In the spirt of debate … my reply

As indicated yesterday, Steve Keen and I agreed to foster a debate about where modern monetary theory sits with his work on debt-deflation. So yesterday his blog carried the following post, which included a 1000-odd word precis written by me describing what I see as the essential characteristics of modern monetary theory. The discussion is on-going on that site and I invite you to follow it if you are interested. Rather than comment on all the comments over on Steve’s site, I decided to collate them here (in part) and help develop the understanding that way. That is what follows today.

My narrative does not repeat all the comments verbatim and may take things a bit out of order. Nothing implied by that. Some of the comments were at the non-end of decent debate and appeared to be just negative railings against government, akin to the hysteria that is going on in the US at present about Obama’s health reform proposals (I will write about these in due course). I have responded to those type of comments if the rebuttal provides insights. Otherwise I just ignore them.

But many of the comments were well intended and worthy of response.

This comment seems to be representative of a lot of misunderstanding:

Bear with me if I don’t come up all the proper economic names and terms. But as a layperson, what’s one of the most frustrating things about the Global Depression? This delusion that endlessly running up the debt won’t cause a problem. All we need to do is throw enough money at the problem. And then life will be wonderful.

I am not sure who is being delusional but I guess it was aimed at modern monetary theory. In that vein, what is being said? First, debt is the way business firms grow and households accumulate assets such as housing (which in the case of most families/households represents the most significant component of their wealth at career end). The private sector is revenue constrained and as such has to obey certain budgetary principles when making decisions to accumulate debt. the most obvious one being that they have to pay it back and to do that they have to save from their incomes.

The government sector is entirely different in this regard because in a fiat monetary system it is not revenue constrained (as the monopoly issuer of the currency). So for it accumulating debt has a different implication. Yes, it has to be paid back and yes, it has to be serviced. But these actions occur at the stroke of a pen by crediting bank accounts.

For the household, paying back debt means they have to sacrifice current consumption (spending). For the government, no such financial constraint is imposed. Its ability to spend now is independent of how much debt it holds and what is spending was yesterday. That situation can never apply to a household or business firm.

Further, in thinking about private debt much is made of so-called toxic debt. But toxic debt today was good debt yesterday in most cases. The difference is today the holder of the debt has just lost their job and can no longer maintain payments. The real problem in this case is not the debt but the lost job. Governments can always maintain higher levels of employment (up to full employment) if they choose to create enough jobs (either directly in the public sector or indirectly via targetted spending in the non-government sector).

This is not to say that some of the “toxic debt” wasn’t based on dishonest assessments of the asset values or incomes of the applicants (by mortgage brokers seeking commisssions and knowing that the debt would be bundled and on-sold as securitised products that some hedge fund would buy.

Of-course, saying that there is no financial constraint on government is not the same thing as saying there are no economic constraints. I am ignoring the political constraints here – these are the constraints that require the government to impose voluntary chains around itself which has it issuing debt in the first place when clearly it doesn’t need to do that – please read Operational design arising from modern monetary theory

The economic constraints are that the government can only purchase what is available for sale. So nominal aggregate spending growth can only run up to the real capacity of the economy to absorb it after which inflation becomes the problem.

If the net spending involved in servicing the government’s debt and maintaining its social program pushed nominal spending growth beyond the inflation barrier then the government has two broad choices – cut some of its program or reduce the capacity of the private sector to spend (via taxation changes).

Another way of looking at this is that the government must fill the spending gap left by the decision to save of the non-government sector for output to remain unchanged and at full employment. Beyond that inflation becomes certain.

So “all we need to do is throw enough money at the problem” depends on what the aim of the government is. I note the terminology “throw” is emotional. Governments spend by crediting bank accounts (adding reserves in the commercial banking sector). If the government wants to achieve and sustain full employment then it has the capacity to do that by closing the spending gap.

This means its deficit will have to equal the non-government sector’s net saving. That will be enough spending. Beyond that – as above – inflation becomes the problem.

I also note that solvency is never a problem for government in its pursuit of full employment – only inflation is the potential problem.

Someone said that:

The Chartalist ideas as depicted by Dr. Mitchell appear idiotic on their face to this noneconomist. The idea that issuing or authorizing fiat currency is “spending” is wrong. Then, the idea that government deficits equals private savings is wrong. It’s very easy to consider a situation in which the government has outstanding a stable money supply with a stable population, and the government administers a system of courts and a small army and navy, collecting import taxes to support this government. At the same time, the private sector is productive and sells its goods internally and overseas, garnering monies from foreign countries (either their fiat currencies or gold) as the savings.

Even