hold (solely) its consolidated deposits. It needs no reserves: the deposits and the reserves are one and the same. It is entitled to charge its deposit-holders for the Giro-type services it provides. Should the bank wind up its business for any reason the CB continues to hold the money on deposit, and back-up arrangements would seamlessly come into operation to continue to disburse deposits on demand by some suitable alternative means.
     2. If the bank is also a credit bank, in addition to its consolidated depositors’ account the bank has two further accounts at the CB: its operational account containing its financial assets, and its investment pool account into which and out of which investors’ funds, loan repayments, payments to investors and loans to borrowers flow.
     3. A loan made results in the sum loaned being added to the borrower’s deposit account. This just means that the bank’s investment pool account at the CB is debited by that sum and the borrower’s bank’s consolidated depositors’ account at the CB is credited by the same sum.
     4. When the borrower spends the loan the result will be that the payee’s deposit bank’s consolidated depositors’ account at the CB is credited, and the borrower’s deposit bank’s debited, by the amount spent.
     5. It will be evident that money loaned derives from investment funds attracted, plus any funds borrowed (by selling bonds for instance) for the purpose of loaning out and earning a profit on the spread. There is no obstacle, in principle, to a bank adding partners’/shareholders’ equity from its operational account to its investment pool account, in which case the two accounts at the CB will be reciprocally adjusted and the amount available to be loaned will be increased commensurately.

     From this:-
     “It is necessary that the credit bank be able to make payment to the borrowing customer in some form that is generally acceptable as a medium of exchange. It can do that it the same way it does now in many cases when it doesn’t credit a customer deposit account – cut a check.”
     I infer that there’s a mismatch between what I’ve described above and the process you describe. If I have understood correctly, you perceive (or have inferred from my earlier postings) there to be a requirement that no loan be added to a depositor’s account with a deposit bank. This is not so: the essential requirement is that no new money be created by the making of a loan and all that’s needed to satisfy this is that nothing is added to one account which is not subtracted from another. If what I’ve previously written has not been clear, I apologise.

     “Finally, assume as always that the central bank is the issuer of reserves – for both the ongoing requirements of the deposit banks and the transaction requirements of the credit banks.”

     The deposit banks I’ve covered above: deposits and reserves are one and the same. Concerning “the ongoing requirements of the credit banks”:- It is assumed that the CB absorbs into its own machinery the existing interbank “clearing-house’s” functionality, dealing only in aggregated and netted-out quantities. If on any given day a given bank runs out of enough liquidity to meet the net demands on it then, strictly, it’s bankrupt. However, as previously commented, there’s no necessity to take a sledgehammer to crack a walnut and – provided that the bank is balance-sheet solvent – the CB would supply it with the necessary liquidity (at interest) to tide it over its cashflow insolvency. Is that the same thing as you had in mind by “the CB being the issuer of reserves”? If so, we are in full agreement in regard to that meaning of “reserves”.

     “I suspect your purpose may include the aspect of tight control over the quantity of money created by such a process. That particular control setting may well not be MMT friendly, even though the operational mechanism is – more on that later.”

     Having read to the end I now understand this as a reference to the quantity theory of money, and that this is an MMT bugbear. I must be up-front and say that I haven’t yet managed to understand that theory 🙂 which makes it a little hard for me to make any intelligent response. The principal architects of the particular form of banking reform I’m attracted to (there are quite a few different proposals around) seem to my simple mind to have adopted a somewhat facile approach to this question of control over the quantity of money. I suspect there’s a lot more thinking needing to be done.

     “I would describe your idea for capital funded credit banks (at least the way I’ve translated it) as the “extreme” case in this broader conception of capital, in that credit bank funding is exclusively equity capital. There are no liabilities. This pure equity funding case is the strongest possible structure in terms of supporting credit risk. It also has an important bearing on bank liquidity risk.”

     Yes, I think I follow your reasoning but I’m not comfortable with confining bank funding exclusively to capital. If you ask me why it’s because intuitively I judge it to be unnecessarily restrictive but (since I’m the opposite of an expert) I can’t really elaborate on that. Just “gut feeling” I’m afraid.

     “And so 100 per cent reserves does not prevent the type of “moral hazard” risk that might still be present with a matched maturity funding regime…”

     I can’t but agree. There needs to be some “give” in the system (but the use to which it’s actually put needs to be kept under constant scrutiny, to prevent “creep”).

     “In any of these cases, the concentrated equity funding structure becomes a somewhat awkward impediment to the operational liquidity that can easily be made available to potential borrowers. E.g. such a bank by definition doesn’t issue short debt to tide over interruptions to the continuity of equity funding. There is a trade-off between the rigidity of the capital protection and the ease of liquidity provision to customers. It is evident then that liquidity pressures on the bank’s asset operations have the potential to create liquidity risk for borrowing customers in the sense that the bank may not always be able to produce the reserves it requires to make the loan at the desired time.”

     Exactly so! An elegant endorsement of my “gut feeling”. So, is there really any compelling reason to employ only equity funding?

     “Hope some of this was of interest to you. In the event you did attempt to wade through it, you may have noticed that Scott’s “very clear paraphrase” of my earlier “impenetrable” argument was in fact a direct quote from my earlier impenetrable argument.

     🙂 ”

     Whoops! More fool me!

     I did indeed “wade through it” but I can’t claim to have understood it all. I shall re-read it – several times!

     I am obliged to you for treating my polemics with such serious and studied attention, especially since the whole subject is one about which I feel strongly and which I believe merits serious attention because of its important consequences for our society, extending into the future.

190. Tom Hickey:

     “Robert, I was confused about this when I first encountered this terminology, also. I soon learned that MMT economists generally do not use the term “money” because it is ambiguous, hence confusing. They use the proper technical terms to obviate conflation of distinct meanings that are important to keep straight. Without learning the operational definitions, it is not possible to understand clearly how the system works. It really isn’t a proper criticism to say to experts that you don’t get what they are saying and it’s all their fault, when you insist on imposing your own loose definitions on a field of study that is highly nuanced.”

     Yes, well that’s a point of view I grant you, and you’re fully entitled to it.

     I don’t happen to share it.

     It’s the case of course that every specialised field employs language in specialised ways, as technical jargon having a meaning different from the meaning the same words have in common parlance.

     But if specialists wish to engage in propagating their views in the wider world there has to be at some point an interface between them and the common herd like me – unless the specialists prefer to remain forever isolated in their own cloister, communicating exclusively with fellow-inmates. And if they aim to influence political decision-making, which means seeking to persuade the people’s elected representatives to their point of view, then it becomes incumbent upon them to explain in terms that the ordinary man and woman can understand just what it is they’re on about, and why.

     I’m entirely unrepentant about making this demand of MMTers, because political persuasion is indeed exactly the game they’ve chosen to take part in. Their entire critique of current policies is political – naturally, since it’s concerned with policies. That puts the onus squarely on them, in my view, to employ the English language without the use of technical terms when engaging in debate with non-specialists. Specifically, when they use the term “money” it must mean what the dictionary defines it to mean. I haven’t the slightest compunction in saying that I have no interest whatever in trying to understand the nuances you speak of. In common parlance money is what you can buy things with, and that’s all there is to it. Sorry!

191. JKH:

     A very interesting and nice exposition. I must admit I’ve never fully gone the way of “pure equity funded balance sheet” exploration although the thought occurred to me in a vague manner.

     A typical Austrian banking construct boils down to pools of loans/bond matched both by quantity and tenor. Obviously, in such system as you indicated earlier, the cash investor (the bond buyer) is still exposed to the “heavenly twins” of liquidity/solvency risk due to possible loan losses. One could argue that the investor should be fully prepared for possible losses in this arrangement without the FDIC callable put fallback.

     In any case, your model holds more promise. Would one call it MMT/NG 😉 ?

192. Robert:

     So, is there really any compelling reason to employ only equity funding

     There does not appear to be any alternative to pure equity funding that would fully eliminate the L/S risk without government involvement/bailout of some sort . That’s the point.

193. Robert,

     Thanks for the quick feedback. I’m going to spend some time absorbing it – will be back later.

     Stone, VJK – thanks also

194. Robert,

     No, when I said only the US government can create money now, I was not speaking in accounting terms. What I meant was that the US government, while not making individual lending decisions (which is an advantage), sets terms and conditions under which loans that create new money can be made. And they dictate which entities can do this. They can change the terms and conditions at any time through an act of congress. The government has outsourced this function, but they retain ultimate control over it.

     It should be obvious that banks can’t create money at will and hand it out to their buddies. If they could do so, why did they need a bail out?

     The problem is that the government has failed to punish bad actors and subverted its own control in order to serve private interests and save their own necks.

195. I’m very late to this discussion and since I’ve only skimmed it I’ll try to be brief in case I’m being redundant. A few thoughts:

     1. I know I’m not the first to say this, but it seems a large chunk of the length of any discussion thread like this is driven by limitations of written language and different ideas of what words and concepts mean. For example I’m pretty sure Scott Fullwiler (e.g., Oct 20 6:09) considered FRB as Federal Reserve Bank, not Fractional Reserve Banking. Also the word “capital” seems to cause no end of trouble, as some people think of balance sheet equity, and others of assets (likely those resulting from equity fund-raising). Maybe my Macroeconomic Balance Sheet Visualizer could help anchor some basic pieces of the discussion (for those who haven’t seen it) though obviously this discussion has gone way beyond that (in the tool’s current form).

     2. The gist of the proposal under discussion, as I’m reading it, is to take away the money creation power of banks. If you call it “100% reserve banking” then you get into trouble with MMTers given that currently the Fed supplies reserves as needed after the loans create the deposits, as it appears JKH and others have covered in detail.

     3. With no bank loans, the economy would rely entirely on something akin to current bond issuance for all lending. You could either have direct lender to borrower bonds, or go through lending intermediaries, with associated necessity of liquidity provisions. But at the macro balance sheet level I think they are basically the same.

     4. I think all MMTers agree that banks should be stripped down to basic utilities that serve the private sector’s desire for loans, so I think it’s important to focus on the merits of basic bank loans without getting too caught up in the current distorted system (rent-seeking problems, political power, bubble and fraud-driven oversupply of debt, etc).

     5. Having thought through this a bit, I believe the existence of bank lending to supplement direct [bond-like] lending allows the private sector self-determination of its quantity of short-duration assets (largely bank deposits) to help meet its self-determined liquidity desires. If that’s not clear, let me know, and I can walk through an explanation. The implication is if you took away the bank loan function, then the non-government sector would have much less control over its quantity of short duration versus long duration assets. Such a scenario may also constrain borrower-driven macroeconomic expansion of demand under certain conditions, but I’m less clear on that until I think through it more.

     6. One (possibly novel?) conclusion of #5 is that if the government forces the private sector to hold more short duration assets than it wants (e.g., via quantitative easing), over the medium term the private sector will COUNTER this by refinancing loans into bonds and reducing the money supply in relative terms. And taking a look at Japan’s raw loan and debt data, net bond issuance swung positive in 2001 onward even amidst still contracting bank loans! (Japan’s QE ran 2001-2005). I may need to write more on this as I haven’t seen it suggested before (but of course I’d like to know if I’m wrong or stating the obvious).

     If I’ve repeated earlier posts in this thread too much… sorry! If #5 and #6 seem wrong, tell me, and I’ll explain in more detail so you can shoot it down based on my specific flawed logic. Okay, that wasn’t all that brief…

196. stone: “If you are proposing to stop that by your targeted confiscations from those you deem rentiers (in contrast to the flat wealth tax) then you will no longer be running deficits and so deviating greatly from what Bill advocates.

     Fiscal policy manages flows. The taxing away of economic rate would be directed for public purpose in case of a private sector surplus without an offsetting trade balance in order to keep the government balance in deficit to accommodate the propensity to save.

197. Robert: I haven’t the slightest compunction in saying that I have no interest whatever in trying to understand the nuances you speak of. In common parlance money is what you can buy things with, and that’s all there is to it. Sorry!

     Then you will never come to understand what is going on here, which is about how the monetary system actually works. Sorry.

198. “The fact that mainstream economics does not understand this correct interpretation of reserves in the modern banking system has led to great confusion in the case of the excess reserves now sitting at the Federal Reserve, as a result of the banking crisis.”

     This may be by-the-by in some ways, but I will ask anyway:

     Is it really true that mainstream economics does not understand how the banking system works?

     Clearly there are some academics out there in universities who have no idea, but all the economists working in the finance/banking industry understand it well in my experience.

199. Robert

     “I haven’t the slightest compunction in saying that I have no interest whatever in trying to understand the nuances you speak of. In common parlance money is what you can buy things with, and that’s all there is to it. Sorry!”

     You raise a fair point about using technical language.

     But I have to say your definition of “money” is really not sufficient. For example, is money that you can use to buy things with right at this very moment exactly the same as money that you will be only be able to access at some point in the future?

     Is $1000 in cash the same as $1000 in a term deposit due to mature in 12 months time?

200. Robert,

     I think I grasp roughly 80 per cent of what you describe above, and much of it fits with my own understanding.

     Looks like you’re combining deposit and credit bank functions in one institution, which is fine. I made the institutional configuration flexible in my presentation, in part because I wasn’t sure which way you were going on that.

     Also, in the beginning, I wasn’t sure you were promoting the pure equity capital model or not, so I described it for illustration purposes at least. But it’s clear that you’re not now. I agree it’s more realistic to allow other forms of liability funding, which is less restrictive in terms of operational effectiveness. As I noted earlier, it does lead to more liquidity risk and potential for reliance on occasional central bank intervention in the credit bank part.

     “The thinking I’m most familiar with proposes that the deposit bank is provided with an account at the CB to hold (solely) its consolidated deposits. It needs no reserves: the deposits and the reserves are one and the same.”

     That’s OK, but consistent accounting depictions are inevitably required. There are three contiguous balance sheets here – central bank, deposit bank, and depositor – each with assets and liabilities. E.g. the account of the deposit bank with the CB is a deposit bank asset and the account of the depositor with the deposit bank is a deposit bank liability – even if you consider the depositor’s funds as a direct “pass through” to the central bank. I was viewing the bank’s deposit with the central bank as a separate replication of the customer’s deposit with the bank.

     However, I do get bogged down on points 2 through 5, and it’s all accounting related I’m afraid – maybe because you use different terminology and a different set of accounts than me. Each balance sheet must balance after each step of each transaction, and I can’t put together a coherent picture of where the various entries are going.

     So I’ll make a few comments on those points and maybe you can help me understand it further.

     2. If the bank is also a credit bank, in addition to its consolidated depositors’ account the bank has two further accounts at the CB: its operational account containing its financial assets, and its investment pool account into which and out of which investors’ funds, loan repayments, payments to investors and loans to borrowers flow.

     – I’m not sure why all these accounts are with the CB. Assuming the credit bank includes the deposit function as well, that looks like 3 different accounts at the CB. The operational account is one of those, but I don’t understand how it can contain “financial assets” at the same time it is a deposit account of some sort at the central bank. If it’s an account with the central bank, I assume that means reserves or money of some sort.

     3. A loan made results in the sum loaned being added to the borrower’s deposit account. This just means that the bank’s investment pool account at the CB is debited by that sum and the borrower’s bank’s consolidated depositors’ account at the CB is credited by the same sum.

     – This point 3 is where I really get lost. I think you’re including the transfer of funds between two different banks here, but I can’t tell for sure. The loan has to be reflected as an increase in a bank asset somewhere but I don’t know where. I think the payer bank’s CB account is reduced and the payee bank’s CB account is increased. But it also looks like deposits in total have increased, which can’t be the right interpretation.

     4. When the borrower spends the loan the result will be that the payee’s deposit bank’s consolidated depositors’ account at the CB is credited, and the borrower’s deposit bank’s debited, by the amount spent.

     I think I see reserves moving between two banks here, but I’m basically in a mild fog at this stage due to the array of accounts I’m still trying to understand. Sorry.

     5. It will be evident that money loaned derives from investment funds attracted, plus any funds borrowed (by selling bonds for instance) for the purpose of loaning out and earning a profit on the spread. There is no obstacle, in principle, to a bank adding partners’/shareholders’ equity from its operational account to its investment pool account, in which case the two accounts at the CB will be reciprocally adjusted and the amount available to be loaned will be increased commensurately.

     I’m pretty lost here as well.

     At one stage I started to think that you may have a configuration of 3 different reserve accounts (or some sort of money accounts) held at the CB, but no separate accounts for the assets and liabilities that must be recorded on the balance sheet and that must be recorded with changes in levels when they give rise to corresponding changes in the reserve account(s). In usual bank reserve accounting, any asset or liability or equity account that changes in such a way as to be associated with an interbank payment will affect both the A/L/E account and the reserve account, all of which are separate accounts. E.g. where there is an associated interbank payment, an increase in assets will be associated with a decrease in reserves; an increase in liabilities or equity will be associated with an increase in reserves; etc. etc. All of these accounts must be recorded on the balance sheet separately while changing together in accordance with such de facto accounting interdependencies when you have interbank flows. So I’m guessing (wildly) that you may be depicting a specified network of reserve accounts, but without recording the corresponding asset/liability/equity accounts whose activity must correlate with reserve account activity whenever there is an associated interbank payment. I’m just not seeing how all of these types of asset and liability accounts fit together on the balance sheet configuration your description should imply.

     That said, I doubt my description of accounts in my own comment is any easier for people to figure out.

     Can you shed any further light based on my struggles noted above?

201. VJK,

     Yes, that’s always been my impression of the Austrian model, although I’ve never spent as much time as I’d like on it.

     The problem I’ve tried to explore from time to time, and I’ve touched on it here, is the precise relationship between Austrian-type matched maturity funding and 100 per cent reserves. They’re somewhat separate ideas, but often knitted together in these types of discussions (Mencius Moldbug used to take it on with a vengeance. Don’t know if he still does.) It’s a challenging exercise. And even more so when you try and analyze it from an MMT perspective.

202. Stone,

     The quantity theory is usually applied to measures of GDP inflation as I understand it – which doesn’t include asset prices. Central banks are still mostly preoccupied with GDP inflation, so if central banks and their critics are trying to anticipate future central bank activity based on quantity theory, and if quantity theory is mostly useless, it’s a real problem. Personally, I think it’s useless in the blunt form typically applied by monetarist economists – because the definition of money is infinitely discretionary, the experience of velocity is infinitely variable, and attempting to divine something about GDP inflation from the combination of the two is infinitely stupid. You can pay attention to money in a sensible way without paying attention to quantity theory in a foolish way.

     Asset price inflation is quite another matter. But I still wouldn’t use (a modified) quantity theory in its usual blunt form as the main tool for investigating that phenomenon.

203. Gamma,

     “Clearly there are some academics out there in universities who have no idea, but all the economists working in the finance/banking industry understand it well in my experience.”

     I have direct experience with more of the latter than the former. I think few of them understand it in the way that Mosler or Mitchell do, for example. The reason is that you’ll find in many cases that finance industry and bank economists are surprisingly remote from the technical money operations of the firms they work in. Also, outfits like CNBC have a continuous parade of these types on air, and I can’t recall any of them explaining it properly.

     But that’s just my experience, and of course there may be exceptions.

204. Robert,

     My response was comment 200 previous page, in case you miss it.

205. Tom Hickey: “Then you will never come to understand what is going on here, which is about how the monetary system actually works.”

     I grant you that, and I’m entirely relaxed about that. My intellectual limitations preclude it in any case (I’m not being ironic).

     But that is precisely my point:- that the use of words to mean anything other than what they are popularly understood to mean precludes 99% of the entire population from understanding what is going on here too – not just me! If you desire only to conduct a private debate then by all means employ a private language to conduct it in, if that’s your preference. It’s a free country. But once you start to seek to make interventions – by influencing opinion – in the political sphere you are obliged to use common parlance. By that I mean that if you use a word like “money” you are obligated to use it only in the sense in which it is commonly understood; if instead you make statements which include that word whilst persisting in using it to mean something other than the way in which (as you know perfectly well) your interlocutors will interpret it – and if you fail to make that semantic distinction crystal clear – you are at best creating needless confusion and at worst deliberately misrepresenting your argument.

     Think of me, if you will, as your typical man in the street and then ask yourself:- What will he make of my using the common word “money” to mean something which is so esoterically-defined as to exclude all but 3% of what is actually used today to buy things with? If that other 97% isn’t “money” – even though it’s indistinguishable in any way or in any practical sense from what you’re electing to apply the same word to – then what in all getout is it?

     Do I make my point?

206. Gamma: “Is $1000 in cash the same as $1000 in a term deposit due to mature in 12 months time?”

     Oh dear, I seem to have unwittingly appointed myself arbiter as to the correct use of common English! Well it’s a dirty job but someone here’s got to do it 🙂

     Answer: no. The term deposit is an investment, aka savings. You can tell that from the fact that it’s not available to me for twelve months to be spent. At the end of that term it becomes money again and as much of it as I don’t reinvest can be either spent or stored in a deposit account (or under the mattress), or a bit of each.

     Does that make sense?

207. Sergei:
     @Wednesday, October 20, 2010 at 20:10

     Sorry Sergei, I wasn’t intending to snub you – I had just completely missed seeing your message ’till now.

     Will get back to you!

208. hbl: “For example I’m pretty sure Scott Fullwiler (e.g., Oct 20 6:09) considered FRB as Federal Reserve Bank, not Fractional Reserve Banking.”

     Thanks for clearing that up. It’s now obvious to me that I’ve unknowingly been contributing my share to the confusion (I hope to a not very great extent) by having adopted the lazy habit of using initials instead of spelling out “fractional reserve banking” in full. It hadn’t crossed my mind that that was ambiguous but, as you point out, for an American it can well be. From now on I shall employ only the full term, to avoid any ambiguity.

     I’m obliged to you.

209. Hi JKH and Robert, at the time, Robert said that the set up I was suggesting fitted in with what he was after too and that it seemed easy to understand. In the hope that it reduces confusion I’ve pasted together the comments where I described it:-
     Oct16 17:43
     Scott, as I understood it the private banking system would be disconected from the state. There would be giro banks that could not lend and charged a service fee to store digital money.
     There would also be lending banks that got their money in the same way that regular non-financial corporations do now. An IPO, retained profits etc would provide a pool of cash for such a lending bank. The lending banks would also issue bonds to get extra cash. The bonds would be mainly bought by institutional investors such as insurance companies, pension funds and mutual funds. A retail investor who wanted to store money in a way that paid interest rather than just being subject to a service charge would invest in a mutual fund that held the bonds from lending banks. The mutual fund would also generally have a small cash holding to provide liquidity but investing in such mutual funds would explicitly be a risk investment and customers would be making a choice to take that risk rather than just suffering the giro bank service charge.
     As now, someone needing funding for a high risk start up company would need to go to a venture capital trust that gave loans in return for an equity stake rather than fixed interest.
     My point in advocating such a system is not to try and create a world free of financial risk. I realise real life has risks and the financial system should reflect that. My point was to prevent the banks from creating money.

     Oct17 18:32
     – I can’t speak for Robert, I can only speak for myself. The hypothetical “lending banks” I described would have no prescribed capital requirement and no connection to a central bank. They would never take deposits and would only lend cash that they already held and so there would be no need for them to be subject to any banking regulations. I should have called them “loan companies” rather than “lending banks” as perhaps the word “bank” created unneccessary confusion. All their cash would come from institutional investors and from retained profits. The same pool of cash would be tapped into to pay bond holders when bonds matured and when bond holders received interest, to pay out as loans to customers and to pay out as dividends to share holders. The size of pool of cash held in relation to the bond liabilities would be a commercial descision of the “loan company”. If a loan company had only made very low risk loans such as 25% mortgages to people earning 50% the value of their house per year, then the loan company would be able to issue bonds at a low rate of interest despite having a small pool of cash. On the other hand, if the loan company was in the buisiness of making loans to people who might not be able to repay, then there would need to be a big pool of cash in order for the bonds to be taken up for a reasonable rate of interest. It would be up to the institutional investors who bought the bonds – If a loan company went bust, the share holders and then the bond holders would take the loss just as with any other type of company.
     I think the crucial overall point is that deposits and loans need to be delt with by entirely seperate institutions (giro banks and loan companies respectively) if we are to have a system where banks are not able to create money. Someone on here said that money creation is impossible to prevent. I’m struggling to get my head around that idea. As Robert says, credit creation of money is entirely dependent on the legal enforcability of receiving repayment of a loan made by someone who didn’t have the money to lend. If people only accepted payment in the form of cowerie shells or whatever then there could be no creation of money by credit. I don’t see why there could not be a digital equivalent of cowerie shells. If anyone was stupid enough to accept an IOU as payment then it would be on the understanding that if they were not repaid, they would have no legal redress. I realise that it is not just banks that create money currently. I guess when I buy materials and the supplier gets paid 30 days after delivery, I am creating money. My employer stipulates that that is what I must do. I think it is just as important to prevent money creation at that level as by the banks. I hope I’m not in too much of a muddle about this.

     Oct18 18:42
     Neil Wilson, “if the bank takes the credit risk, then it needs capital as a buffer – and then you’re back into how many loans is the bank allowed to make and who insures the depositor against loss if a double-six comes up on the dice and the bank burns all its capital.”- I have to reiterate that the “loan companies” I was proposing would not take deposits. They would get money from selling bonds etc as I described. There would be no more call to protect the bond holders than there is to protect holders of other commercial bonds issued by say manufacturing companies. If you wanted to prevent any retail investors from being at risk of being tempted to invest in commercial bonds you could have a rule stipulating that each bond had to cost >£1M or whatever. Deposits would only be held in giro banks. Retail investors could invest in mutual funds that held diverse commercial bonds and the mutual fund managers would be professionals exerting due diligence to ensure that the lending practices of the “loan companies” were appropriate for the yield their bonds paid out.

     “Our current system gives depositors capital security and an interest on their savings, because as the state regulates the banks the state should insure that regulation should it fail – which is what happened during the Financial Crisis.”
     Our current system is a blank check offered on a plate to the financial sector. The financial sector is consequently growing at 10% of GDP per decade or whatever it is -as is its power to thwart any future attempt at regulating it. The clock is ticking.

210. JKH “Asset price inflation is quite another matter. But I still wouldn’t use (a modified) quantity theory in its usual blunt form as the main tool for investigating that phenomenon.”-
     To me one of the most significant factors in the global economy over the last few decades is the faster rate of global asset price inflation as compared to consumer price inflation. It is the way that that creates a ponzi effect for global asset prices that worries me. Do you agree that having no money creation would prevent that effect?

211. Stone,

     “I think the crucial overall point is that deposits and loans need to be dealt with by entirely separate institutions (giro banks and loan companies respectively) if we are to have a system where banks are not able to create money.”

     So you’re describing a system where deposit banks and credit or lending banks are institutionally separate, which is fine but different than Robert’s. Your description is understandable overall, although a little more specificity would be helpful in describing the balance sheets of the different entities. E.g. the term “pool of cash” needs to be more specific if it’s part of the design of the system, although I’m not sure it’s supposed to be a design feature as opposed to a more general description of the flow of funds.

     “Someone on here said that money creation is impossible to prevent. I’m struggling to get my head around that idea.”

     That’s an interesting perspective. I think it means in our context that lending banks must simply be prohibited from taking or creating deposits. What that means in effect is that lending banks must be forced to match increases in lending with increases in non-deposit funding. That will prevent the creation of money insofar as lending banks are concerned, and that will limit money creation to deposit banks. Your overall description fits these criteria. In fact, your overall description of the system is similar to the partition of today’s system between banks and non-banks, except the proposed partition is between deposit banks and lending banks. In today’s system, non-banks for the most part issue non-money liabilities, which is the same constraint the proposed system forces on the lending banks.

     Note that the way I’ve described it puts the design constraint more on the liability side of the balance sheet – deposit banks take only deposits and lending banks issue only non-deposit liabilities. The constraint isn’t specified in terms of what type of “cash” clears through the asset side clearing accounts with the central bank. The financial institutions make payments amongst themselves through those accounts. The way I had set it up, both the deposit function and the credit function cleared through the same type of reserve account held at the central bank – it’s just that the deposit banks had the additional structural constraint that they must have a stock of reserves in that account equal to 100 per cent of their deposits.

     A couple of other points referring back to Robert’s model:

     All banks need accounts through which they clear payments. As I understand Robert’s model, the deposit bank/function clears its payments through an account with the central bank. Robert fused the idea of the customer deposit with that of the bank’s account held at the central bank and referred to the single item as a deposit. Since deposits are supposed to be reservable, it seems to me this clearing account should be labelled as a reserve account corresponding 1:1 to the deposit account.

     Credit banks (or at least the credit/lending function) are not allowed to take deposits. Robert identified two additional accounts that the credit bank/function maintains with the central bank. I can understand a dedicated central bank account for the credit bank, but I don’t understand yet why two such accounts are required. Since credit banks do not take deposits, I can understand why a credit bank clearing account would not be labelled a reserve account.

212. Stone,

     “Do you agree that having no money creation would prevent that effect?”

     “No money creation” seems a little extreme. But sure, directionally, less money creation rather than more wouldn’t hurt the cause of mitigating Ponzi behaviour. But I think there’s so much more to it than that. Credit creation is far more important than money creation, because low interest rates means that credit creation can be funded with low interest liabilities. And leverage is a driving factor, meaning that credit creation can be boosted with low levels of equity at risk and high levels of debt.

213. JKH @Thursday, October 21, 2010 at 1:32

     In the final section of your analysis of my proposal you mildly admonished me to look less unkindly on MMT, by giving due recognition to the fact that it has its own agenda for addressing the perceived ills in our polity, no less deserving of respect than the different agenda I’m promoting. A fair point, and one I wouldn’t dream of contesting.

     To me it all turns on one’s answers to two questions:- what harm can fractional reserve banking be held to cause to society, and what ought to be done to remove such harm as it is judged to cause? I can’t of course claim to be objective but it appears to me that MMT judges fractional reserve banking purely as a system and, finding it to be a good system in functional terms, gives it the MMT seal of approval. A bit like looking at, let’s say, a tank and judging its merits as a piece of applied engineering, in terms of fitness for purpose. The obvious fact that the tank’s purpose is to kill people, efficiently, is set on one side.

     Yes I know that’s a loaded analogy, but I think it makes the point nevertheless. Because the whole purpose of this machine called fractional reserve banking is as I see it to bestow corporate welfare upon those corporations who participate in and control it and – in consequence – unwarranted and grossly disproportionate pecuniary rewards upon the owners (and many of the employees) of those corporations, to the detriment of others not favoured in the same way and to society as a whole. “Bankers own the earth” as one of them once candidly said – he was of course employing hyperbole (though not that much!) for rhetorical effect but he knew exactly what he was talking about, being himself a living demonstration of the truth of his own dictum. Those interests which consistently throughout the past couple of centuries in both Britain and the USA have pressed most strongly to be allowed to create money through bank credit have consciously done so in order to promote their own and their caste’s financial welfare – and they have succeeded in that aim beyond their wildest expectations.

     MMT, whilst not ignoring these outcomes, ascribes them not to any flaw in the beautiful, intricate, machine but to the perverted use of it. The tank – which it was presumed would fire only upon the enemy – has been hijacked by subversives who instead have trained its gun on us and are threatening to blow us all to kingdom come! MMT says:- don’t blame the tank, instead overpower the subversives who have captured it and then point its weapon where it was intended to have been pointed; do that and the threatened harm will be averted.

     I say:- it was inherent in the design of the machine that it bring about harm. It was designed to have the potential to enrich some few at the expense of all the others and that is what it is, very efficiently and inexorably, doing and will go on doing unless it is permanently put out of action. I argue (as in point of fact did that selfsame candid banker) that in fractional reserve banking’s place ought to be put a differently-designed machine which does not have the potential to favour the interests of those who control it over everyone else’s. Because so long as the current machine remains available human nature decrees that it will inevitably be put to the use for which it was designed. MMT does not see fractional reserve banking the way that I see (or that banker saw) it.

     There isn’t any obvious way in which these two opposed views can be reconciled, unfortunately, and MMT will as matters stand give no support to the abolition of fractional reserve banking which i wish to see.

214. JKH -This is probably a very naive question, but with my set up couldn’t the private giro banks and loan companies never interact at all with a central bank? In Kenya people widely use cell-phone talk time credit as money as they can text it to each other and redeem it for cash. In principle couldn’t they set up giro banks and loan companies (like those that I described) but with the entire process (including equity funding for the loan companies) exclusively using cell-phone credit? If that could be done, then surely the central bank is also redundant for the process even if it is using “real” money such as USD or UK£?

215. JKH-“Credit creation is far more important than money creation, because low interest rates means that credit creation can be funded with low interest liabilities. And leverage is a driving factor, meaning that credit creation can be boosted with low levels of equity at risk and high levels of debt.”
     -My hope was for the government to just recirculate a fixed stock of money (using a tax on private assets matching a pay out through a citizens dividend and government spending) and for the private “loan companies” to be the sole providers of credit with interest rates being set on a commercial basis by those “loan companies” with no central bank involvement. I thought that such a set up would also prevent reckless credit creation- ie a curb to money creation would lead to responsible credit creation.

216. Robert-“Those interests which consistently throughout the past couple of centuries in both Britain and the USA have pressed most strongly to be allowed to create money through bank credit have consciously done so in order to promote their own and their caste’s financial welfare – and they have succeeded in that aim beyond their wildest expectations.”-
     I think the key difference between MMTers and you and me is the MMTers do not see it as a concern if large amounts of wealth accumulates with the banks or with oligarchs. I think the MMTers’ position is that if banks or oligarchs do harmful things (such as hoard the global grain supply or whatever) then the state should act to prohibit the harmful activity rather than being concerned about the wealth that empowered the harmful activity in its self. Personally I think that position is foolish because we have all seen how easily wealth captures politicians. Politicians hang around with the wealthy in order to get political funding. This leads them to expect such wealth for themselves. They then see an attraction in getting lucrative “lecture tours” and “consultancies” (such as the £20M Tony Blair has raked in since leaving office) and they tow the line of the financial interests at the expense of everyone else. Once politicians are captured they are not going to curtail the harmful activities of the wealthy.

217. Robert,

     You may see the problem as the tank and want to redesign it – while MMT fiddles standing next to the tank, so to speak. But others may see the problem as the portfolio of the tank, the fighter jet, and the battleship. And they may choose to preempt or lose the battle by ignoring the tank, while winning the war by upgrading the fighter jet and the battleship.

     E.g.

     Tank = FRB
     Fighter = credit risk
     Battleship = capital requirements

     More later on your specific question about the harm done due to FRB.

218. Robert:

     it was inherent in the design of the machine that it bring about harm.

     There is no doubt that the modern banking system is an utter engineering failure in more respects than one.

     It is interesting to note that some Austrians have opinions different from those of von Mises as to credit creation trade-offs
     Hayek, for example had this to say:

     So long as we make use of bank credit as a means of furthering economic development we shall have to put up with the resulting trade cycles. They are, in a sense, the price we pay for a speed of development exceeding that which people would voluntarily make possible through their savings, and which therefore has to be extorted from them.
     

     Extortion, indeed.

219. Stone,

     Central banks typically provide the payment system facility and set the policy anchor for interest rates. They do that by providing reserve accounts for the banks and controlling the aggregate amount of money in those accounts.

     If there is no central bank, those functions need to be replaced or modified somehow.

     Your phone system could be part of the advancing technology for direct customer transfers among banks. Banks would still need to aggregate net effects to determine offsetting actions required to balance their assets and liabilities. I suppose that could be done within the same technology envelope.

     At the end of the day, though, banks need a point of ultimate payment clearing and settlement, and that point needs to provide overdraft credit as necessary – otherwise even the most minor payment disruption could cause systemic bank failure. Such a credit facility needs to be available to all direct participants in the payment system and therefore is a central function by construction. I see no reason why that central credit provider would be anyone other than the central bank, particularly since the credit facility is the same mechanism that anchors interest rate control. Abandoning that central control of both ultimate credit and interest rates is to invite or at least risk financial chaos.

220. JKH:

     Here’s my attempt to answer as many of the points you have raised as I can.

     One thing I need to clear up straightaway. By requiring that deposit-holders’ money is held in the deposit bank’s consolidated depositors’ account at the CB deposits are thereby made inaccessible to any credit bank. Therefore whether said credit bank is entirely separate from the deposit bank or another part of a hybrid deposit-taking and credit-banking entity would have no special significance. One potential commercial advantage is that a hybrid institution might garner investments from its deposit-holders which would not necessarily have come its way otherwise, but that would be only one of a number of business considerations influencing whether to be hybrid or not. I’ve gathered you’re relaxed about this either way.

     “- I’m not sure why all these accounts are with the CB. Assuming the credit bank includes the deposit function as well, that looks like 3 different accounts at the CB.”

     Yes. The thinking is that it’s the CB which functions as the all-seeing all-knowing spider at the centre of the (information) web. Although each bank’s database contains all information about each of its customers’ individual accounts, and the customers’ interface is solely with his bank or banks, all transfers of money into, out of and between banks’ own accounts at the CB are effected by amending the CB’s spreadsheet – to which the banks’ spreadsheets are slaved. The supposition has been that the banks themselves would find it more convenient that their investment pool account at the CB be separate, but no point of principle is at stake here so far as I’m aware.

     “The operational account is one of those, but I don’t understand how it can contain “financial assets” at the same time it is a deposit account of some sort at the central bank. If it’s an account with the central bank, I assume that means reserves or money of some sort.”

     I’m afraid this is my unfamiliarity with proper terminology showing through. I readily defer to your superior knowledge!

     “- This point 3 is where I really get lost. I think you’re including the transfer of funds between two different banks here, but I can’t tell for sure. The loan has to be reflected as an increase in a bank asset somewhere but I don’t know where. I think the payer bank’s CB account is reduced and the payee bank’s CB account is increased.”

     Yes the transfer of funds between two CB accounts of two different banks is involved, the “donor” being a credit bank and the recipent being a deposit bank (they might be two parts of the same hybrid institution but that’s by the by).

     “But it also looks like deposits in total have increased, which can’t be the right interpretation.”

     But it is. Deposits in total would have increased, by the amount of the loan. Simultaneously the total balance of the payer bank’s investment pool account at the CB is reduced by the reciprocal amount. Hence the stipulation that no new money be created is met. Are you seeing this as problematical? Why wouldn’t the increase be reflected in the deposit bank’s assets? I’m not seeing the problem at present.

     “So I’m guessing (wildly) that you may be depicting a specified network of reserve accounts, but without recording the corresponding asset/liability/equity accounts whose activity must correlate with reserve account activity whenever there is an associated interbank payment. I’m just not seeing how all of these types of asset and liability accounts fit together on the balance sheet configuration your description should imply.”

     This crystallizes the problem we’re having, I think. I’m only able to give an impressionistic outine of the guiding principles and the bare bones of the system (and may not be succeeding in doing even that very well!) whereas you need to transpose that into an operational setting to check that all the parts fit together satisfactorily and the whole thing would function, would satisfy auditors’ requirements, and so forth – and I haven’t the necessary technical accounting knowledge to help you do that. I’d dearly like to help, if only I could.

221. Robert: Do I make my point?

     No.

222. JKH, “Abandoning that central control of both ultimate credit and interest rates is to invite or at least risk financial chaos”-
     I thought that prior to 1907, the USA didn’t have a central bank. Am I in a complete muddle about that? It isn’t immediately obvious to me why interest rates need to be set centrally anymore than say milk prices. I realzse that there was financial chaos before 1907 but I thought that with the hypothetical giro bank and loan company system the cause of that chaos would be avoided.
     “otherwise even the most minor payment disruption could cause systemic bank failure”- I was thinking all the giro banks and loan companies would be independent of each other and all payments would be with money that in every case they already had and had confirmed they had before making any payment. Basically they would hand over money in the same way that a grocery hands over potatoes to retail customers. As such I don’t see how any systemic failure could crop up. An individual loan company could go bust just as now an individual manufacturing company can go bust but in both cases it is only the share holders and perhaps the bond holders who loose out.
     I’m just trying to see how much of modern banking is just corporate welfare.

223. JKH,

     “I have direct experience with more of the latter than the former. I think few of them understand it in the way that Mosler or Mitchell do, for example. The reason is that you’ll find in many cases that finance industry and bank economists are surprisingly remote from the technical money operations of the firms they work in. Also, outfits like CNBC have a continuous parade of these types on air, and I can’t recall any of them explaining it properly.”

     My experience is quite different. In Australian banks, many economists sit on the trading floor directly next to the people who are working directly in the money markets. Almost all would all be aware of the basics of how the reserve accounts work.

     I am sure there are some who don’t – but having some technically incompetent people is not unique to banking or finance. In a previous life as a graduate engineer I remember being told by a senior designer something so laughably wrong about how power supply to electric motors works. He clearly didn’t know what he was talking about.

224. Robert says

     “Answer: no. The term deposit is an investment, aka savings. You can tell that from the fact that it’s not available to me for twelve months to be spent. At the end of that term it becomes money again and as much of it as I don’t reinvest can be either spent or stored in a deposit account (or under the mattress), or a bit of each.

     Does that make sense?”

     Yes I understand that is how you see it. But it is not consistent with the way the vast majority of the population understands the term “money”.

     I have money held in term deposits as well as savings accounts accessible at 2 day’s notice. You are trying to say that neither of these constitutes money – most people in the wider community as well as most economists would disagree with you. They are both forms of money.

     So using your definition then, the only thing you consider to be “money” is physical cash, and balances held in transaction accounts, is that correct?

225. Robert,

     “But it is. Deposits in total would have increased, by the amount of the loan. Simultaneously the total balance of the payer bank’s investment pool account at the CB is reduced by the reciprocal amount. Hence the stipulation that no new money be created is met. Are you seeing this as problematical?”

     Problematical, unfortunately, but this is how progress is made.

     I noticed your parallel conversation with Tom Hickey (which seems to be in a petering state right now), and I think I have to respect his point here about the issue of what one means by the word money as it is used in various contexts. I have to agree with him that money can mean different things to different people in different conversations, and that any of those meanings can be quite reasonable and sensible in context.

     In this case, it appears to me that you are talking about central bank money – i.e. the money that banks hold in their accounts with central banks. But I’ve been assuming all along that we were talking about private bank money – i.e. the money that bank customers hold in their accounts with private banks.

     I’ve assumed this all along because that second type of money is the only type that private banks have the power to create. Private banks do not have the power to create or destroy money in their accounts at a central bank – merely as the result of making a payment in respect of a customer transaction (the only exceptions to this are transactions to purchase or redeem physical central bank notes or currency, and tax payment transactions – but leave those aside for now because those are very special cases). The debiting of your investment pool account and the crediting of the central bank account corresponding to the new deposit actually demonstrates that. This principle of the preservation of central bank money holds in the case in the account structure I proposed in my long response to you. And it would be the case in any account structure that could be validated as rational and coherent. Banks simply don’t have the power to create money in the form of liabilities of other banks (e.g. central banks) that are higher up in the hierarchy of liability issuance. To make the point in a more fundamental way, I can’t create a liability on my own balance sheet that is the same type of liability as say, a deposit with Citibank (which is a Citibank liability) or for that matter commercial paper issued by GMAC (which is a GMAC liability). Only Citibank or GMAC can create those types of liabilities. In the same way, private banks have no power over the creation of money in the form of deposits that they themselves hold at central banks. What that means is that the type of money preservation that you describe in your example is automatic – in terms of the lack of power of the credit or deposit banks to have any effect to the contrary.

     On the other hand, deposit money created by banks has increased in your example. And since that is the only money over which the private banks have control over the power of creation, I always assumed that was precisely the type of money creation you were attempting to stop.

226. Gamma,

     OK. I stand corrected in the case of your experience. No problem.

     Maybe it’s not what they’re seeing on the trading desk, but what they’re reading on Billy Blog.

     🙂

     In any event, please fly a squadron of them over to New York, so that they can appear on CNBC and educate Wall Street on how banks work.

227. Stone,

     “I thought that prior to 1907, the USA didn’t have a central bank.”

     Good point. I’m not enough of a historian to respond intelligently.

228. JKH:

     At the end of the day, though, banks need a point of ultimate payment clearing and settlement, and that point needs to provide overdraft credit as necessary – otherwise even the most minor payment disruption could cause systemic bank failure.
     

     In principle, banks do not need a central point to settle their mutual obligations. They need a trusted medium of exchange and an interbank network to exchange settlement information. A rudimentary interbank network had existed in the pre-Feds era in the form of correspondent accounts(which still exist today for direct clearing although they play a somewhat diminished role). The trusted medium of exchange for settling mutual obligation was of course gold.

     More recently, the idea of “free banking”, without need for the Central Bank, has been advanced by White, Selgin, et al. Selgin, in particular, argues that fiat could be a better than gold kind of interbank money provided its stock is fixed. The fixed nature of interbank money is also supposed to limit credit expansion without outside (the CB) intervention (unfortunately, I do not know if any numeric model exists to estimate the latter claim).

     
     Such a credit facility needs to be available to all direct participants in the payment system and therefore is a central function by construction.
     

     The assumption and the current practice is that a credit facility is sine qua non for a functioning banking system.

     There are at least three objections:
     (1) practical, in the pre-Fed era, and theoretical possibility of settling mutual obligations without relying on such a facility;
     (2) abysmal performance record of the credit facility and interbank market borrowing hybrid during the recent financial crisis. If one is to judge the system by the results of its performance, no other adjectives other than utter an unmitigated disaster can be used to describe the CB based construct.

     The commercial and shadow banks (not all, but a substantial majority) treated, for example, the interbank market as completely frictionless, paying only lip service to “liquidity” management. The results of such treatment are here for everyone to see and marvel at.

     (3)From a design point of view, having a single point of failure (the CB) and a communication system (the interbank market) that is capable of spreading “contagion” rather than preventing it boggles a first-year engineering student’s on any reasonable person’s mind.

     A distributed, system of relatively autonomous depositary or other financial agents in which a specific entity would not cause a near collapse of the entire system, without any need to rely on a single point of failure, ain’t rocket science.

     Abandoning that central control of both ultimate credit and interest rates is to invite or at least risk financial chaos.
     

     That is debatable. The empirical evidence, however, is that “central control of both ultimate credit and interest rates” did not prevent the 2007 financial crisis, but made it worse precisely by manipulating interbank rates and encouraging unsustainable credit expansion.

     Eliminating credit creation entirely (as in your equity funded banking) may be going too far, or may be not. Certainly, variations on the theme are possible for some customers preferring “easy” credit whilst the bulk of the banking system could be credit-less. Also, witness the misguided and purposeless voyages of QE1 and QE2 to judge the CB intelligence in trying to “control” the system.

     [I have not even tried to touch upon other mis-features required for and built in a “properly” functioning current banking system, such as moral hazard/bailouts/bank subsidies/etc that have been amply covered elsewhere. Such features are logical results of the system original construction]

229. Sergei @Wednesday, October 20, 2010 at 20:10:

     If my grandma wants to save now she can put her money into some sort of savings account, at a low rate of interest – but then she won’t have instant access to it.

     So if she wants to have instant access to it she can put it into a current account (aka “demand deposit” account) at some bank, at an even lower rate of interest. And in exchange the bank will give her its IOU (her bank statement) and a promise to pay out any of the money it owes her whenever she asks for it. Separately, the governnment guarantees that if her bank goes belly-up she will not lose her money (subject to a maximum payout).

     Under this proposal she can still do either of those things. However, the deposit bank will be at liberty to make a charge for its services (which it might decide to waive if it were to see any potential business advantage to itself in doing so – but that’s unlikely in her case). On the other hand, the money will have continued to be her property and will not have become a loan to the bank. But she probably won’t be too impressed by that.

     If by chance the government were to direct some of its new-found financial resources to resurrecting the National Giro, she would be able to use that instead, at no charge, and her local post office (which there would no longer be any reason to privatize) or sub-post office could become the equivalent of her bank counter – if she preferred that to using a home computer.

     So I don’t even begin to understand the reasoning which causes you to paint the lurid scenario you do.

     Are you sure you’ve fully understood the proposal?

230. To reiterate, it seems like what Robert and Stone are describing is exactly the system we have today, but with banks no longer allowed to make loans. I’m not sure why it’s any more complicated than that, other than spelling out what types of regulation, government guarantees, and government liquidity support are needed. You can rename the banks “giro banks” and expect that they’ll need to charge a service fee as their other sources of profits are reduced. Their assets are still vault cash or electronic reserves, and their liabilities are still customer deposits. I’ll link to a visualizer of this in a second comment (since it will be delayed by moderation).

     The private sector already provides countless lending intermediaries that issue fixed duration liabilities against fixed duration assets, and it would continue to do so if you took away bank lending. Just think of all the securitization vehicles… same thing, in essence, right? Or Fannie and Freddie (though they have been nationalized now). You wouldn’t really need to design anything new except for the sake of defining regulation/rules.

     But bank loans are a tiny portion of overall lending in the US (current bank loans total $6.8 trillion but total debt totals $52 trillion). So I don’t think bank loans (and thus the ability of banks to create money) is the real problem driving unsustainable lending booms and asset bubbles.

     Here’s in brief why I believe bank loans serve a useful purpose in allowing the private sector to self-determine the size of the money supply, somewhat independently from the amount of debt it desires (see also my previous comment):

     Consider the similarities and differences between a bank loan versus a bond issued… i.e., two borrowing mechanisms that can be chosen between for any given borrowing need. For the borrower, both approaches add a new short duration asset (money) and a new long duration liability (loan or bond), i.e., they are identical. For the lender, both approaches add a new long duration asset (loan or bond), again identical. The KEY DIFFERENCE is that for a bond issuer, the act of lending requires giving up a short duration asset (money) in exchange for that new long duration asset (bond), while for a loan issuer, the act of lending requires adding a short duration liability (deposit) (since loans create deposits on a bank balance sheet).

     Both bond issuers and loan issuers should in theory offer similar interest rates to borrowers. The bond issuer has to price rates for borrowers to include include credit risk (chance of defaults), inflation risk, and the opportunity cost of giving up that interest-bearing short duration asset (bank deposit aka money). The loan issuer has to price rates for borrowers to include the same credit risk and inflation risk plus the ongoing cost of paying interest via the new short duration liability. That third item in each case prices in the current interest rates banks are paying on deposits, so should be the same rate at a given point in time under either approach, i.e., whether it is a liability (banks paying interest to depositors via a new liability) or a foregone asset (loss of a savers’ interest-bearing bank deposit in return for the new long duration asset).

     So will bond-issuers (lending intermediaries) or loan-issuers (banks) offer a more competitive interest rate to prospective borrowers? I’d argue that when the money supply is “too large” (i.e., enough savers want to trade into longer duration assets) then competition will drive offered bond lending rates lower, leading to bond lending beating out bank lending, thus limiting expansion of the money supply until an equilibrium is reached. And the converse, if the money supply is “too small” (not enough savers want to trade short duration assets for longer duration ones) then banks will “pick up the slack” by doing the lending instead. This does create money, and once there is “enough”, then the equilibrium will again be reached.

     Hence my conclusion that the existence of bank lending has little effect on the growth in debt (assuming fraud etc are just as likely at lending intermediaries as at banks), but does allow the private sector to determine how big a money supply it wants, to satisfy its liquidity preference. It’s a kind of automatic mechanism for calibrating the asset duration mix, a bit like automatic stabilizers that partially calibrate the demand (flow) level of an economy.

     Of course the private sector can’t control the duration mix of government liabilities that it holds, only the government can, but I’m arguing it can decide how much extra “money” (short duration assets) it wants ON TOP OF this base provided it by government, so the flexibility falls within a range.

     Apologies if Bill or others have covered this before, but I haven’t noticed it. And as always, tell me if I’m wrong. I could be, but there does seem to be evidence from Japan that post-QE (which is a forced change of asset duration mix performed by the government), bond issuance grew amid bank loan contraction, as the private sector tried to adjust back to its desired level of “money”.

231. Robert or Stone (or others),

     Apologies if you’ve already seen, but I wonder if this might be helpful in visualizing the way bank loans increase the money supply and other effects, and maybe it will help in understanding my 2:59 comment:

     http://econviz.com/balance-sheet-visualizer.html

232. To clarify my long comment above, I do think the one situation where the removal of bank lending from the system would have a material effect on growth of debt is with an “insufficient” supply of money (not enough savers wanting to trade short duration assets for long duration assets at any given point of time), then the ability of borrowers on aggregate to expand aggregate demand would be limited. (But longer term rates might adjust upward to partially compensate, at a higher cost to borrowers?)

     Thus I’m not sure this is a benefit given that demographic expansions are often best served by the private sector self-determining its rate of demand expansion (as long as you use fiscal policy to limit bubbles, as Bill advocates). You could probably handle it with smart government policy (like a job guarantee, or maybe just issuing enough of the government liability mix at the short end of the curve to induce more private bond-like lending) but it might be trickier in some ways.

233. Gamma @1:05:
     “I have money held in term deposits as well as savings accounts accessible at 2 day’s notice. You are trying to say that neither of these constitutes money – most people in the wider community as well as most economists would disagree with you. They are both forms of money.

     So using your definition then, the only thing you consider to be “money” is physical cash, and balances held in transaction accounts, is that correct?”

     Not necessarily.

     Historically there have been periods when time deposits have been used by banks as a device to enable them to issue greater volumes of credit, due to reserve requirements for time deposits having been made less stringent while for the borrower the advantage was a better rate – so both parties were happy, unless there was a bank run. What actually happened when there was, was that 30-day time deposits were treated not one whit differently than demand deposits, thus making it plain that that was what they had really been all along – ie money.

     I’m aware that there’s a tricky conundrum which would need resolving (in what must unavoidabably be an arbitrary way, I imagine) around where the line would be drawn in regard to time deposits. And by the way it’s a pretty abrupt switch you’ve made between 12 months (which was the term in your original question) and the 2 days’ notice you’ve now introduced.

     I’m going to dodge that one. I don’t believe it to be a “make or break” issue and I’m not equipped to deal with it competently anyway.

234. hbl @2:59:
     “To reiterate, it seems like what Robert and Stone are describing is exactly the system we have today, but with banks no longer allowed to make loans. I’m not sure why it’s any more complicated than that, other than spelling out what types of regulation, government guarantees, and government liquidity support are needed. You can rename the banks “giro banks” and expect that they’ll need to charge a service fee as their other sources of profits are reduced. Their assets are still vault cash or electronic reserves, and their liabilities are still customer deposits. I’ll link to a visualizer of this in a second comment (since it will be delayed by moderation).”

     Perhaps I’m just dense but I don’t altogether recognize this as a description of what I’ve put forward. What JKH for convenience dubbed “credit banks” would be able to make loans. That would be what they existed to do.

     Secondly, you would not be renaming these banks as “giro banks”. They would be entirely separate operationally from such deposit-taking institutions (termed by JKH “deposit banks”, but “giro banks” will do just as well).

     The deposit banks would have the assets and liabilities you describe and it is they who would not be permitted to make loans.

235. Robert @ 3:31,

     In my mind we are talking about the same thing, I probably just picked up on the wrong terms from all the prior discussion, sorry…

     These “credit banks” as JKH said are “not allowed to take deposits”. I understand their has been some discussion as to whether they are funded by pure equity (share issuance) or by long term liabilities (like bonds). Either way I’m arguing that this is the type of institution we already have to do lending that involves no money creation… e.g., securitization vehicles, Fannie and Freddie, etc. With proper regulation you could let them evolve in whatever way and form served the public best.

     And as for “deposit banks”, I realize they take deposits and don’t issue loans. That’s why I was arguing they are functionally equivalent to our current banks after you take away their ability to make loans.

     This feels like again a terminology thing and it would be so much easier with everyone around a whiteboard… but I could be the one missing something on this point.

236. VJK,

     Are you saying that in the pre-Fed era the banks simply had bi-lateral credit risk exposure with each other?

     I.e. if bank A owes bank B funds and can’t find the money to pay it, bank A is overdraft with bank B, whatever the amount?

     Do you know the nature of the funds that the banks used to make payments to each other?

     (i.e. what was the payment form compared to today’s fed funds?)

     Or did they settle up imbalances every day with claims on gold stored somewhere?

     I’m completely unfamiliar with this.

237. hbl 3:48,

     That’s about right, I think.

     I compared Robert’s (and my) split between deposit banks and credit banks to today’s split between banks and non-banks.

     From today’s starting point, the deposit / credit bank split moves more stuff (loans and non-deposit liabilities) from banks to non banks, and specifies reserves as the only remaining assets and deposits as the only remaining funding.

238. Hbl”And the converse, if the money supply is “too small” (not enough savers want to trade short duration assets for longer duration ones) then banks will “pick up the slack” by doing the lending instead. This does create money, and once there is “enough”, then the equilibrium will again be reached.”

     -thanks for that very clearly explained point. How I came to this was from the standpoint that financial speculation has a limitless demand for money because it makes money from money (by buying low and selling high in volatile markets). As such, with that positive feedback loop, the banks will engage in ever escalating money creation. Because of this, a fixed stock of money must be imposed rather than letting things sort themselves out since rather than sorting out to a happy medium they sort themselves out to an exponential crisis. My hypothetical reform idea was to have a circulating fixed stock of government created money (with an asset tax and citizen’s dividend to keep it circulating) and no private money creation. That would lead to a scarcity of money for investment so as to prevent speculation and instead favour investments that earnt a yield.

239. JKH and VJK, the description VJK gave fits in with what I thought. I thought that, for instance, the internet was specially designed to NOT be centralised precisely so as to avoid systemic failure. In this age of rapid electronic communication I don’t see why there need be credit risk between giro banks. Payment could literally be a transfer of actual electronic files each representing a unit of money. There would not be any delay between a transaction being authorised and settlement being completed (I hope my terminology is ok). I used the payment by cell phone talk time transfer in Kenya as an example of where just that is done. I think interbank lending and a central bank are counterproductive to the social purpose of banking. I don’t see why banks couldn’t be very very simple, risk free private utilities that employed no more highly educated people than say fast food chains did and that formed much less than 1% of GDP :).

240. JKH:
     “But I’ve been assuming all along that we were talking about private bank money – i.e. the money that bank customers hold in their accounts with private banks.”

     You were right, I have been.

     “In this case, it appears to me that you are talking about central bank money – i.e. the money that banks hold in their accounts with central banks.”

     Ah. The proposal doesn’t distinguish between the two. I appreciate that this may seem heretical, but I ask you to recognize that the proposal is expressed in everyday language – because it has to be to be communicable to the man or woman in the street (and their MP, come to that).

     This is the selfsame principle that I’ve been trying (and failing) to get Tom to acknowledge. I would certainly concede to Tom’s view that it would make my task easier here in a purely utilitarian sense if I were able to teach myself to speak the lingo.

     I have two reasons though for not attempting that. The first is that life’s too short. The second is that I hold strongly as a matter of principle that the onus is on specialists to use English, not their own private language, if they desire to communicate their ideas to a wider public (and not the other way around), not least when their ideas – as in MMT’s case – purport to be motivated by concern for the public good. I’ve reached impasse with Tom about that.

     May I try to clarify my meaning in the passage you cited (above)? Please understand that for me the concept of “central bank money” (and the whole field of reserve accounting) is unfamiliar. As I see it, the money which the credit banks under this proposal would be required to hold in their investment pool accounts at the CB (as well as of course their own capital held in their operational accounts) would be their own, not the CB’s. The CB functions as a central clearing-house changing numbers in its spreadsheet reciprocally up and down in the respective accounts to effect the movement of money from one to another. But none of the money thus moved around is the central bank’s money (I’m ignoring emergency injections of liquidity by the CB to overcome shortlived crises).

     So long as any money loaned (ie which creates a deposit) is matched by a corresponding changing of a number down in the investment pool account of the lending bank, existing money is merely being moved from one CB account to another and no new money is being created by that loan.

     For my part I can’t see anything in the foregoing sentence which implies a sense of the word “money” different from that in which it is used in common parlance. I’m sure if you disagree with that statement you’ll say so, and why.

     “Private banks do not have the power to create or destroy money in their accounts at a central bank – merely as the result of making a payment in respect of a customer transaction (the only exceptions to this are transactions to purchase or redeem physical central bank notes or currency, and tax payment transactions – but leave those aside for now because those are very special cases).”

     I had understood that and had not seen my formulation as being in conflict with it. Does my elucidation enable you to concur?

     “On the other hand, deposit money created by banks has increased in your example. And since that is the only money over which the private banks have control over the power of creation, I always assumed that was precisely the type of money creation you were attempting to stop.”

     Yes, but I’m not seeing any new money as having been created by the loan in the universe as a whole (as it is under the present system), since a sum corresponding to the loan is simultaneously being deducted from the lending bank’s balance in the CB master-spreadsheet.

241. I just heard the BBC radio4 history of the world in a hundred objects (awesome series, well worth checking out and is on the web) which has now got up to the present day and choose an HSBC Islamic credit card. Does anyone on here now what Islamic banking is and whether it resembles giro banks or what?
     PS That series has many types of money scattered through the series (eg the first gold coins, Viking chopped silver, spanish pieces of eight, the first ancient chinese paper money etc).

242. Robert,

     Responding to your earlier at Thursday, October 21, 2010 at 21:15,

     Reflecting more on your original question, I’m not sure I can defend the right of credit banks to create money. But I can’t really condemn it either.

     The fact that credit banks issue money is relevant to the issue of the supply of money and the control over it.

     The fact that credit banks have balance sheets that include risky assets along with deposits is relevant to the issue of the safety of money. FDIC assures that safety at the risk of some residual cost to the taxpayer.

     Low cost deposits are a form of inexpensive leverage and contribute to return on bank capital. The alternative of moving all deposits into 100 per cent reserved deposit banks would force credit banks to issue higher cost liabilities. That in turn might put upward pressure on loan rates, since banks still have to cover the cost of capital.

     I think the MMT approach to the question has several prongs. The first is that MMT views inflation as a dynamic that is driven by a mismatch between aggregate demand and the availability of real resources. It does not view inflation as the result of an excess stock of money. So on that count, I guess MMT would be agnostic on the issue of whether or not credit banks should have the right create money, I think. Second, MMT views prevailing monetary policy as being driven by the price of money – i.e. the interest rate – and views the central bank as controlling price. Again, the stock of money or the stock of bank reserves is not the issue. Price is the issue. Third, one MMT proposal favoured by Mosler and Mitchell proposes that conventional monetary policy be abandoned. It proposes that the government spends but does not issue bonds and instead creates commercial bank money and matching central bank reserve money as the direct result of deficit spending. It would set interest rates at zero permanently. The government would use tax policy instead of interest rate policy to control aggregate demand when necessary. Taxation becomes the “thermostat” for policy control.

     I think these are all rationales for why MMT would not be particularly sensitive to the issue of the supply of money in general. Combine these with the Mosler/Mitchell type proposals for other banking system reforms, and you have the rationale for allowing private banks to continue to create money by lending.

     But that doesn’t really answer your question in the sense that it doesn’t provide the downside of switching to a system of deposit banks and credit banks. At the same time, I don’t see a sufficiently forceful argument yet demonstrating that we should switch to such a system. So at this point, I’m caught in the middle, which is status quo on the issue.

243. stone @5:40 said “How I came to this was from the standpoint that financial speculation has a limitless demand for money because it makes money from money (by buying low and selling high in volatile markets). As such, with that positive feedback loop, the banks will engage in ever escalating money creation.”

     Thanks for clarifying your rationale. While I agree that excess debt-fueled speculation is a problem, what I tried to explain above is that I’m not certain that removing the ability for banks to make loans of the money creation sort would make much difference in reducing speculation. One illustration of this I mentioned was that there is $52 trillion in horizontal debt, only $6.8 trillion of which is bank loans (for which money was created). So the bond-like types of lending are already dominant. Even Steve Keen whose main focus seems to be on the perils of debt-fueled speculation (as described by Minsky) hasn’t publicly suggested eliminating bank loans, but has suggested other regulatory measures for limiting speculative borrowing (of all types) instead.

     One implication of your wording might be that banks are lending to themselves for speculative investment purposes. While that does (I think) happen now, I think all MMTers want the hedge fund type functions stripped from banks, so I don’t think they’d disagree with that.

     As my 3:11 comment suggested, I do think there are circumstances (but not in all cases) where a no-bank-loan policy would reduce aggregate expansion of borrowing… but without fiscal policy to target speculation directly, how do you make sure that the lending that does happen in that situation favors the new college graduate needing a loan for a new car to drive to work versus the loan to a leveraged hedge fund? Such an approach seems like another example of what Bill refers to as a “blunt instrument”.

244. JKH:

     Re: “Are you saying that in the pre-Fed era the banks simply had bi-lateral credit risk exposure with each other”

     Quote:

     During the period 1837-1913, the United States did not have a central bank.

     Correspondent banking thus provides the possibility of economizing in the payments process by multilateral netting, which reduces the need to make actual money transfers even below the level that would be required under bilateral netting.
     (“Interbank Settlement and the Emergence of Central Banks”, at minneapolisfed dot com)

     Re. interbank medium: Before the Reserve Banks provided a streamlined interbank settlement service, there was a large, direct cost in the form of expensive shipment of currency or gold. (ibid)

     So, it was mainly gold in the old times I imagine with the “expensive” part being somewhat exaggerated given the source. Nowadays, it is not too challenging, given the desire to do so, to devise other than gold reliable medium of exchange as interbank money. JPM and Mellon cope with repos clearing quite well, Treasuries playing the role of gold..

     Are you saying that in the pre-Fed era the banks simply had bi-lateral credit risk exposure with each other?

     Not necessarily, if they used the DvP(delivery vs payment) in repos parlance. The banks that trusted each other could use FoP (free of payment) thus granting a credit.

     “Where there is a will there is a way” 😉

245. hbl:

     Do you have the original, not some other web site, source for this:

     there is $52 trillion in horizontal debt, only $6.8 trillion

     I vaguely recall the number, but it may have been “42” for all I know.

246. VJK,

     You’re right, I shortcut by using the FRED2 data and forgot I needed to subtract out government debt. My mistake. The horizontal debt is closer to $42 trillion.

     http://research.stlouisfed.org/fred2/series/TCMDO
     (Check the Fed Z1 release, table L.1 for details)

     http://research.stlouisfed.org/fred2/series/LOANS

247. Robert at Friday, October 22, 2010 at 6:15,

     Just one quick point of clarification for now:

     “As I see it, the money which the credit banks under this proposal would be required to hold in their investment pool accounts at the CB (as well as of course their own capital held in their operational accounts) would be their own, not the CB’s.”

     I understand that and agree.

     My terminology “central bank money” was not meant to connote “the central bank’s money”.

     It was meant to identify money that the central bank issues as an (accounting) liability but that is held as an asset by the credit banks/deposit banks.

     E.g. people sometimes refer to the notes or currency issued by modern central banks (e.g. $ 20 bills) as “central bank money” even though it is clearly held by the public as an asset. The same terminology is used sometimes for the type of money that is held by banks in their reserve accounts at the Fed.

     I’ll get back somewhat later on the rest. I see something now in your banking configuration that I hadn’t seen before – something that is quite interesting.

248. VJK,

     Thanks for the info.

249. VJK and JKH

     Yes, you obviously can have and have had systems without central banks. However, those systems also are far more prone to crises in payments systems, which are very easily avoided when there is a central entity with the power to provide overdrafts that does not have to worry about its own profitability. Also important is not being constrained by gold standard or currency board-like rules–so, even with a central bank, the US still had a depression that started in 1929. That’s the core point. Y2K, 9/11, fall 2007, and especially fall 2008 are just the most recent examples of rather rather quick (though, maybe not so quick in fall 2008) diffusion of payments system crises that could have created far larger problems that may not have been possible without a central bank able to provide such overdrafts without concern over its own profitability. And we also know that the period 1937-1913 experienced quite a few such crises.

250. Scott,

     Makes perfect sense.

251. Scott:

     However, those systems also are far more prone to crises in payments systems, which are very easily avoided when there is a central entity with the power to provide overdrafts that does not have to worry about its own profitability.

     Of course, I disagree, and the 2007 crisis is a clear enough evidence of how badly broken the current system is.

     In my opinion, it is broken beyond repair, since the design is inherently flawed by any commonsense measure.

     I won’t belabor the point, though, as it is impossible, experimentally, to show superiority or otherwise of any alternative system.

     One would hope that the next fin crisis is not going to happen too soon…

252. JKH:

     Makes perfect sense.

     Perhaps, in Canada, but not elsewhere.

     There are only two or three banks that matter there.

     Or used to be.

253. VJK,

     So, a payments system without an entity willing and able to provide overdrafts without concern over its own profitability is just as stable as one with such an entity?

254. Robert:

     “I’m aware that there’s a tricky conundrum which would need resolving (in what must unavoidabably be an arbitrary way, I imagine) around where the line would be drawn in regard to time deposits. And by the way it’s a pretty abrupt switch you’ve made between 12 months (which was the term in your original question) and the 2 days’ notice you’ve now introduced.

     I’m going to dodge that one. I don’t believe it to be a “make or break” issue and I’m not equipped to deal with it competently anyway.”

     I’m not exactly sure what your point is. And with all respect, it seems like you aren’t quite sure either. This is how I think about the money supply, maybe you could relate your objections to it.

     There are many “forms” of money, and they all have slightly different characteristics but yet still function in some way as money in the economy. It is not a black and white thing. It would be nice to say “this is either money, or it is not”, (similar to a comment you made above), but unfortunately it isn’t so. It is more like a spectrum ranging from things which are obviously and undeniably money, to things which are better described as “money-like” or “quasi-money”.

     So this is how I see it:

     These things are considered part of the money supply (ie M0, M1 etc):

     -Currency – physical notes and coins in circulation
     -Transaction account deposits – can be used to make payments in or withdraw cash from the electronic payment system
     -Savings account deposits – cannot be used to make payments or withdraw cash, but available to move to a transaction account at short notice (typically 1 or 2 days)
     -Term Deposits – deposited for a fixed term, but can be actually be withdrawn early for a break fee

     These things are not considered part of the money supply but are very important parts of the way the money markets function:
     -Reserve balances at central bank
     -Goverment bonds and semi-government bonds (quasi-money)

     Then you get to things like deposits with money-market funds, which look very similar to term deposits but are often not considered as part of the money supply, and the list can go on.

     So which forms of bank-created money do you object to?

255. hbl:

     Thanks for the info. It’s been a while I looked at the exciting Z1.

     Anyway, with respect to the perceived minor role of the commercial bank in the debt structure.

     In the shadow banking system, the securitization process starts with a depositary institution of some kind (C-bank, credit union, whatever), known as the “originator”, as it is the only point in the system where credit can be created.

     So, the cancer starts at the depositary institution/originator and spreads thence.

     So, if one want to kill the CDO, ABS beast, it should be nipped in the bud, as it were, at the depositary institution.

     Reasonable people may differ on the desirability of nipping.

     Disclaimer: I am no expert on securitization and may be off base, but that’s my understanding with respect to the origination point.

256. Scott:

     I’d argue that yes it would be more stable provided that:

     (1) stock of interbank money is constant regardless of its nature

     and

     (2) the system implements either:
     (a) no-maturity transformation bond/loan pools with some L/S risk passed partially or entirely to the investor
     or
     (b)JKH’s equity funding

     (1) by itself is not much help obviously.

     I do not think, but may be wrong, that a clearer or multiple clearers is required at all. Assuming it is, arguably, there is substantial experience the repo clearers to make use of their experience. Apparently, the fees the private repo clearers charge is quite palatable to the counterparties if that’s your worry.

     I am not sure about Selgin’s “free banking” proposal at this point.

257. VJK,

     I was aware that the securitization process often began with bank loans, but wasn’t sure it was exclusively that way (versus an originator who might “skip” in some sense having the debt ever exist in loan form). But assuming you are correct (likely), then it appears my previous statements about the proposal looking like “today’s system minus bank loans” are probably false due to that constraint in the process (which I assume must be a regulatory one). However, assuming you changed regulations to allow long-duration-liability-plus-long-duration-asset lending vehicles in the absence of bank loans, I still think the outcomes might look similar.

258. VJK,

     I guess it depends on what you mean by “cancer”. Credit is created each time a firm sells a bond or stock. It does not need to originate with bank deposits. Blackrock and KKR are not banks. Until recently, GE capital was not a bank, either. They sell bonds instead of accepting deposits. In the 1980s, we had an LBO mania that was funded by junk bonds and private equity firms, when depository banks were still prevented from participating in these markets. We also had a .com stock bubble.

     The reason why “banks” are so central now is because of consolidation, which is due to the lower cost of funds and presumed government backstop enjoyed by the depository institutions, not because functionally a deposit is necessary for credit creation to occur.

     But if you then pull the banks out of those markets, the markets themselves wont disappear. If there is money to be made by selling shorter term liabilities and buying pools of credit card debt, then someone will do that even if you don’t let the banks participate.

     It would be done by different players who would face higher funding costs. You can argue that they would face greater leverage restrictions due to “market discipline” than banks do, and so the problems would not grow to be so large. On the other hand, market discipline is very fickle. The system of market based credit creation, including maturity transformation, is not only older than deposit-based credit creation, but has historically been much larger. It wont disappear if banks are not allowed to dominate it.

259. hbl:-“One illustration of this I mentioned was that there is $52 trillion in horizontal debt, only $6.8 trillion of which is bank loans (for which money was created). So the bond-like types of lending are already dominant.”-
     Sergei has also brought this up on this thread. It is for this reason that I consider an essential part of any such hypothetical reform to be a change in commercial law such that you can only gain legal ownership of something if you pay for it in cash. So under the reformed system if one person had a bond and the other had a share, then in order to swap them with each other, they would both need to get hold of cash to by them. In that way availability of cash would always be a limiting factor to financial expansion. There would need to be some legal minimum time that cash transaction were conducted in (eg 1hour) so as to prevent flash nano second duration cash transactions or any such nonsense. I hope I’m not in too much of a muddle about this.

260. hbl “While I agree that excess debt-fueled speculation is a problem, what I tried to explain above is that I’m not certain that removing the ability for banks to make loans of the money creation sort would make much difference in reducing speculation”.-
     Another critical part of the hypothetical reform reform would also be to shift all of the tax burden onto being a flat tax on all gross assets (eg cash, real estate, shares bonds etc). That would encourage things to be owned out right because the overall tax burden would then only be half that of the same physical asset bought via a matching financial asset (such as a bond). It would also stop assets from attaining a value disproportionate to their earning potential.

261. Gamma @10:25:
     “These things are considered part of the money supply (ie M0, M1 etc):

     -Currency – physical notes and coins in circulation
     -Transaction account deposits – can be used to make payments in or withdraw cash from the electronic payment system
     -Savings account deposits – cannot be used to make payments or withdraw cash, but available to move to a transaction account at short notice (typically 1 or 2 days)
     -Term Deposits – deposited for a fixed term, but can be actually be withdrawn early for a break fee…

     “So which forms of bank-created money do you object to?”

     So far as I know, there is only one form of bank-created money:- that which is added by banks to transaction account deposits whenever a loan is made.

     My working assumption is that that’s the sole channel through which bank-created money enters into the money-supply. (I seem to remember JKH referring in passing to a bank “cutting a check” instead of creating a deposit, where the borrower has no account; I wouldn’t see that as being any different in kind).

     But if there are in fact other forms of bank-created money (which your wording implies that there could be) and other channels through which that enters the money-supply, you will no doubt tell me what they are.

262. hbl “how do you make sure that the lending that does happen in that situation favors the new college graduate needing a loan for a new car to drive to work versus the loan to a leveraged hedge fund?”-
     -I think both the car loan and the leveraged hedge fund need to be consigned to the dustbin of history. The new collage graduate should get the bus until she has saved for a car and then get a 10 year old second hand car that can be paid for out of one months savings :). Debt fueled consumerism is destroying the planet let’s face it.

263. JKH “But that doesn’t really answer your question in the sense that it doesn’t provide the downside of switching to a system of deposit banks and credit banks. At the same time, I don’t see a sufficiently forceful argument yet demonstrating that we should switch to such a system. So at this point, I’m caught in the middle, which is status quo on the issue.”
     -I think a critical point to keep at the forefront of our minds is the immense cost of the current banking system. Any argument in favour of the status quo has to factor in the fact that the FIRE sector has grown to be a huge chunk of the economy. If all the average Joes were forced to pay one third of their earnings to pay for the brightest and best to have pillow fights 24/7 then would be saying “what’s the harm in that” as you seem to be doing.

264. Robert at Friday, October 22, 2010 at 6:15,

     Let me play back my understanding of the system you propose:

     The objective is to prohibit private banks from creating money, and to achieve that by designing a system whereby deposits are effectively 100 per cent reserved.

     I’ll assume a single commercial (i.e. private) bank that offers both deposit and lending functions.

     The bank takes money on deposit from customers and that money is put directly on deposit at the central bank. Your view of it is that the customer deposit with the commercial bank is essentially the same as the commercial bank’s deposit with the central bank. Effectively, the customer has a deposit with the central bank.

     I understand that view now, and would characterize it as the commercial bank playing the role of agent in accepting the customer’s deposit and passing it through to the central bank. The role would be similar if the commercial bank were accepting a deposit of gold and placing it on deposit at the central bank as agent for the customer.

     So, the idea of 100 per cent reserves against deposits equates to the idea that the customer deposit is passed through to the central bank.

     With regard to the credit function, I’m going to modify slightly what I think you presented based on our previous discussion of it.

     First, the commercial bank makes loans under the credit function and books those loans as assets.

     Second the commercial bank has an additional account with the central bank. This account is used to hold money that the commercial bank uses for its own transactions, in contrast with the first account which represents the agency pass through of customer funds.

     I characterize this as the commercial bank playing the role of principal when using this account for its own transactions, and agent when using the other account on behalf of customer depositors.

     So in summary the commercial bank holds two accounts at the central bank. It uses one as agent for customer deposits; the other as principal for its own transactions.

     What I’ve called the principal account is what you’ve called the “investment pool account”. I’m going to stick with the principal account label for it.

     There was some question in our discussion about whether there might be a third account. I’ll bypass that for now. I think two accounts may be adequate to achieve your objective. Also, remember there is a loan account, which I do not view as an account with the central bank. It is simply a record of the loan made to the customer.

     The agency account may be viewed as a reserve against customer deposits, although you state that you view the account at the central bank and the customer deposit with the commercial bank as essentially the same thing. I think the two interpretations are fungible with each other.

     We can now run through the type of transaction you illustrated. The commercial bank makes a loan and pays the borrower with funds from its principal account at the central bank. Either the loan recipient or a subsequent payee deposits those funds with the commercial bank. The deposit of those funds with the commercial bank then becomes a deposit in the commercial bank’s agency account with the central bank.

     In this example, these flows occur within the same bank. One can view it as a flow of funds between two accounts at the central bank or a bookkeeping entry that redistributes the record of funds between those two accounts. Either way, there is a movement from the principal account to the agency account, although there has been no net change in the totality of deposits that the commercial bank holds with the central bank in total. Conversely, in an example where the bank of deposit is different than the lending bank, there would be an interbank flow of funds that resulted in a reduction in the lending bank’s principal account, and an increase in the recipient bank’s agency account.

     The new customer deposit that has been created as a result of lending is backed by 100 per cent reserves in the form of the deposit pass-through with the central bank. Again, you view that arrangement as equivalent to the interpretation that the commercial bank’s deposit with the central bank is the same as the customer’s deposit with the commercial bank. That interprets as the customer’s deposit being 100 per cent reserved.

     Finally, it’s my understanding that you characterize either type of deposit at the central bank as money. I think it helps to be explicit about that.

     So I agree with your example assuming my interpretation is correct. I hope I’ve finally understood your intention here, and that you are OK with the description and the language I’ve used.

265. Doesn’t government created high powered money provide the critical backstop to the entire edifice of $42T of private horizontal credit creation? Faith in the asset values driven by the horizontal credit creation depends on purchasers nervously considering how far horizontal credit creation has pushed out from the minimum to which prices could fall. If it is widely accepted that global levels of high powered money are due to increase decade on decade for the forseable future, then it becomes a safer bet to borrow money now to make speculative investments that ride out the asset price inflation that is sure to come. It is that ponzification of the global economy that is leading to everything becoming so deranged.

266. A lot of people have correctly pointed out that the idea of 100% reserve banking has a monetarist/Austrian connection. In this regard, I found a wonderful quote by Joan Robinson recently on the equation MV = PQ:

     If the quantity equation had been read in the usual way, with the dependent variable on the left and the independent variable on the right, though rather vague, it would not have been silly

267. RSJ:

     I guess it depends on what you mean by “cancer”. Credit is created each time a firm sells a bond or stock.

     By “cancer” I mean uncontrollable or controlled by the wise Fed, through the interbank interest rate manipulation, credit expansion. Such credit is created ex nihilo and relies on maturity transformation for its funding. Let’s call it keynesian credit, or K-credit.

     Credit is created each time a firm sells a bond or stock.

     Ah, but that is a dramatically different kind of credit. It is created out of existing stock of cash and does not involve any maturity transformation. To put it simply, the investor can buy the bond only if he has cash — you spend what you have. The same with stocks, obviously. The investor plays the role of the misesian bank:

     The credit that the bank grants must correspond quantitatively and qualitatively to the credit that it takes up

     Let’s call this kind of credit misesian credit, or M-credit.

     I do not believe that any of the examples you gave is K-credit. I think all of them are M-credits.

     Should the backbone of the financial system be K-credit institutions relying on explicit or implicit government put options, i.e. bailouts?

     One would imagine the answer would “no”.

268. Wonderful quote, Ramanan

     Forever backwards

     What a profession

269. Ramanan:

     Who cares about the equation ?

270. “Who cares about the equation ?”

     The monetarists.

     They have it written on their foreheads.

     Even though they’re the only ones who listen to each other. It’s quite a party.

271. VJK So, “the cancer starts at the depositary institution/originator and spreads thence.”
     To me the real start of the cancer is one step back from that with expansion of high powered money by government. It is the sure anticipation of further such expansion that drives the asset price ponzi inflating process.

272. I really think that the way economists pigeon hole concepts into belonging to “schools of thought” is a millstone that severely hampers progress. In my view it provides a lazy get out to avoid the discomfort of facing up to each piece of data or model for interpretation with an open mind. Other fields do very well without any “schools of thought”. No one responds to say molecular biology with reference to whether they align themselves to say the “Chicago school” or “Singapore school” of molecular biologists or any such drivel. Everyone involved squares up to the data and tries to make sense of it even if that means disposing of the body of concepts they have spent years developing. Most people involved in such fields actually want to have their understanding turned on its head. I just wish that the 2008 financial crisis had been taken by the economics profession more in the way that a major slew of new data would be in other fields.

273. JKH:

     The monetarists.

     Oh, thanks.

274. JKH: “I hope I’ve finally understood your intention here, and that you are OK with the description and the language I’ve used.”

     You have, and I am. Thanks!

     Is there a catch? 🙂

275. stone: -I think both the car loan and the leveraged hedge fund need to be consigned to the dustbin of history. The new collage graduate should get the bus until she has saved for a car and then get a 10 year old second hand car that can be paid for out of one months savings  . Debt fueled consumerism is destroying the planet let’s face it.

     The simplest solution here is an ancient one – make interest illegal. Several religious traditions did this, including Christianity. Interest is still not permitted in Islam, and Islamic banking is a religiously accepted way of dealing with this limitation. Another is the Jubilee, the cancellation of debt after a certain period. In ancient times, this period was fifty years, roughly corresponding approximately to the long financial cycle that Minsky described.

276. Robert,

     I figured you’d be perceptive/instinctive enough to ask about a catch.

     There is a very minor one – no big deal, just a reflection of sorts – it doesn’t change the fact that I finally understand what you’ve been describing.

     I’ll return somewhat later on it as a footnote.

277. Tom Hickey:
     Friday, October 22, 2010 at 0:37

     “Robert: Do I make my point?

     No.”

     Let me ask you this then:-

     Imagine a debating-society amongst the rules of which is that, although its members’ mother-tongue is English, all proceedings are to be conducted in latin.

     Imagine that one day the hon, sec. receives a letter from the local planning authority telling him the lease which the society has with the Council will not be renewed, because it is planned to demolish the building and build a pickle-factory on the land.

     The society’s members hold a meeting and after heated debate (in latin of course) decide to launch a campaign aimed at arousing sufficient public indignation to deter the Council from carrying out its plan. To achieve this aim it will be obvious to them that they will need to explain to the public the society’s purposes and to succeed in convincing the public of its relevance to the needs of the local community.

     Would they conduct their campaign in latin?

     Because that would be analagous to what you’re telling me that MMTers can and should do.

278. stone: It is for this reason that I consider an essential part of any such hypothetical reform to be a change in commercial law such that you can only gain legal ownership of something if you pay for it in cash.

     Sorry, when you start talking about changing commercial law in the capitalistic world to a cash only basis for contract enforcement you really lose me.

279. JKH,

     Yes forever backward. Even the supply demand diagrams. The x-y coordinate system was invented by mathematicians and they would represent curves as y = f(x). Economists do it the opposite. They have p in the y-axis and have supply/demand on x-axis and have S=S(p). Thankfully, non-mainstream knows the limitations of supply-demand analysis.

280. VJK,

     The Bank of England I guess is the oldest central bank. The open market desk or whatever they called it in the early 20th century understood that central banks cannot control the money supply. Sir Dennis Holme Robertson who used to work at the BoE wrote a book in 1922 called Money and mentions this. And you know what – Mervyn King the present Governor – said this recently

     The Bank of England’s key role has always been to ensure that the economy is supplied with the right quantity of money – neither too much nor too little. For fifty years, my predecessors struggled to prevent there being too much, so leading to inflation. I find myself in the opposite situation having to explain that there is too little money in the economy. But, in the wake of the financial crisis, and the sharp downturn that followed, the amount of money in the economy as a whole – broad money – is now barely growing at all. That is restraining activity and pushing down the outlook for inflation. So the Bank of England has taken extraordinary monetary policy measures – through our so-called “quantitative easing” programme of asset purchases – to ensure that the amount of money starts growing again in order to support a recovery and keep inflation on track to meet our target in the medium term.

281. Other fields do very well without any “schools of thought”. No one responds to say molecular biology with reference to whether they align themselves to say the “Chicago school” or “Singapore school” of molecular biologists or any such drivel.

     Not exactly true. However, these disagreements eventually get sorted out when the field drops one set of terminology in favor of another. I was just reading a paper by evolutionist David Sloan Wilson describing this and accusing another well know scientist of being a lone stick in the mud that the field had passed by.

     In economics, however, these disagreements can persist for a long time, and they are often decided not by open debate and appeal to evidence, but by politics, e.g., who gets the Harvard or Chicago endowed chairs.

282. Robert @2:31

     The important difference is that you are the one who chose to critique MMT, not the other way around.

283. JKH @ Friday, October 22, 2010 at 22:29

     JKH and Robert,

     When you talk about “customer deposits”, are you only referring to demand / transacton account deposits, or do you include term and all other deposits in this?

     If you mean that only transaction account deposits must be backed with 100% reserves, then this proposal is not that different to the banking system as it exists currently.

     For example in Australia, the entire banking system contains around 1250bn of bank deposits, but only about 200bn of this is in demand deposit accounts. The banking system has about 75bn of reserves / govt bonds, around 40% of the level you want.

     On the other hand, if the proposal is that all deposits must be backed with reserves, then this is a radical change that would essentially eradicate banking as we know it. All bank lending would be have to be funded from equity.

284. Tom Hickey “Sorry, when you start talking about changing commercial law in the capitalistic world to a cash only basis for contract enforcement you really lose me.”-
     – My wake up call about our commercial law came when the Fair Pack Christmas saving scheme collapsed here in the UK. Fair Pack was a long established pre-payment scheme where people paid a small amount at regular intervals through the year and then got goods at Christmas. The people who ran it had a side project and that lost the money of the savers and so when Christmas came their was no money left. There was no legal protection of the savers money because our commercial law does not protect prepayments. Our commercial law is all about enforcing credit contracts.
     Basically our commercial law is set up as a charter for credit expansion. I find it very hard to summon much respect for our commercial law.

285. Robert, you have arrived at a site where people are speaking a technical language based on accepted operational definitions in the fields of national accounting, monetary economics, finance, and money and banking. Instead, you want to impose your own imprecise concepts as a norm of the universe of discourse.

     You object that MMT’ers are not addressing the common people. That is basically true. The MMT’ers are economists who are operating in their field, writing papers, teaching at universities, working in finance, etc. The MMT economists are speaking and writing for the profession. That is their job. Financiers knowledgeable in MMT are busy trading, and this gives them an advantage. Why should they share it? The failing as far as the common people are concerned is that the press has failed to pick up on important addition to the policy debate.

     Since when do professionals operate in their field gratis? MMT’ers are not getting paid to advocate their position to the common people. A few MMT’ers kindly take time unpaid to interact with interested people on blogs, where they step down the knowledge so people willing to apply themselves can get something of what they are saying professionally. Randy Wray did take the time to write a book for educated non-economists, Understanding Modern Money, and Warren Mosler has just published The Seven Deadly Innocent Frauds, aimed at common people. That’s about it so far. I don’t see that as a failing.

     I have spent a good deal of time on this blog and others assisting others to get these technical concepts based on operational definitions, as other have helped me and continue to do so. But when someone says that they are not interested in learning about what is happening here, e.g., because it requires picking up a technical language that ordinary people done’s understand, then I haven’t got time to deal with that request. To me this is a waste of time, since it is bound to end in confusion.

     For example, you want to define the term “money” as what people can spend (“the common meaning that everyone understands”). You also want to call reserves “money,” even though people can never spend reserves to purchase anything. You say currency = reserves? FRN and coin are not reserves. Reserves are numbers in accounts on spreadsheets. Bank exchange bank reserves to get vault cash, which they distribute to individuals on demand. Reserves never leave the cb spreadsheet, where they are marked up and down on various accounts for settlement. In addition to their settlement function, they act as a liquidity provision in the interbank system (FRS). They have very precise functions operationally that are usually misunderstood and completely misinterpreted by people who don’t know how the system actually works. The operational definitions come from understanding now the system works, and they are crucial to that understanding. To say that one is not interested in them is to say that one is not interested in how the system actually works, but rather in how one thinks the system works, not based on experience.

     I am happy to see that others, especially JKH, are bending over backward to work within your parameters. So I’ll pass the baton to them. JKH is far better qualified than I am anyway.

286. Tom Hickey, theoretical evolutionary biologists are also a bit prone to ideological sectarianism ( evolution by jerks versus evolution by creeps etc). I guess they have the excuse that they have such a dearth of data to work with (the fossil record) and that the devil makes work for idle hands. I think most “how living things work” type molecular biologists genuinely are not prone to pet theories and function much better for it. Also who cares if someone has a chair in Harvard. Einstein did his best work in a patent office. Economists don’t need large hadron colliders or have any such need to kowtow to anyone. They have less excuse for not being free thinking than just about anyone.

287. Ramanan at Saturday, October 23, 2010 at 3:20:

     Yes. I nearly mentioned that one.

     The first time I heard it was on a Steve Keen video. I nearly pee’d myself laughing. In all my years of not studying formal economics, it was the first time I’d heard what surely must be the root reason why.

     Incredible. I still have to think hard when somebody starts talking vertical curves this and horizontal curves that – in supply demand land. It’s nearly as bad as seeing monetarists talk about bank reserves. But nothing else could be that painful.

288. I’m sure this is a very elementary question but from what I can gather everyone on here says that the amount of money in banks does not influence how much they lend. Why then do banks offer 2.75% interest for savings accounts in the UK when base rates are 0.5%? People seem to be saying that if the amount of savings were to increase or decrease 10x then that would have no influence on the likelihood of any credit expansion. If so, then what is causing banks to accept savings at all let alone pay 2.75% interest for them?

289. stone, if you think that the endowed chairs at major universities aren’t the norm-setters and pretty effectively control the universe of discourse and therefore the entire thrust of the discipline at the time, you don’t know how academia works.

290. Tom Hickey “if you think that the endowed chairs at major universities aren’t the norm-setters and pretty effectively control the universe of discourse and therefore the entire thrust of the discipline at the time, you don’t know how academia works.”-
     That only becomes the case if everyone not in that position becomes preoccupied with saying that those peoples ideas are wrong rather than with getting there own ideas more correct. MMTers seem to put more effort into discussing ideas MMters consider stupid than they do towards just about anything else. In say molecular biology when someone realizes a concept or model is not furthering their understanding, they just move on, they don’t spend the next ten years critiquing it.

291. MMTers seem to put more effort into discussing ideas MMters consider stupid than they do towards just about anything else. In say molecular biology when someone realizes a concept or model is not furthering their understanding, they just move on, they don’t spend the next ten years critiquing it.

     MMT’ers are doing both. First, you have to show the weakness of the opposition, then you have to establish you own position, and finally you need to get exposure. It’s happening.

     Bill Black and Randy Wray’s post on putting Bank of America into resolution over the foreclosure meltdown is the front page lede story at Huffington Post right now, and Lynn Paramore is featured on the Business page.

292. Tom Hickey-“MMT’ers are doing both. First, you have to show the weakness of the opposition, then you have to establish you own position, and finally you need to get exposure. It’s happening.”-
     And yet MMT seems entirely complacent about having gaping holes in its own comprehension of the facts on the ground. I’ve entirely failed to work out how MMTers accomodate the $1T USD Yen cary trade up to 2007 into your theory for instance. To me it smacks of MMTers being too complacent and self indulgent to actually critically reassess their pet theories in the light of data as it comes in.

293. Robert,

     As discussed, in your proposed system, commercial banks have several accounts with the central bank. There is a specialized account, which I labelled the agency account, whereby the commercial bank has effectively passed through the deposits of customers on a 1:1 fully reserved basis. I labelled the other account the principal account, which is what the bank uses as a source of funds for its own transactions. This is the account that’s most comparable to the reserve accounts of banks in the existing system.

     Through the agency account, the customer effectively has a deposit directly with the central bank. That’s one interpretation of the 100 per cent reserve system – in the sense that the reservable deposit of the customer equates to the reserve deposit of the bank.

     Thus, under this interpretation, the commercial banks and the public both effectively hold reserve type deposits with the central bank.

     You confirmed that these two different types of deposits held at the central bank correspond to your definition of money.

     The system we have today clearly is not 100 per cent reserved, and the public does not have reserve deposits with the central bank. Required reserves are a small fraction of total deposits in the US and there are no required reserves in Canada, for example. Because of this difference, it’s obviously the case that customer deposits with the banks cannot be the same as bank deposits (reserves) held at the central bank.

     So if these customer deposits and corresponding reserves are different things in today’s system, it must be the case that the same definition of money can’t apply as for your proposed system. In today’s system, customer deposits with the banks and bank deposits with the central bank are either both money, or they’re not. If both are money, then customer deposits are money even though they are not deposits with the central bank. But that’s a different definition than applies in the proposed system. Conversely, if bank deposits with the central bank are not money, that’s different again. And if customer deposits with the commercial banks are not money, that’s different again – because then the customer allegedly has no money, even though the same deposit could have resulted from the same new loan in either system. In all cases, we have a conundrum regarding a consistent definition of money as between the two systems.

     The only conclusion to be drawn therefore is that the definition of money depends on the design of the monetary system. Note that the argument I’ve made does not appear to depend on “expert” language.

     There’s another way of looking at this. Your original objection had to do with the ability of private banks to create money. The proposed design precludes such money creation. The reason it works this way is that private banks can’t create money as it is defined in your proposed system. They cannot create ex nihilo what I referred to earlier as “central bank money”, which is money that is issued as a liability by central banks. Such money includes any deposit that a commercial bank or the public holds with the central bank, such as the principal and agency account funds we discussed in your proposal. It also includes the reserves that commercial banks hold with the central bank in the existing monetary system. Private banks can’t create central bank money – i.e. the money that private banks hold with central banks.

     So the upshot again is that the definition of money depends on the design of the monetary system. Along with your proposed change for the design of the monetary system, the definition of money has changed due to the design change.

     That was the catch.

294. stone: I’ve entirely failed to work out how MMTers accomodate the $1T USD Yen cary trade up to 2007 into your theory for instance.

     I think you are seeing things in the carry trade that aren’t there. I am not knowledgeable in international finance, so someone else who is may be able to clear this up. However, from what I can determine carry trade involve highly liquid financial instrument, since a reversal in the fx relationship necessitates quick exiting from the borrowed currency. Carry trades are not used to purchase RE, which is illiquid. They are used to purchase securities including ABS. The yen carry trade exacerbated the GFC, since a lot of securities that were purchased to take advantage of it had to be unwound.

     I don’t find evidence that the yen carry trade was causal of the GFC by funding it in the way you claim.

295. JKH, VJK

     On your discussion of clearinghouses, I think in the US, banks use CHIPS a lot (Clearing House Interbank Payments System). I do not know how big it is compare to the Fedwire, though. Scott’s paper “Setting Interest Rates In The Modern Money Era” has some discussion.

     “For example, the Clearing House and Interbank Payments System (CHIPS) clears many international transactions and other payments between large New York banks. Gross CHIPS payments rival Fedwire transactions in terms of dollar value; netted CHIPS payments are settled via Fedwire.”

296. Stone:

     ” If so, then what is causing banks to accept savings at all let alone pay 2.75% interest for them?”

     Ill take a stab, JKH seems busy on some of the other parts of the thread.

     Lets say you had 10M, started your own bank (10M capital). Now you could go out and lend some customers approx 100M to buy autos for instance, you would lend at 7% APR. Once you placed the 100M, these loans would be 100M of assets at your bank. Assets=Liabilites+Capital(or Equity). So you have your 10M in capital that you put in, and now you have 100M assets of auto loans at 7% producing 7M of gross return for you. You put in 10 and you get back 7 the first year, 70% gross return on capital (sometimes it’s good to be a banker!). Sounds sweet, get your champagne….but wait, where are your liabilities? Now you have to go out and “aquire” your 90M of liabilities, for a bank, deposits are the liabilities (darn!). So banks offer deposit accounts that bear interest imo to attract necessary liabilites to build a complete balance sheet.

     This is my perhaps convoluted way to explain the “Loans create deposits” aspect of MMT. Resp,

297. stone:

     If so, then what is causing banks to accept savings at all let alone pay 2.75% interest for them?

     In order to settle interbank obligations resulting from say granting a loan at bank A and depositing the check at bank B, bank A has to procure cash aka “base money” aka “central bank money” aka “high power money” since interbank obligations can be settled only in cash — private credit money won’t do.

     The most reliable source of cash are vanilla retail deposits. That’s exactly why commercial banks devote so much time and money to developing a retail depositary network. Note, that cash has to be obtained by the source bank not only when someone deposits a check drawn on the source bank, but also as a result of any interbank transfer. Clearly, no cash is needed if the settlement occurs between two accounts in the same bank.

     There are other sources of cash the bank can use, such as interbank loans, wholesale deposit loans, the central bank loan, etc., but they are much less stable and/or more expensive (as in the case of wholesale deposits) than deposits of bank customers (which are in fact also loans of “zero maturity” to the bank).

     Some commercial banks may choose a different business model that neglects retail deposits, but those banks (such as Northern Rock) quickly discover how wise their choice with respect to procuring cash was.

298. VJK and Matt Franko, your helpful and clear descriptions, of why banks seek retail savers, have confirmed my gut feeling about what the situation was. It confirms that high powered money is the limiting nucleus for credit expansion. As such, expansion of high powered money (aka governments not taxing to match spending) is responsible for the credit expansion that MMTers (like everyone else) wring their hands about. Tom Hickey has just said in the comment above that the Yen carry trade in the lead up to the 2008 crisis was not something that MMTers need to take stock of to reassess their advocacy of deficit spending (in that case deficits in Japan creating money transfered to USA, UK and euro zone). I just can not square the way that in essentially the same breath it can be said that high powered money is the limiting factor for credit expansion (as VJK has just said) and yet injection of $1T USD of high powered money (as was done by the Yen carry trade) is something that can be blithely ignored (as Tom Hickey has just said). I appreciate that I’m assuming that Tom and VJK have the same overall veiwpoint -sorry if I’m wrong about that.

299. VJK “Clearly, no cash is needed if the settlement occurs between two accounts in the same bank.”
     -Does this give an advantage to very large globally dispersed banks such as HSBC etc? Are such banks a particular danger for ramping up asset bubbles?

300. Tom Hickey “from what I can determine carry trade involve highly liquid financial instrument, since a reversal in the fx relationship necessitates quick exiting from the borrowed currency”-
     -That was also what I gathered- it was basically a way of coverting the huge amount of Yen in 0% interest retail deposits in Japanese banks into USD, £ and euros to inflate bubbles in US, UK, Iceland, Spain, Ireland etc. How you come to the conclusion that that can be ignored is what looses me.

301. stone: your helpful and clear descriptions, of why banks seek retail savers, have confirmed my gut feeling about what the situation was. It confirms that high powered money is the limiting nucleus for credit expansion

     you keep on targeting at the wrong animal. It is not about high-powered money but it is about market share. If you imagine a two bank economy with one bank having 90% of the market and another having 10% then while “loans create deposits” the first bank will have to explicitly fund just 10% of the balance sheet while the second bank will have to fund 90%. Now, since deposits created from loans are typically on demand deposits and therefore essentially free funding, it will not be for long before the second bank goes out of business. This is the whole reason why and how we got to TBTF. This is their modus operandi, reason to exist. Please note that high-powered money plays no role here. It is just the medium of exchange in the payment system.

302. Tom Hickey, I’m not sure whether you are implying that money from the carry trade did not find its way into inflating real estate prices. Think of the Northern Rock example that VJK gave. Where do you think the high powered money that they got on the wholesale markets originated from? Basically banks such as Northern rock that were making the 110% mortgage loans were buying wholesale money from financial intermedaries who were converting Yen into £ and USD.

303. Sergei, am I right in thinking that you are saying that once we get to the point that there is only one private bank in the world, then we will no longer be able to blame the government because at that point infinite instant credit expansion will be possible by that monolithic bank without the limiting constraint of a finite stock of high powered money? That scenario is still a few months down the line :). As things stand now there are still a few banks and so we should still hold the government to account because the supply of high powered money is still a limiting constraint that the government is failing in its duty to keep constrained.

304. Stone, Matt,

     I agree with Matt’s explanation.

     my version …

     The idea that “loans create deposits” works at the macro level at loan origination.

     But the bank making the loan can’t ensure that it will retain/attract back the deposits that have been created by the loan without competitive pricing.

     The MMT theory is that the central bank is always there to provide a backstop in case of reserve shortfall. That’s fine. But the reality includes the fact that the banks will price competitively in order to manage their reserve positions in such a way as to avoid backing into the central bank.

     There’s constant fluidity in the balance sheets of the banking system such that competitive pricing is an ongoing factor on both sides of the balance sheets – trying to win loan business and deposit business through pricing.

     “Loans creates deposits” assures that the system balance sheet will be in balance and assures there is enough deposit money in the system to achieve balance in individual bank balance sheets – but only by retaining/attracting those deposits to the banks that need them through competitive pricing.

     “Equilibrium” pricing at a point in time is determined by banks assessing what prices they can afford on various assets and liabilities in order to achieve their overall target return on capital. They bid up deposit interest rates because they can afford to and still meet their ROC target on new business – or they need to because some other bank is being aggressive on deposits and they need to maintain their existing base or become short on reserves.

     Best to think of “loans create deposits” as a macro phenomenon where the distribution of loans and deposits at the micro level gets resolved through pricing. The resolution of loan and deposit distribution is what achieves the desired distribution of reserves as well – i.e. where there are no shortfalls or as few shortfalls as possible.

305. stone:

     Cash may be a limiting factor for credit expansion inasmuch as it hampers interbank obligations, not in direct way as capital requirement is.

     With some interbank settlement networks, cash requirements for interbank settlement can be greatly diminished.

     Consider Fedwire vs. CHIPS Ramanan mentioned earlier. With the former, so called “real time gross settlement” system, settlement requires as much cash as needed to settle each transaction while with the latter transactions are settled on the net basis, and only the leftover is cleared, with cash, over Fedwire.

     So, one can imagine a situation with two banks where each bank would grant a 1mil or 1trillion loan to the customer of the other bank. When settled over CHIPS, no cash is required. In effect the settlement would be achieved with credit money.

     f the interbank market was completely “frictionless”, zero cash would be required for settling interbank obligations regardless of the settlement network employed. But, then again in a totally frictionless world, there would be no need for intermediaries, such as banks, at all.

     In the real, world the banks that assume frictionless world, with little need for cash, end up as Northern Rock did.

306. JKH,

     Everything you say about banks needing retail deposits is, of course, correct. But note that banks try to avoid going to the CB precisely because the CB has set the system up that way, or the legislature has required them to do so. One could set the system up quite differently and the CB could at least in theory replace much of the wholesale mkts financing of bank balance sheets–though retail mkts financing would still be preferable in terms of profitability for individual banks. Whether or not CBs doing this is desirable is another matter–and aside from crises, it’s generally considered by most CBs and govt’s that it isn’t desirable.

307. Scott,

     Note however, that the Euro Zone and even the financial setup of nations in the Euro Zone before it was formed had a system where the central banks would force the banks to be indebted to them. Both deposits and central bank overdrafts are a part of the banking balance sheet financing on the whole.

     Consider the Euro Zone before the crisis. Every week the Euro Zone would run the Main Refinancing Operation and the banks sector as a whole needs to go to the ECB (via NCBs) to borrow reserves. In fact except the Anglo-Saxon setups, most systems are like that. (?)

     However, I guess you are here talking of large scale financing.

308. Scott,

     Quite right – that is certainly a feasible alternative operational design for the monetary system. Also a useful one to put the existing dynamics into perspective. I recognize that from your own writing as well as Warren M.’s actual proposals of course (and maybe Bill’s? I don’t know).

309. P.S.

     Agree or disagree, it occasionally dawns on me how huge some of these Mosler (and others’) MMT related proposals are – while at the same time being so well thought out.

310. So to sum up- Bill is talking rubbish whenever he claims that government deficit spending does not aid and abet destructive credit expansion such as led up the the 2008 crisis :).

311. stone, I think you are misunderstanding me here, and perhaps I am misunderstanding you, too. There is no doubt that carry trades can and do result in mispricing risk owing to lower rates obtainable abroad that distort a domestic market when large amounts are borrowed externally and converted into the domestic currency for speculation. There is no question that the yen carry trade affected asset prices negatively in many countries, not only the US, for decades. That’s inherent in international finance and free capital flows, and the invisible hand does not smooth it out.

     However, I read you as saying that this money was used to drive up RE prices in the US. I replied that carry trade funding is volatile and is therefore put into liquid assets, not tied up highly illiquid assets like RE. Carry trade money likely did contribute to the demand for MBS that generated a corresponding demand to write mortgages that where imprudent, if not fraudulent. Bundled into securities that were then misrepresented as AAA result in underpricing risk. The rest is history.

     If that is what you are claiming, then I would agree that the yen carry trade played a role, just like the underpricing of risk by the Fed’s keeping interest rates too low for too long. But these were contributing factors that may not have been causal at all. It is becoming clear now that the cause of the GFC was extremely imprudent lending practices, in many cases involving the large institutions like Countrywide, that were dominated by fraud originating from the top and pervading the process.

     However, if the carry trade was at the basis of the GFC, why did this not bounce back hard on the Japanese banks when loans went massively bad, like it took down North Rock and almost took down the largest US banks? I see no evidence of that having happened. In addition, there has been virtually no brouhaha in the US over the carry trade as having been heavily implicated and needing regulation. What am I and apparently most others missing here?

     There is now a carry trade in dollars that is potential more serious than the yen carry trade because there are many more dollars. As I said, I am not knowledgeable in international finance, so I cannot address this professionally. Perhaps one of the economists here will do so.

     As far as MMT goes, I am not an MMT economist either, so cannot speak to this professionally. As far as I can tell, the MMT position is that the first obligation of governments is to their own people, and this involves sustaining an economy at full employment when it is possible to do so, which it always is under the present monetary system, using expansionary fiscal policy to address lagging demand. Countries should not impose hardship on their citizens unnecessarily. However, sound economic policy also has to include reforming inefficient and ineffective pockets that develop, generating imbalances and leading to sub-optimal demand and distribution. But the ideal is to avert the danger that has not yet come though appropriate policy instead of trying to fix it after it has arrived.

     Governments have control over their banking systems. They can impose controls over how money is used and where it comes from. If foreign governments feel that their currencies are either under attack or that they are being flooded with foreign-based assets, they can defend their currencies in the fx market (as they do now) and they can erect capital controls to prevent the inflow of foreign capital (as emerging nations have been threatening). The G-20 are working on these issues right now, so far unsatisfactorily as far as I can tell. Geithner’s idea of limiting capital surpluses does not address carry trades, and I don’t know whether the issue was addressed at the meeting. Maybe someone here who is following it does. I would imagine it was raised, since emerging countries have been complaining lately.

     As a globalist, I see the world as a closed system with great asymmetries. For example, wealth and income, hence real resources, are asymmetrically distributed within nations and among nations. TI don’t see the problem as being about the amount of money created, but rather about distribution. There is something radically wrong with the distribution process than needs to be corrected in order to produce a more symmetrical outcome. The Keynesian solution is that income needs to be distributed symmetrically in order to generate symmetrically distributed demand. It is effective demand that elicits and distributes potential supply.

     This involves influencing the way that money flows, not the quantity that is created. If flow is not addressed, no matter how big or small the pie, the pie will still be sliced unevenly and the wealthy and powerful will have disproportionally large slices. The quantity of money by itself has little to do with the distributional issues that constitute the economic issues our asymmetrical world is facing. As far as I can see, these are issues that MMT’ers are addressing.

     However, I would like to hear more about how global problems can be addressed, in addition to national problems, because I think that this is at the core of what will be happening in a 21st century world dominated by globalization and the decline of the nation state in geopolitical importance as interdependence becomes more prominent than independence (“sovereignty”). So far nations are at the level of adolescents, trying to establish independence and boundaries instead of adults cooperating no longer based on kinship (families>clans>tribes>nations) but realization that the human species is a family united by kinship and that kinship links all life forms on the planet, extending to the emergence of the first cells.

     The problem has been the blind faith of neoliberalism in free markets, free trade and free capital flow based on “the invisible hand.” Zealots failed to recognize that these can easily be subverted and that the reaction of the invisible hand is a smack down. That blind faith needs to be made more realistic, and controls are needed that make the system work optimally for all, generating sustainable global prosperity to the degree possible given existing resources, including human resources, the chief of which are knowledge and wisdom.

312. Tom Hickey “why did this not bounce back hard on the Japanese banks when loans went massively bad, like it took down North Rock and almost took down the largest US banks?”
     -because ,as I said before , the Japanese banks were making a continuous series of short term loans to financial intermediaries that banks like Northern Rock etc then converted into long term mortgages. As soon as the Japanese banks got nervous, they decided that they wouldn’t make another short term loan. It wasn’t until AFTER the last short term loan had been paid back that the shit hit the fan.

313. JKH . . . it’s not about an alternative, really, though I know what you mean. The MMT approach to analysis (as opposed to policy, though policy proposals are obviously connected–and yes, big, for sure) is to always at least try to start from the most general operational perspective. So, central banks most fundamentally operate the payments system and set the price on CB reserve balances, taxes and bonds don’t finance govt spending, etc. Then, we can move to the specifics of real-world monetary systems and understand them as special cases of the general case. MMT policy proposals then address how the special cases are often mistakenly understood by economists and policy makers to be the general case. I think you already know this, but just wanted to point it out for others.

314. Tom Hickey “The quantity of money by itself has little to do with the distributional issues that constitute the economic issues our asymmetrical world is facing.”-
     That claim is exactly the MMT assertion that I’m saying flies in the face of the reality on the ground. I’m using the Yen carry trade fueling the pre 2008 credit bubbles as an example of how the quantity of money created a global crisis that ultimately led to starvation of millions of people. Another example of stocks of money being the driver of poverty is the way that a government spending deficit enables a trade deficit. That allows wealthy elites in exporting countries to exchange the goods from their countries for personal hoards of USD. Also a constant increase in high powered money leads to a decade on decade increase in asset prices and that ponzi effect redistributes wealth to those who initially hold the most assets.
     As I see it, the reason why MMT is rejected by the public is not because the Harvard professors are not MMTers, it is because MMTers have a quasi religous aversion for facing up to the facts when stocks of money rather than just the flows exert malign influence. People may not have all bothered to unpick precise examples of how that is wrong but they can smell a rat and so ignore all of MMT including the sensible parts about aggregate demand etc.

315. The MMT idea that flows and not stocks of money are all that needs to be considered is like an engineer saying to the inhabitants of a river valley that it is only flows of water and not stocks of water building up behind a dam that need to be considered. Hence it is entirely safe to have an ever higher dam entirely capturing the flow of river water and just build the dam 10 meters higher each day to prevent over flow. No one would want to live downstream of such a harebrained river dam. MMT is the economic equivalent -with the increased build up of high powered money like the build up of water behind an increasingly precarious dam.

316. “The MMT idea that flows and not stocks of money are all that needs to be considered . . . ”

     And when has any MMT’er ever said anything so stupid? Honestly, I don’t know why anyone here engages you, MMT or not, as you clearly have no interest in actually understanding what you are critiquing.

317. Stone,

     My hypothetical banking example above had nothing to do with ‘high powered money’. You are regressing. There is no analogy to be made between gravitational forces and accounting. You are way off base here.

     Resp,

318. VJK,

     I have argued elsewhere that the private sector bond sales are also “K” credit.

     At the sectoral level, the non-financial business sector does not wait for widows to save their nickels before selling bonds, but they sell the bonds and spend the proceeds simultaneously, and this supplies the income necessary to buy the bonds, just as banks grant loans and simultaneously create matching deposit accounts. Or just as government deficit spending occurs simultaneously with government bond sales and supplies the income necessary to purchase government bonds.

     Here “simultaneously” is of course an approximation, as there is a discrepancy. But in an overlapping market with some bonds maturing and new bonds being issued, almost all of this nets out, just as with bank transactions. In both cases, there are short term funding markets to absorb these fluctuations. But as long as those short term funding markets are working, then both kinds of instruments are “K” credit.

     The distinction is really what happens when there is a crisis at which point the private sector debt stops being “money good”. But that does not mean that the risky instruments didn’t expand credit during the boom, or that they don’t do so in the normal course of events.

319. RSJ:

     they sell the bonds and spend the proceeds simultaneously, and this supplies the income necessary to buy the bond

     What you describe is impossible operationally.

     My simple point was that a party other than the commercial bank cannot create credit ex nihilo due to lack of special operational arrangements that only the commercial bank possesses. Such a party can only grant a loan which is 100% backed up by cash that the party has already at its disposal. The loan of this specific variety(a bond) would be an “M” loan rather than “K” loan due to the former 100% backing by cash under any circumstances..

320. Scott Fullwiler: “The MMT idea that flows and not stocks of money are all that needs to be considered . . . “And when has any MMT’er ever said anything so stupid? “-
     -Exactly that “stupid” claim is made every time each MMTer advocates long term deficit spending. Can you point me to a single Billy Blog post that does not do that?

321. RSJ “they sell the bonds and spend the proceeds simultaneously, and this supplies the income necessary to buy the bonds”-Isn’t that just a case of the same pot of money being passed from party to party in contrast to an expansion.

322. Scott Fullwiler: “The MMT idea that flows and not stocks of money are all that needs to be considered . . . “And when has any MMT’er ever said anything so stupid? “-
     After all this is the comment section for a particular one of Bill’s Blogs so we should draw the example from this Blog post (though it could be from any of the others). True to form, Bill says:
     “a modern monetary perspective which says that if the non-government sector desires to net save then aggregate demand must be supported by the government sector for output and employment levels to remain high. All throughout the period shown in my graph above – those deficits were supporting a solid private saving ratio. And it is typical for the private sector to save a proportion of their income (in aggregate).”

     – The sane (in my view) view would be that although the “the non-government sector desires to net save” , taxation has to prevent that from taking place on a net aggregate basis because “aggregate demand must be supported by the government sector for output and employment levels to remain high” and as Scott you yourself point out it would be “stupid” to take the only other way out that the accounting realities dictate which would be to allow stocks of money to increase indefinately. Bill’s whole post is an advocacy of that “stupid” other way out.

323. stone, it is your personal and political belief that savings are bad and should be taxed away before government spends anything. So feel free to express it next time at the ballot box. But other people are allowed to have beliefs as well and also different from yours. Why do you push so hard with your view and try to make sure everybody subscribes to it and if they don’t you say they are religious. Who is actually religious here, you or others including MMTers? Everybody has a right to have an personal opinion and express it but people will stop listening if you push too hard just because you want to make sure everybody blindly accepts your beliefs. This is religion.

     Regarding the carry trade you keep on pushing exactly the same arguments while this discussion has already been here a while ago and it was quite clear then that you have a rather weak understanding of currency markets operations. Now you raise this topic again as it has never occurred. So what new insight or question do you have to raise this issue once again?

324. Sergei “it is your personal and political belief that savings are bad and should be taxed away before government spends anything.”-
     I’m just saying that stocks of money do have a major macroeconomic influence which is also what Scott seems to be aknowledging. So whilst everyone may “desire to net save”, it has to be faced up to that realistically that leads to crisis as it leads to ever increasing stocks of money. I keep bringing up the carry trade because people keep saying that empirically stocks of savings in one country do not correlate to an immediate crisis in that country (eg Japan in the last couple of decades). Bill has linked to his post saying that more than to just about any other post. No one has refuted that one way or another 1T USD found its way from Japan to the West. As such how can it be said that the “empirical evidence” that stocks of savings are benign can ignore such a carry trade. I don’t think these points are anymore “political” than any other economic points. I class myself among the six billion people who are not economists or financiers but who suffer the consequences of what they do. As such we ought to be holding them to account.

325. stone, No one has refuted that one way or another 1T USD found its way from Japan to the West

     you think of carry trade as a flow but it is not. And you problem comes from the wrong association of currency markets visualized by flows of cash money. In order to enter a carry trade no one really borrows in the sense that you put into it. This is the key mistake that you make. If you want to enter an fx-transaction, you sell one currency and buy another one. The currency you buy serves as collateral against the currency you sell. Should the price of the “short” currency move against you then your position will be liquidated for you unless you put more money as deposit. This can happen any moment during 24/7 because currency markets are the most liquid markets of all and function 24/7. This means that currency markets do not work as flows! They work as electron-positron pairs created whenever a position is opened and then annihilated when positions are closed. It is a zero-sum game. Yes, there can be flows in this system but they are represented by the changes in the exchange rates. They are not represented by inflows of money. Carry trade is not an inflow of “hot” money. It is a bet on the exchange rate.

326. stone –

     I find your posts increasingly unclear and ambiguous. To clarify, are you arguing that, because Japan’s allegedly MMT-style fiscal policy resulted in the USD-JPY carry trade and asset bubbles abroad, the US and UK govts would be wrong to pursue aggressive deficit spending today for fear of engendering similarly unfortunate consequences for other foreign countries?

     If so, then this wouldn’t refute people who “keep saying that stocks of savings in one country do not correlate to an immediate crisis in that country”, as it’s other countries where the ‘crisis’ would have occurred. Now you may say in return that, say, the UK govt has a moral obligation not to pursue policy which could harm other countries’ economies; this might not be a position many would agree with, but in any event someone could agree with you that this is the case and still encourage aggressive deficit spending since (1) MMT would prescribe large deficit spending for a huge number of countries (the private sector almost everywhere is retrenching), and (2) countries that might be ‘targeted’ such new such ‘carry trades’ have the ability to forestall crisis with a more thoughtful fiscal/monetary policy than the US displayed.

     I also think it’s unhelpful when you refer to “stocks of money” – it often sounds like you are referring to net financial assets rather than the money supply as such. MMT always points out that money is a relationship, not a thing, so it’s always preferable to be clear about whose asset or liability you are discussing. If I understand you, it is private sector net financial assets which trouble you; if you want to talk about stocks, are you able to articulate a threshold stock ratio of private NFA / GDP which you think starts to cause problems?

     Finally: “Exactly that “stupid” claim [that flows are all that should be considered] is made every time each MMTer advocates long term deficit spending.” This is pretty unfair: MMT always points out that the prescription of long-term deficits which grow or shrink along with idle capacity, will lead to higher GDP, shrinking private NFA/GDP.

     Best wishes
     MMTP

327. RSJ:

     Just to be clear. If a commercial bank buys a bond, the situation is no different from a non-bank buyer doing the same in the sense of extending M-credit rather than K-credit. In terms of a bond buyer’s balance sheet, no balance sheet growth happens, only mere asset swap (cash for bonds) occurs.

328. MMTP- sorry for being unclear and ambiguous. Also thanks for the fact that despite all that you joined the dots and worked out what I was trying to say. You were right that I was trying to say that, thanks to carry trades, the global levels of high powered money needs to be thought of in the same way as we think of atmospheric carbon dioxide levels or chlorofluoro carbon levels. If one country deficit spends, the whole world feels the conscequencies. I agree that fiscal stimulus is currently needed in a most countries in the world. That is quite different from saying that deficit spending is needed. Massive fiscal stimulus could be achieved with no deficit by shifting the tax burden away from consumers and onto asset holders.

     ” MMT always points out that the prescription of long-term deficits which grow or shrink along with idle capacity, will lead to higher GDP, shrinking private NFA/GDP.”-
     My issue is that the growth in GDP that occurs in developed nations as a response to deficits is simply a growth in the FIRE sector which grows to deal with all that extra money that needs managing. As MMTers point out, a large FIRE sector is a burden on everyone. In that way “the prescription of long-term deficits” is a prescription for an ever increasing burden.

329. Stone at 19:03

     I don’t see anything in Bill’s quote there or your further discussion that has anything to do with your statement that suggests there is an “MMT idea that flows and not stocks of money are all that needs to be considered . . . ” Where have MMT’ers ever said that stocks NEVER need to be considered?

330. Stone

     MMT’ers have written A LOT on financial instability and the growth of FIRE. The US has had deficits that did not accompany financial fragility and exceptional growth of FIRE (1940s) and those that did (1980s, 2000s). The US also had surpluses that accompanied exceptional growth of FIRE (1990s). The common denominator is generally the form of (de)regulation in the FIRE sector, not the deficit itself. Furthermore, deficits can decrease the FIRE sector, at least theoretically; for instance, a large tax cut for indebted households (such as a payroll tax holiday) that led to massive deleveraging could actually end up shrinking the aggregate balance sheets of FIRE.

331. Stone

     I should add that the Minskyan influence of MMT’ers requires us to acknowledge that “stability is destabilizing.” This means that both cyclical and secular growth/stability in the macroeconomy will grow the FIRE sector, left unchecked. And, to the degree that govt deficits contribute to such macro stability, there is absolutely recognition of a relationship in MMT between that and FIRE/financial fragility..

332. Scott Fullwiler “Where have MMT’ers ever said that stocks NEVER need to be considered?”-
     I’m just delighted to at last have an MMT conversation about stocks. It seems you do consider stocks but I have failed to pick up on it-sorry . Please let me make up for lost time and educate myself all about MMT consideration of stocks.

     “The US has had deficits that did not accompany financial fragility and exceptional growth of FIRE (1940s)”
     – That is a very special case because a massive war was being waged and then the USA was bailing out europe with the Marshal plan etc. I said that increases in high powered money tend to increase the FIRE sector in DEVELOPED nations. To my mind the very special situation in the 1940s rendered the USA economy more akin to that of a developing economy. I totally agree that massive deficits could be run in much of Africa currently and so long as the economy was well managed the entire ensuing increase in GDP would be in the form of transforming sanitation, healthcare, transport etc etc “with no FIRE sector increase. The current situation in the UK and USA is quite different from that.

     “The US also had surpluses that accompanied exceptional growth of FIRE (1990s). “-
     What I’ve been saying is that the global increase in the stock of savings leads to an increase in the global FIRE sector. Japan had embarked on massive deficit spending in the 1990’s but much of the injections into the Japanese economy ended up as Japanese savings that the carry trade delivered to the USA, UK and Europe. Those fueled the UK and USA FIRE sectors.

     “Furthermore, deficits can decrease the FIRE sector, at least theoretically; for instance, a large tax cut for indebted households (such as a payroll tax holiday) that led to massive deleveraging could actually end up shrinking the aggregate balance sheets of FIRE.”
     -What has a payroll tax holiday, JG or any other MMT spending plan got to do with deficits? All of those spending ideas are great but need not be deficit funded. They could just as well be funded by a tax on asset values such that there was no deficit. I’m sure you are not saying that a payroll tax holiday matched $ for $ by an asset tax would decrease the FIRE sector less than a payroll tax holiday that was deficit funded.

333. VJK,

     I think you are making a logical error here:

     Yes, in each specific asset purchase, a bond investor buys $X worth of bonds for $X worth of cash. But that does not mean that, in a given accounting period, that the amount of borrowing is constrained by the amount of cash in the economy, or by the size of household assets (assuming households are doing the lending) at the beginning of the period.

     For example, you have $100 in cash and $100,000 in other assets, say inventory. I sell a bond to you for $100. I buy $100 of your inventory. I sell another bond to you, etc. At the end of the day, I can sell you $100,000 in bonds to buy all of your inventory, even though you only started with $100 in cash. The amount of cash is irrelevant. You can lend up to your assets and/or what you can borrow. But part of your assets will be other people’s bonds, so you have endogenous credit growth. I.e. my balance sheet went from having a business idea to having $100,000 in inventory and $100,000 in bond liabilities.

     And you can see how, as a result of this, my dissaving will increase the value of other speculative assets or businesses whose inventory I purchase, so that they will in turn be able to obtain more credit by selling more bonds to fund their purchases, possibly of my products, etc.

     It is ex-nihilo credit just as with bank lending. Balance sheets expand, leverage expands, prices can be driven up, you can have bubbles, etc.

     It is the process of netting that allows credit to expand beyond the stock of cash, and not the fact that the deposit liabilities, or IOUs are redeemed for cash at a single geographic location rather than in a de-centralized market. The market mechanism just allows anyone who happens to have the cash at that time to redeem your IOU, whereas the bank teller knows how much total cash is in the vault and just hands it over. So what? In one case you have somewhat higher search costs in needing to announce public bids, but in both cases a fixed pool of cash supports a growing pool of credit.

     Under a gold standard, the reason why banks could expand deposits beyond the amount of gold in the vault is because they don’t need all that gold. There are both outflows and inflows, and the gold required is that needed to cover the discrepancy between outflows and inflows. Holding additional gold is wasteful, as it could be used to purchase interest bearing assets.

     And in this sense, the credit markets are no different. At any given time, bonds are being bought and sold, and the amount of gold required is only enough to cover the discrepancy. Credit markets are nothing more than de-centralized banks, but without any requirements for lending against collateral and also without government backing in times of crisis.

     As an aside, it was credit markets that were the first major creators of credit, in the form of Bills of Exchange to finance cross country trade. Starting with the middle ages, but continuing even today, merchants would issue negotiable post-dated checks to their suppliers to finance inventory, to be repaid when the sale was complete. The vendors would pay their own suppliers with these bills and the bills became a form of quasi-money that was interest bearing and short term in nature. Those with surplus gold offered to buy the bills for gold on demand at a small discount, or to “discount” the bills. In this way, they could obtain interest for their surplus gold.

     The bills of exchange became the quasi-deposits in the de-centralized bank that is the credit market, backed by a much smaller pool of gold.

     Established merchants would have a money desk, or a discount desk which was manned by a “bill discounter” that would buy and sell the bills of exchange and manage the cash-flow of the business, all using market funding.

     As long as people were willing to park their surplus gold in the form of these bills, then an arbitrary quantity of borrowing could occur. It was the first commercial paper market and, like any other bank, was susceptible to “runs” if everyone tried to redeem their bills at the same time.

     The banks would also tap these markets to manage their own cash-flow, and they would sell “bank bills of exchange” that circulated along with the “trade bills” sold by merchants, and they also had their own discount desks.

     During times of crisis, the Bank of England wouldn’t ship gold into the vault of banks facing a run, but would publicly offer to discount that bank’s bills, and sometimes merely the announcement of being willing to discount the bills of a given bank was enough to end the bank run.

     Then, as now, the difference between banks and merchants was not the creation of credit ex-nihilo but the government backing and subsequent lowered discount rates offered to banks over the rate offered to merchants. You can argue that bank credit is more prone to abuse, but both forms of credit allow for increasing leverage as well as bubbles.

334. RSJ, what you are saying all makes sense and fits in with what I thought too. The critical thing is that the people selling the bonds inorder to buy overinflated inventory are not also holding retail deposits (in contrast to a bank) and so do not need to have government backing if they get in out of their depth. It is the extra false courage that comes from an expectation of a government bailout that makes the current set up so dangerous.
     A more minor point is that the growth in credit by the repeated bond sales is linear not exponential because there is only ever the £100 in cash that must be recirculated for each purchase. That slows down the bubble growth somewhat in comparison to a situation where with each cycle a larger purchase can be made such as when banks create private money. It also means that whenever someone in the market needs to liquidate a large part
     of their inventory for cash, they will not be able to do so. That will tend to put a dampener on the bubble expansion.
     Once bonds start getting used as pseudo money, then as you say they might as well be money. The key thing is for legal recognition of purchases to depend on cash having been exchanged.

335. RSJ:

     I think you are making a logical error here

     That’s quite possible, but unlikely 😉

     For example, you have $100 in cash

     At each step of this shell game, the lender extends an “M”-loan to the borrower — no “K” credit is created, a bond is exchanged for cash, cash is exchanged for inventory. The game is fully equivalent to the case when the lender would sell the inventory to a third-party and exchanged the cash resulting from such a transaction for the bonds.

     The lender balance sheet does not grow, the asset side simply changes its composition, the liability side is unaffected, no leverage therefore is used and no bubble is possible is this game.

     Note, that a modern commercial bank could also decide, for whatever reason, to extend a full or partial M-credit by funding it, fully or partially, through a bank asset sale.

     credit to expand beyond the stock of cash

     The stock of cash is irrelevant, at least to a point, for the commercial bank ability to create the asset/liability pair, K-credit, out of nothing. No other entity has access to operational arrangements to do so and is limited in its lending ability, at any point in time, by the available stock of cash for the lending transaction to clear.

     Without going into details, your historical references are for the most part, the modern commercial bank description, in essence. It is not applicable to modern non-bank entities unless I am missing some clandestine institution.

336. RSJ, “my dissaving will increase the value of other speculative assets or businesses whose inventory I purchase, so that they will in turn be able to obtain more credit by selling more bonds to fund their purchases” and VJK “no bubble is possible is this game”-
     Is the point that in order for the price to keep being driven up, the sellers would only ever be able to put $100 worth up for sale at anyone time. So as the price was driven up, a smaller and smaller quantity of the goods could be put up for sale. It would have to be a very strange kind of market to get a speculative price increase in that way.

337. No other entity has access to operational arrangements to do so and is limited in its lending ability, at any point in time, by the available stock of cash for the lending transaction to clear.

     Yes, the credit markets are constrained at any “point in time” by the available stock of cash, but at the next “point in time” that stock of cash is available to fund more borrowing.

     You can’t say anything about how much borrowing is possible during a non-zero period of time. This is a stock/flow distinction. During a given accounting period, the distinction between “K” credit and “M” credit is meaningless.

     And the effects are the same on the economy. The granting of credit “ex-nihilo” — which is *always* how credit is created, is when the borrower convinces the lender that his business proposition is “worth” a certain amount. That is when the borrower’s balance sheet expands from having assets of “business proposition” and liabilities of 0 to having assets of $100,000 and liabilities of $100,000. The fact that this balance sheet expansion occurred as a series of cash purchases and sales or as a series of transactional deposit purchases and sales, with cash settlement occurring later, makes no difference in principle.

     The lender balance sheet does not grow, the asset side simply changes its composition, the liability side is unaffected, no leverage therefore is used and no bubble is possible is this game.

     Leverage wasn’t used in that example to fund the bond purchases, but it could have been used. The lender could have sold bonds and used the proceeds to buy other bonds. Then the borrower’s balance sheet would have grown.

     If our economy consists of the borrower and lender, then leverage increased from 1 to 2 as a result of the transaction. The assets in the economy went from 1 business idea, $100,000 in inventory, and $100 in cash to $100,000 in bonds, $100,000 in inventory, and $100 in cash. Liabilities grew from 0 to $100,000 in business debt.

     If credit market investors decide that Verizon’s expansion plan is “worth” 10 billion, then they will fund it with 10 billion, without any recourse to bank loans, and without decreasing their assets by $10 billion in order to do so. Verizon will be able to place those bonds.

     You can still maintain that this is fundamentally different than a bank creating a loan for $10 billion, securitizing the loan and selling it as bonds to investors, or that that is fundamentally different from the bank granting the loan and keeping it on its books, but there is no economic distinction. The economy still went from state A to state B.

338. RSJ, “You can still maintain that this is fundamentally different than a bank creating a loan for $10 billion, securitizing the loan and selling it as bonds to investors, or that that is fundamentally different from the bank granting the loan and keeping it on its books, but there is no economic distinction. The economy still went from state A to state B.”-
     Is the difference that the bond way will not be able to push up asset prices in liquid markets (due to cash becoming scarce) but it will be able to finance large expansion plans?

339. RSJ:

     
     Yes, the credit markets are constrained at any “point in time” by the available stock of cash, but at the next “point in time” that stock of cash is available to fund more borrowing.
     

     Not *all* credit markets are so limited, but only non-banks. You have not demonstrated, operationally, so far, how a non-bank can be *not* limited by the available stock of cash. One can create an illusion, as with tri-party repo settlement for example, that a security acquisition can be divorced in time from the final cash settlement, but under covers there is a commercial bank standing by and making an intraday loan to make the illusion look like a reality.

     Being constrained by the stock of cash at any point in time means being constrained along the entire time axis. The commercial bank is rarely so constrained due to well know systemic arrangements, but the non-bank, in particular the bond market, is, unless you add a bank, as a player, to the bond market. But such addition would be cheating.

     The granting of credit “ex-nihilo” – which is *always* how credit is created

     Perhaps, misunderstanding stems from the fact that we apply the ex nihilo locution to different counter-parties: me, to the lender and you to the borrower.

     On the bond market, the borrower exchanges an intangible asset(his reputation, idea, etc., i.e. “creditworthiness”) for cash. The bilateral credit/debt contract is created of something valuable to both parties. The creditor balance sheet is unchanged, numerically, on the asset side and not at all on the liability side.

     With a commercial bank, the borrower exchanges his creditworthiness for what is in essence nothing of value to the bank, a mere accounting record, on the bank book, at the point in time the loan was granted. The bank liability(deposit) may remain nothing of value to the bank, without need for the bank to procure cash, for the duration of the loan provided that all transactions happen within the same bank, or the netting settlement system ensures that the cash role is rather unimportant in closing positions. Now, the reality is more complicated and the details of that reality lie at the core of my disagreements with MMT’s presentation thereof. However, as an approximation one can adopt, as some real banks did to their detriment, that not much cash, if any, is needed to settle mutual obligations. So, one can approximate multiple bank behavior with a single bank creating the debt/credit pair with “a mere stroke of pen”, as it were.

     So, the crucial difference between K-credit and M-Credit is in the ease with which the debt/credit pair can be created (with all the attendant risks, too numerous and well known to list).

     In the balance sheet terms, we have a numerically constant M-lender balance sheet vs. an expanded K-lender balance sheet. Of course, the borrower sheet is the same in both cases, or so he might think.

     It is the M-credit something/something pair vs the K-credit nothing/something pair tremendously amplified by maturity transformation that, arguably, is at the root of uncontrollable credit expansion and various bubbles we have recently been lucky to witness in awe and admiration.

     Parenthetically, on the face of it, eliminating maturity transformation might be enough to eliminate uncontrollable credit expansion, but I have not thought that through.

     I won’t comment on “leverage” because my understanding of leverage==assets/(assets-liabilities) does not appear to match yours.

340. Sergei I just saw your earlier comment: “Carry trade is not an inflow of “hot” money. It is a bet on the exchange rate.”-

     I’ve been trying to reconcile that with what I thought the term meant based from other places I had seen it used. The wikipeadia entry describes it as”investors borrow low-yielding currencies and lend (invest in) high-yielding currencies”- which was the sense I was meaning. They go on to describe:-
     “Since the mid-90’s, the Bank of Japan has set Japanese interest rates at very low levels making it profitable to borrow Japanese yen to fund activities in other currencies.[5] These activities include subprime lending in the USA, and funding of emerging markets, especially BRIC countries and resource rich countries. The trade largely collapsed in 2008 particularly in regards to the yen.”

     My understanding was that a trader would take out say a thirty day loan in Yen and convert the Yen to £. Then lend the £ to say Northern Rock bank for thirty days. At the end of the thirty days they would be paid back the £ by Northern Rock which they would convert back to Yen to pay back the loan in Japan. They would repeat the same thing for the next decade. Because they were getting 5% interest from Northern Rock and paying 0.5% interest to the Japanese bank they were profiting. The “inflow of hot money” came about because all of the money involved was in the UK and not in Japan whilst it was going on.

341. “Being constrained by the stock of cash at any point in time means being constrained along the entire time axis. ”

     OK, water flows through a pipe of area 1. Assuming an incompressible fluid, the water is constrained by the area of the pipe. You know nothing about velocity. You don’t know how much water, in terms of volume, can flow through the pipe in a given unit of time. To get to volume, you need to integrate a variable flow. The total amount of cash in the economy does not constrain the amount of borrowing that can occur in a given accounting period.

     In terms of leverage, the total assets in our 2 person economy are 100,000 in bonds, 100,000 in goods and 100 in cash. I just ignored the cash due to rounding. The total liabilities are 100,000. Total leverage is therefore A/(A-L) = 200,000/100,000 = 2. Prior to this, the leverage in our economy was 1.

     Look, the real difference is the likelihood of abuse, not something fundamental about the “type” of credit created. If you asses a fee equal to the current GS10 yield on all non-cash assets on bank balance sheets, and prevented banks from holding any assets other than loans that they originate and cash, then this wouldn’t be a problem, even if you allowed them to borrow from the discount window in unlimited amounts at zero rates. Then you could also stop doing open market operations and have a yield curve set by the private sector.

342. RSJ “The total amount of cash in the economy does not constrain the amount of borrowing that can occur in a given accounting period.”
     -That is true but it is also true that the amount of borrowing is not the only thing needed to create a bubble. A bubble needs the price to be supported by sufficient able buyers. If cash is limited to $100 there will not be any capable buyers to support a bubble.

343. Stone, you are right in that the money supply needs to expand in a growing economy. The frictions are not zero. The CB makes sure that the market remains liquid by OMO. There are special provisions for banks, such as the discount window, but the provision of base money is economy wide, and is supplied to the money markets as whole.

     Nevertheless, a “shortage” of cash does not constrain lending. It’s just not helpful to think in terms of “running out” of cash, or not having enough cash to buy or sell an asset. Neither is it helpful to say that something can only be purchased with cash.

     An asset is purchased with another asset, whether via a bank or an investor, and the payment system is able to support that.

     All those banks complaining about being short of cash were really short of assets, or their assets were marked down. When Bear was unable to roll over huge overnight loans against pools of sub-prime mortgages, it was not because of a system wide cash shortage. There was no cash shortage, there was a system wide shortage of desire to lend to Bear. Because banks have such opaque balance sheets and hidden liabilities, the re-pricing of assets turns into a loss of confidence in the institution, and a corresponding lack of willingness to fund the institution. If that confidence was there, then there would be more than enough cash in the system to allow the funds to be supplied.

     Belief is what expands and contracts, belief is what funds credit, independently of the settlement technology. And even historically, none of the major financial panics occurred because of a shortage of gold against which to execute transactions, but rather because of a rumor that a bank had too many junk railroad bonds, which turned into a panic and run on the bank. Or perhaps the bank really did buy too many junk assets, and they declared bankruptcy, causing others to doubt the solvency of their own banks, etc.

     The great depression hit first with an asset repricing and bank failures followed in the early 30s, really exploding in 1933. Borrowing, together with house prices, began declining in 2006, and the recession hit in Dec. 2007, and the banks failed later. In all these cases there is a period of pretending as the banks watch their asset quality deteriorate, and then rumors start to circulate and finally there is a panic.

     To an individual trader calling out bids, it may seem that gold can’t be found, but the gold is available, just not to him or just not against the collateral that he is offering. And the reason it’s not available is not because there are too many transactions occurring, so that the gold is “busy”, but because the public has lost faith in his institution or in his collateral. The stock of base money against which transactions are made is not a constraining factor to the amount of money that can be borrowed. Gold standard payment systems are more fragile, but the source of the fragility is not that the stock of gold is finite, but that because the stock of gold is finite, commitments to bail out banks or depositors are not credible. A lack of belief, rather than a lack of gold, causes the crisis, just as the granting of belief, rather than the granting of gold, creates credit.

344. RSJ:

     In your stylized example, the final loan is limited by the lender assets whatever the velocity of the “liquid” is. My saying that lending is limited by available cash means just that. If the lender can and wants to convert his assets to cash that will be his available cash.

     Assuming the velocity of cash flow high enough to implement the desired swap of assets during the accounting period, the attained leverage, as you pointed out, would be 2:1.

     It is a remarkably low leverage. It is also maximum achievable leverage in your stylized example whatever the cash flow velocity is provided it is high enough for the swap to complete. If you take into account that a typical Canadian bank leverage is about 18, and the American number was about 40, and the LTCM unbeatable record was about 1000, the advantage of using M-credit should be obvious immediately — the disease won’t spread very far.

     then this wouldn’t be a problem, even if you allowed them to borrow from the discount window in unlimited amounts at zero rates

     I am not sure what would be the exact mechanism of limiting credit growth in your banking system model.

345. RSJ:

     All those banks complaining about being short of cash were really short of assets,

     Just wanted to point out that “those banks” refer to investment banks or investment divisions of commercial banks. The investment bank is dramatically different in its activity from the commercial bank being a non-depositary institution and not having any access either to the interbank market or the discount window.

346. stone, you quote wikipedia saying

     a. investors borrow low-yielding currencies and lend (invest in) high-yielding currencies
     b. Since the mid-90′s, the Bank of Japan has set Japanese interest rates at very low levels making it profitable to borrow Japanese yen to fund activities in other currencies

     So what I am trying to highlight here is the fact that there are two currencies involved and as long as there are two currencies involved there is an exchange rate risk. Now there are two scenarios for final borrowers, i.e. those who actually spent money on something and not just borrow: 1) final borrowers really borrow in foreign currency 2) they actually borrow in their local currency

     I do not know how widespread is/was fx-lending in the UK/US but I would assume it was small meaning that final borrowers were actually borrowing in local currency paying local currency interest rates. It was different in Eastern Europe but in any case it is just tells you where the fx-risk sits. Nothing more.

     Do lower interest rates in one currency compared to any other currency prevent or tease anybody into entering a new fx-trade? Not at all. All that interest rates tell you is how forward fx-rates are calculated, i.e. the point where you break even on your currency bet. If you want to hedge out this risk then you effectively end up with local currency and local currency interest rates. So if “funding” currency has lower interest rates it just changes your break-even fx-rate in your fx-bet. Nothing more, nothing less.

     Conventional understanding of “carry trade” implies some inflow which creates demand which drives up asset prices. However Japanese yens never leave the Bank of Japan computer. The reality is that banks or whoever else were smart enough to push the fx-risk on borrowers who did not understand what they were doing (majority of retail in “borrowing” countries) or understood what they were doing but still decided to pursue it (financials in “borrowing” countries and probably majority of retail in Japan). But there is no inflow. There are a lot of fx-bets which happen all over the place all the time with all currencies in all directions. fx-markets are the most weird markets of all where hardly any fundamental logic can be found.

347. RSJ:

     Gold standard payment systems are more fragile, but the source of the fragility is not that the stock of gold is finite, but that because the stock of gold is finite, commitments to bail out banks or depositors are not credible.
     

     The system is fragile because it is broken by design. It is built on the foundation of practically unlimited leverage at a very little cost, at the proverbial “stroke of pen”, as well as maturity transformation leading to theoretically and practically unmeasurable “liquidity” risk and consequent runs on bank.

     A fixed stock of base money, gold or otherwise, would make continuing bailouts hard or impossible further exacerbating the fragility problem, that’s correct.

     Equity funded lending as in a typical bond buying scenario and maturity matched intermediation would eliminate need for a government backstop, liquidity risks, bank runs, intermediation interest risks (thanks to maturity matching) at a cost of arguably slower growth since credit would not be as easily available and could be obtained at a much steeper long-term price. That would perhaps make 30 year mortgages an avis rara, but at the same time would push housing prices down to sane levels.

     Arguably, eliminating maturity transformation would have led, in a natural way, to equity funded lending.

     In essence, defending the existing banking system implies defending the abhorrent idea of socializing losses and privatizing profits that have been happening and still are before our collective eyes.

     Even some central bankers start to realize the fundamentally flawed design of the system:

     
     King said that the banking system’s “Achilles heel” is still its reliance on short-term debt.

     “Risky long-term assets are funded by short-term deposits” and “that makes banks so hazardous,” King said. “Many treat loans to banks as if they were riskless. In isolation, this would be akin to a belief in alchemy. To work, financial alchemy requires the implicit support of the taxpayer.”
     

348. “It is a remarkably low leverage. It is also maximum achievable leverage in your stylized example whatever the cash flow velocity is provided it is high enough for the swap to complete. ”

     Yes, the ratio will be 2, but this doesn’t mean anything about stability, credit growth, bubbles, etc. The reason is that the “assets” backing the liabilities can just be someone else’s liabilities. You can imagine, for example, a production chain in which consumers buys final output from firm 1, which buys intermediate output from firm 2, etc. At each step, a 10% premium is added, all the way to firm N, which does not borrow from anyone. Of that 10% premium, half goes to wages and half is profit. The profit is used to purchase consumer debt. All purchases are funded by selling paper to someone else. The consumer earns the wages of each firm and borrows an amount equal to the profits of each firm.

     There are no banks, yet this economy can have bubbles and can easily be in a ponzi state for an extended period of time.

     Everything is funded with “equity”. But the overall level of equity is also a function of how much is borrowed. There is no a priori objective “equity” that determines how much is borrowed. If the consumer borrows more, then firm assets increase, allowing other firms to borrow more and allowing the consumer to borrow even more, etc. Nevertheless at each point the leverage will be 2. So what? If banks could hold on the asset side of their balance sheet tons of corn or business propositions, then they would also have much lower leverage.

     Whereas as you are arguing that the value of inventory, the estimated profits of a firm, etc., are all independent of how much credit market debt there is, so that there is some natural limit in terms of “real” underlying assets. That isn’t the case.

     It has nothing to do with banks per se. Banks are pernicious because the opacity of the balance sheet and the government support, but credit itself provides instability and the possibility of ponzi finance, regardless of whether that is market credit or bank loans.

     In terms of maturity transformation, there isn’t a lot of demand for maturity transformation. Households keep about 2% of their assets in the form of checkable deposits, and about 15% of their assets in short term debt. Banks have to compete with the money markets in order to get savings, CDs, MM accounts, which means that households are fine with some maturity. And the remaining 80% or so of household wealth is split 2:1 as equity claims and bond claims. If anything, households want more maturity. I’m going by memory here, but this is about right.

     The service that banks provide, in terms of value add, is credit analysis, for those who can’t access the credit markets. Not maturity transformation.

     Which is not to say that investment vehicles or those closer to the credit creation process do not expand their balance sheet by borrowing short and lending long, but they are not providing some needed service, they are crowding out others who want to lend long.

349. Sergei:-“Japanese yens never leave the Bank of Japan computer.”-
     Is the critical point that the Yens, rather than siting unused (in the Japanese bank that can fail to find borrowers in Japan) instead are lent out (to those conducting the carry trade)?
     In the example I gave;-
     “a trader would take out say a thirty day loan in Yen and convert the Yen to £. Then lend the £ to say Northern Rock bank for thirty days. At the end of the thirty days they would be paid back the £ by Northern Rock which they would convert back to Yen to pay back the loan in Japan. They would repeat the same thing for the next decade. Because they were getting 5% interest from Northern Rock and paying 0.5% interest to the Japanese bank they were profiting.”
     All of the fx risk is born by the financial intermediaries who are conducting the carry trade. The people borrowing from Northern Rock obviously are not bearing any such risk. The people conducting the carry trade clearly might sometimes loose (or sometimes gain) from exchange rate changes during the course of each thirty day loan. The primary purpose of the carry trade is not speculating on such exchange rate changes. It was simply exploiting the difference in interest rates that were available in Japan versus the west.
     It has just occurred to me that in a tiny way my brother and his wife contributed to it (except that they were not using borrowed money). They were living in Japan at the time (my sister in law is Japanese) and I know they saved for their wedding in a UK savings account, converting their Yen to £ and then before the wedding taking the savings out and converting back to Yen. I’m sure that they had never even heard of the term carry trade, they were just doing what seemed to be a no-brainer as they had bank accounts in both countries and the UK one offered massively higher interest at the time. All I’m talking about is the grand scale of the same process (which amounted to $1T USD in 2007).

350. Sergei: further to my above comment, I appreciate that other people speculate on the fx markets- betting on how the exchange rates will move (that market amounts to $6T per day or something crazy). That is quite a different process to the carry trade (using the term as I understood it).

351. VJK “at a cost of arguably slower growth since credit would not be as easily available and could be obtained at a much steeper long-term price. That would perhaps make 30 year mortgages an avis rara, but at the same time would push housing prices down to sane levels.”

     I wonder whether genuine technological development might not actually benefit greatly if all credit was from equity lending. In such a hypothetical future scenario, people seeking venture capital investment (which always has to be equity lending) would no longer be at an unfair disadvantage when competing for investment.

     PS: Everything you’ve been saying really chimes with how things seemed to me. It’s great to hear the same view point from someone who actually knows about the subject rather than just from a inarticulate, bystander such as myself :).

352. RSJ:

     imagine, for example, a production chain

     In your stylized economy profits are impossible as they would immediately be lent to workers to create the profits — operationally private maey flows will cancel each other.

     Unless, I misunderstand your description.

     In terms of maturity transformation, there isn’t a lot of demand for maturity transformation.
     Demand is irrelevant. MT is the core profit engine of the commercial as well as the shadow banking systems. An institution engages in maturity transformation each time it buys assets with short-term loans: e.g. zero-maturity demand deposits fund bank non-zero maturity credit facilities of various kinds, both on-balance and off-balance, as well as dubious long term investments such as MBS.

     The shadow banking zero/short term maturity loans were/are repos of various kinds and commercial paper, in particular ABCP.

353. Demand is irrelevant. MT is the core profit engine of the commercial as well as the shadow banking systems

     Absolutely agree, and this was the point I made about funding costs. The funding costs are lower because short rates are lower than long rates, whereas the non-financial sector has long duration liabilities, so they are put at a relative disadvantage.

     This is why I suggested the asset tax, to cancel the net interest income that is attributed to MT, and leave only the income that is a result of credit analysis.

     My point was that MT doesn’t “enable” banks to create deposits and make loans at the macro level. They would create deposits and make loans, and simultaneous to that they would sell bonds, and households would buy the bonds with the deposits because they prefer longer maturity assets.

     You only need to do MT to just provide enough liquidity for the deposits to buy the bonds, or very little MT at any time, given overlapping transactions. For example, if the mean time before the creation of a deposit and the purchase of a bond was 10 days, and the mean period of the loan was 10 years, then at any given time, even though $1 of deposits was created simultaneously to $1 of loans, still only about 3% of the loans would be backed by deposits, and 97% would be backed by bonds or longer term liabilities. That is not a lot of MT at the aggregate level, and I don’t see anything wrong with that system.

     In your stylized economy profits are impossible as they would immediately be lent to workers to create the profits – operationally private money flows will cancel each other.

     I was sloppy as “profits” are a flow, but you do have financial profits, and they always boil down to accumulating IOUs on others. The cancellation of cash-flows is a feature, not a bug: cash in = cash out, and it allows a fixed pool of cash to support a larger pool of economic activity. When someone earns a profit, the cash out term is spent on the acquisition of financial assets, basically the IOUs of those who have dissaved. The amount dissaved is the amount saved.

     Just imagine 1 firm with 1 worker, who is also the consumer. The firm has $10 in cash. In period 1, the worker produces 2 goods, and is paid a salary of $10. With the $10 he buys one good. Now the firm has $10 again. The firm lends him $10 to buy the other good. Now the firm has an IOU of $10 and $10 in cash.

     If the accounting period consists of these two transactions, then the firm has revenues of $20, costs of $10, and earnings of $10, which were parked in pools of consumer debt. Here, profits = borrowing, and this is a general maxim.

     You can repeat this, so that after N periods, you have 10N debt and a consumer debt to income ratio of N. It’s unbounded, even though total leverage in the economy remains at 2.

     Obviously at some point there will be a crisis, but again no banks were needed. Credit market borrowing was enough. And it could be a while before the crisis hits, at which point the IOUs are repriced and the consumer cuts down on his purchases.

354. RSJ:

     Just imagine 1 firm with 1 worker, who is also the consumer. The firm has $10 in cash. In period 1, the worker produces 2 goods, and is paid a salary of $10. With the $10 he buys one good. Now the firm has $10 again. The firm lends him $10 to buy the other good. Now the firm has an IOU of $10 and $10 in cash.
     

     Interesting. Are you saying that the source of the firm profits is workers’ ever increasing indebtedness, “macro-economically” speaking? Besides, there is no room for the firm owners consumption, unless at the expense of the original $10 capital. They cannot eat the loan the workers cannot repay.

     I think the model needs fixing before showing its bubbly nature.

355. Are you saying that the source of the firm profits is workers’ ever increasing indebtedness, “macro-economically” speaking?

     In this example, yes. It doesn’t always need to be this way. The source of the owner’s profits can come from government deficit spending, from the foreign sector, from other owners, or from investment. Basically his financial assets need to be matched by the liabilities of others. I think for the U.S. in the recent crisis, that this was the case. Basically the growing household borrowing was due to goods costing too much, and to workers overpaying for goods by purchasing them on credit, at least indirectly.

     At the end of the day, cash in = cash out. Some actors will have a cash-flow surplus in the goods market, and will subsequently spend that cash by acquiring assets in the financial market. The net acquisition of financial assets will be profits over that period. Those earning profits will be matched by those who are borrowing from them so everything balances to 0.

     Note that this is different from “Savings” in the NIPA sense, since in our example economy, Savings is zero. All output was consumed and there was no investment.

     If you want a more complicated example in which the owner also consumes, assume that the firm starts with an owner, $10 in seed cash, and that the worker produces 3 goods in a given production period.

     The worker is paid $10 and he uses it to buy the good. The firm sends a dividend check for $10 to the owner. The worker wants to consume more, so he borrows $10 from the owner and buys another good. The firm sends a dividend check to the owner for $10. The owner uses that check to buy the third good.

     At the end of this period, the owner has received an income of $20, of which $10 was spent on consumption and $10 was used to acquire a financial asset — the worker’s IOU. His profits for the period were $10. The worker’s indebtedness increased by $10. We are back to the same state as before, with the firm having $10 in cash and the worker busy creating another 3 goods.

     After N periods, the worker’s debt to income will be N. For the economy as a whole, GDP is $30, so total debt to income will be N/3 — still unbounded.

     Note that the interest rate is zero, but that is because the economy as a whole is not growing. If the rate of interest were > 0, then you would need a lot more borrowing. The worker would need to borrow the interest from the owner each period as well, or alternately, the owner could just mark up his assets by the interest and the worker would mark up his debt in the same way.

     Then debt/income would grow exponentially rather than linearly.

     Note that this situation can be stable — if everything is growing and *firms* are borrowing from both owners and workers in order to invest more, and subsequently produce more, then both worker and owner profit desires can be met. And some household debt is also OK, with the young borrowing from the old, etc to smooth consumption over their lifetime.

356. RSJ:

     or from investment.

     Let’s do that option, shall we ?

     The worker is paid $10 and he uses it to buy the good. The firm sends a dividend check for $10 to the owner. The worker wants to consume more, so he borrows $10 from the owner and buys another good. The firm sends a dividend check to the owner for $10. The owner uses that check to buy the third good.

     What is the original investment ? Where does the dividend come from ?

     I am curious.

     Thanks.

     I am curious.

357. Gamma @Saturday, October 23, 2010 at 3:42:

     “JKH @ Friday, October 22, 2010 at 22:29

     JKH and Robert,

     When you talk about “customer deposits”, are you only referring to demand / transacton account deposits, or do you include term and all other deposits in this?

     If you mean that only transaction account deposits must be backed with 100% reserves, then this proposal is not that different to the banking system as it exists currently.

     For example in Australia, the entire banking system contains around 1250bn of bank deposits, but only about 200bn of this is in demand deposit accounts. The banking system has about 75bn of reserves / govt bonds, around 40% of the level you want.

     On the other hand, if the proposal is that all deposits must be backed with reserves, then this is a radical change that would essentially eradicate banking as we know it. All bank lending would be have to be funded from equity.”

     Sorry not to have replied before; I awarded myself a week off.

     The proposal I’ve paraphrased here (not my own but which I support) would have demand/transaction-account deposits backed 100% – by means of requiring that they be lodged with the CB. It’s obvious that you’re better-informed about the banking system than me, so perhaps you’re right to describe this as “not that different”, although I would have thought myself that 100% was by any standards significantly different from 40%. That 75bn of reserves/govt bonds would have to be increased to 200bn.

     To reiterate, the aim is to stop banks creating money ex nihilo, as debt. From the instant a loan causes a deposit-account balance to be marked up the borrower can (and does) spend it because that’s what he requested the loan for. I don’t really understand your bracketing-together demand deposits (money created by loans) with loans having specified maturity dates (or extended minimum-notice periods) made to banks. The bank does not create this money; the lender forgoes the use of it for the period contracted. No new money is involved, instead existing money is transferred from the lender to the bank. I see nothing in common.

     Demand deposits have a zero term by definition: I’ve already said that I don’t know how 2-day term loan ought to be treated (although I would have thought it ought to be viewed as no different in principle).

     That aside, would you really not see forbidding banks to have any access to that 200bn in demand deposits as a significant change from the present system? Nor being allowed to create deposits by issuing loans?

358. The limit rule to any credit vehicle generation is dictated by the expected and variable worth and liquidity of its collateral. Money is its own collateral by identity (definition,measure) and thus the unit anchor for any collateral. Period!

359. A credit vehicle burden, net of any inflation effect, is convex to the risk and concave to the liquidity of the quantity of its collateral unless it is identical to this collateral. Period!

360. VJK,

     What is the original investment?

     The original investment? The initial conditions are an owner whose assets are the firm. The firm, whose assets are $10 and 3 consumption goods. An employee that works for the firm (making 3 goods each period in exchange for $10 in wages). The model then begins with the payment of the wages to the employee (as he has just made 3 goods).

     I don’t define where the employee came from, or how the owner came to own the firm, etc, or where the $10 came from.

     
     Where does the dividend come from ?
     

     The dividend comes from the proceeds of the sale. Whenever the employee (or the owner) buys a good for $10, the firm has $10 and as the labor costs were already paid, it can send the proceeds to the owner for the sale of the goods. After the period ends, we are back to the worker having created 3 more goods, the firm pays him $10 and the situation repeats.

     I feel silly tracing out these transactions 🙂

     The journeys of our $10 bill are not important. But in order to see that, you have to convince yourself that the quantity of cash does not constrain spending, borrowing, lending, or anything else. No “expansion” of deposits via fractional reserve lending is needed. You can have an expansion of credit just via the credit markets.

     Once you’re convinced of this, then you don’t worry about “where money comes from”, you only worry about the price of money, the price of goods, the profit rate demanded of firms, the growth rate of income, wages, and assets. You realize that all of these can be disconnected from sustainable levels due to ponzi borrowing, and you monitor income inequality and financial asset accumulation to see whether there is a problem.

     If the employee was steadfast and did not buy more than 1 good until he was paid enough to buy 2 goods, then his real wages would go up and the owner’s profit would be zero. The owner could still earn a “profit” in terms of goods, which is where Kalecki’s “workers earn what they spend and owners spend what they earn” comes from. But the reality is that “workers earn *less* than what they spend, and owner’s spend *less* than they earn, and the discrepancy is the increase in financial claims”

     But suppose that the employee only stops being willing to borrow after, say, 20 years of excess borrowing.

     Now he stops buying in order to repay his debt. That period of holding firm means wasted output: the employee has $10 but is not buying, and the firm has goods and is not selling, because it believes its cost of capital is 33%, and so the goods rot. The firm can’t lower prices, as it is required to earn a certain margin.

     There is no need to introduce “sticky prices” — a sticky cost of capital is sufficient. But the cost of capital, because it’s forward looking, will always be more sticky than spot prices in the goods or labor market, regardless of how flexible those prices are.

     So in our model, the worker says “no more borrowing” and the owner retaliates by liquidating the firm, as he believes that the revenue collapse was due to something wrong with that particular firm as opposed to believing that the error was in all his previous years of earnings. All the firms say “we need to slim down, become more efficient, cut costs” in order to restore themselves to the level of profitability and earnings growth that they expect.

     No one wants to believe that for 20 years they have been earning “too much” relative to the wages of others, and permanently lower levels of earnings (for them) are required going forward, corresponding to permanently higher levels of earnings for others. That would be an interesting shareholder letter.

     It takes a long time for the long term cost of capital to fall, particularly if government is simultaneously subsidizing profits by deficit spending in response to a demand shortfall. You will find that “the stimulus worked but was captured by profits” and you will keep saying this over and over again.

     And if the worker is truly insistent on repaying debt, rather than just not incurring any more, then you need either debt cancellation or for the government to take the worker’s debt on its own books, as the firm cannot earn a negative profit. Now you have hit the zero bound. Economies find it very hard to tolerate a decline in aggregate borrowing.

     When Bill said:

     Marx focused on the special role that money plays and demonstrated that it is more than a “means of exchange”. It is the medium by which the exchange of commodities falls into two separate acts which are independent of each other and separate in space and time. This is the key to understanding crises in capitalism.

     The “separate in time and space” is the IOU. The capitalist wants to earn a positive cash-flow, but in terms of balance sheets, he is not adding cash to his balance sheet but financial assets generally. I.e. IOUs of others.

     Of course he spends whatever he earns, and he does sell in order to buy, but he sells a good in order to buy an IOU. He does not sell the good in order to buy another good. The profit motive is a desire to stockpile IOUs, e.g. financial assets. Say’s Law stops working as soon as you introduce credit markets, it’s not a question of the base money per se, or of the medium of exchange. Even in a barter economy, if you allowed debt (say payable in kind), then Say’s Law would be violated and you could have ponzi lending.

361. Rule again!

     A debt deflation process occurs not because credit is unlimited but because it is limited!

362. Rule again!

     Fragility of credit creation is positively related to the degree or chain of interdependence of credit counterparties (layers) and the surprise rate of unforeseen consequences. These are positively related to the size/quantity of credit creation. The combination of an expected and variable worth (risk) and liquidity of the corresponding collateral with the fragility of credit creation brings financial instability that can generate a debt deflation process. This is the basis of the Financial Instability Hypothesis (FIH) introduced by Minsky. Now combine all rules. Period!

363. RSJ “No one wants to believe that for 20 years they have been earning “too much” relative to the wages of others, and permanently lower levels of earnings (for them) are required going forward, corresponding to permanently higher levels of earnings for others. That would be an interesting shareholder letter. ”
     -There is exactly such a shareholder letter as a pdf on the Bershire Hathaway web site!

     Do you think it would create a much better system if much more was funded using direct equity investment rather than credit? I read something about large UK homebuilder that ran an almost zero borrowing buisness model. They trailed way behind competitors during boom times but made up ground in each real estate market collapse. Overall they had slow steady growth of market share. If all taxation was in the form of a tax on gross assets (so a real asset bought via a matching financial asset would suffer double tax), then that would favour such a low borrowing style of buisness.

364. RSJ, I’m still trying to get my head around the thrust of your argument. Is it that you consider neither the quantity of cash available for investment nor the ease of loan creation to be genuine limiting factors to unsustainable credit fueled bubbles? You consider that the crucial reform required is an asset tax set to the long term government bond rate and that if that were in place then all restrictions could be overlooked? My difficulty is that the situation seems to me to be an evolving one. I can see that currently the quantity of cash available for investment is not a limiting factor but isn’t that a fairly recent (last few decades) phenomenon that potentially could be reversed? Also as the amount of money availble for investment increases further and long term government bond rates fall further, then things will move to a next stage. Your clear simplified model ponzi economy did not include a government sector cross feeding government created money into the system and so alowing it to be perpetuated for longer before the indebted workers took fright.
     I think it was Ramanman who pointed out that the current Chinese real estate bubble is driven more by people spending their own savings on investment properties and less by people borrowing money to invest. I suppose that when such a bubble bursts, it does not create debt deflation and so only redistributes money to those who sell at the peak of the bubble. Nevertheless such non-debt bubbles still cause massive malinvestment, waste and enviromental destruction.

365. RSJ:

     I am still not happy with money flow. I do not care about individual bills, but, before thinking about the credit growth, I need to understand how the profit formation path in your stylized economy works.

     In your description, the investment of $10 and worker labor create 3x$10 goods. The worker get $10 in wages, buys one good and the owner recoups his original investment.

     There is no money in the system to buy two remaining goods because neither the owner nor the worker have money to do that. So, it is not clear how the owner can consume, much less grow.

     We agreed (I believe) to exclude other firms bankruptcies and the worker borrowing from the owner as sources of profit, leaving only the investment->profit path.

     Something is missing or I am misunderstanding.

     Of course, by the worker and the owner/firm, one means the entire collection of firms and workers.

     I am quite familiar with Marx’s M-C-M idea which is tangentially related to the discussion.

366. VJK,

     In terms of interest, the rate was zero. But if you want a positive interest, that is also fine. Everything is doable as long as the economy is ponzi. When the next period rolls around, just have the worker borrow the interest from the owner as well, cutting out the firm and the purchase of the good. But now we need change for our $10 bill. Note that no interest will be required in the same period that all these transactions occur, as this is a discrete model.

     The point is that what prevents ponzi lending is accurate future knowledge about the income of the worker. The use of fractional reserves is not the source of ponzi lending.

     And you can see how even honest mistakes will propagate because as aggregate dissavings goes up, aggregate incomes go up, so the credit profile improves, causing lending to go up, causing incomes to go up, etc. For banks, you have the same dynamic of more borrowing driving collateral values up and incomes up, justifying more borrowing. So that you can argue that an individual bank is a price taker and is merely performing “good credit analysis”, however in aggregate the price of real estate during the boom is a function of how much banks are willing to lend against it. This is a classic case of externalities, and hence the “we’re still dancing” comments just before the crisis. I don’t see why, a priori, credit markets would do a better job of this than banks. Although I agree that with banks there is more opportunity for abuse as they don’t need to mark assets with markets so the bubble can keep growing longer.

     As an aside, this is one concern with the zero rate proposal, and the idea that we just need banks to engage in good credit analysis and then things will be OK. The payoffs need to be variable so that for each dollar lent, a fee is imposed equal to the additional unit of systemic risk created by the loan, together with insuring that the parameters of the idiosyncratic risk model are adjusted as the macro risk changes. This variable fee will end up looking like an interest rate reaction function.

367. Stone,

     No, I am not arguing that the quantity of base money is irrelevant in the real world — you do need some base money, obviously, and this amount has to grow over time.

     I’m arguing that the dynamics of credit bubbles do not rely on an expansion of base money, nor on bank lending. Neither do we risk a bubble because base money increases. I’m also arguing that private credit is created in the credit markets just as much, or even moreso, than in the banking system. The source of endogenous money has nothing to do with loans per se, but with balance sheet expansion on the part of the borrower. Loans are just one way to accomplish that expansion, but selling bonds works equally well.

     The quantity of base money and the demand for credit are driven by different factors. For example, look at the time path of the monetary base from trough to peak of the last cycle. It grew at a slower rate than NGDP, yet debt grew significantly faster over that time. In the U.S. bank deposits as a whole did not grow faster than GDP, and household checkable deposits, even adjusting for sweeps, are basically at 1980 levels.

     I don’t think that the size of base money should go into any type of macro model, or that currency + reserves should go into the model. Interest rates, credit, incomes, expectations should go into the model.

     About China, I don’t think it’s accurate to say that housing is not credit driven. You have a lot of things going on, and the data is not reliable. On the one hand, households invest in informal lending markets that have high interest rates, because the rates paid by banks are controlled. So you can have a dynamic of the form:

     Someone owns a house, the house appreciates and so they borrow against the equity from the official banking system and invests the proceeds in an informal credit market, earning 10%. The borrower of another house borrows “prudently” from the bank (due to credit restrictions) and borrows the remainder from the informal lending market. Real estate prices appreciate. The house appreciates, so the borrower has equity. The borrower takes out an equity loan from the bank (at the low rates) and repays the informal market, etc.

     re: China,

     One consequence of the understanding that “loans create deposits” is the realization that at the macro level, dissaving can crowd out consumption by forcing a certain amount of savings to occur. So if you subsidize dissaving for capital investment via artificially low borrowing rates, then you must be somehow decreasing real incomes for a majority of your populace. That could be via inflation, or via a tax on consumption, or hidden taxes, wage control, etc. But the mechanism doesn’t matter. In aggregate consumption, and therefore living standards, will continue to fall relative to GDP until you stop subsidizing the borrowing rates. But at that point, you have massive overcapacity and insufficient household income to purchase the output.

     Those who can’t see that dynamic will declare “China is a nation of savers”, but this savings is forced. Consumption has fallen from, say, 2/3 to 1/3 of GDP, plus a trade surplus of about 10% of GDP — in that environment, whatever the true size of “G” happens to be, say, 20%, still that gives you an “S” of about 50-60% of GDP, yet wages and salaries are only about 40% of GDP.

368. RSJ:

     I am trying to digest your mesage, but here are some preliminary comments:

     Everything is doable as long as the economy is ponzi.

     As I commented earlier, workers ongoing borrowing implies that the owner extracts profits by getting the workers deeper into debt, dollar for dollar. Sort of zero sum game.

     The point is that what prevents ponzi lending is accurate future knowledge about the income of the worker.

     How exactly money flow would work in a non-ponzi scenario ? Could you spell out required transactions from an investment until the production cycle completion ?

369. VJK,

     It must be a zero sum game in this economy, if you think about it, because the economy is not growing. Incomes are not growing. There is no investment, etc. In that context, all profits must be ponzi in nature.

     For a non-ponzi no-investment example in a constant economy, you can imagine young workers saving by purchasing IOUs from retirees. The retirees themselves purchased the IOUs when they were young, etc. The IOUs allow you to transfer consumption into retirement. In that case, barring demographic changes, the total stock of IOUs is constant. It just changes hands. Also a shell-game, but non-ponzi.

     For a non-ponzi investment example, things get complicated because we need a production and profit model in order to determine whether a given investment is worthwhile. And we also need a discount rate, etc. That drags in consumer choice, growth theory, etc. It can be difficult to determine whether an economy is in a ponzi state or not.

     I’ll give an example in a moment.

370. RSJ “you do need some base money, obviously, and this amount has to grow over time.”-

     What do you think the consequence would be if the amount of base money was frozen and the tax burden was moved to being an asset tax (flat rate on cash, real estate, stocks etc)? I thought that that would lead to asset price deflation initially but then to a more stable and rational economy driven by maximisation of earnings rather than ponzi asset appreciation.

     I see what you mean about subsidized borrowing causing distortions (overcapacity, unemployment). That was why I thought it better to have a credit system where all credit was from loan companies (that couldn’t take deposits and sold bonds) rather than banks and the borrowing rates would be set entirely by the market with no government involvement.

371. Stone, it wouldn’t lead to asset price deflation per se but to multiple payments crises and an increased risk premium. Having interest rates too high is also bad for the economy and can also lead to lower growth and unemployment.

     As VJK points out, the assumption that base money is not necessary is equivalent to an assumption that all transactions occur with infinite speed and zero cost. That isn’t true, and so you need base money to support the functioning of the payments system.

     My point was that when engaging in demand management and economic policy, you should focus on the economically important issues and assume that the payments system is working. You don’t take crime into account when setting fiscal policy, but that doesn’t mean that you don’t worry about it — it’s a law enforcement problem, but not an economic problem.

     A smooth payments system is the problem of the central bank, but it’s not an economic problem. That does not mean that the issue is not important, or that you can ignore it — but it’s not why we have 2 years of mass unemployment, or a lost generation in Japan.

     Central bankers are quite grandiose if they think that a shortage or excess of reserves has this effect. Of course they think the great depression was caused by “too little money” and that recovery was caused by “monetary expansion”. Of course they believe that by increasing reserves they can control inflation and economic activity. But we don’t have to believe that — we don’t need to be bank fetishists; we can look at economic causes of economic problems, and search for economic solutions. Offload the payment system to the central bank, and offload crime to the police, and then deal with unemployment via economically relevant policies.

     That does not mean that we should try to undermine the payments system. Relying on payments crises as a mechanism to try to enforce reasonable asset values seems insane. Why not argue that we can prevent real estate bubbles by letting houses burn instead of having a fire department? After all, if people lived in fear, then real estate bubbles would be less likely, and people would know better than to overpay for something that can burn down at any moment.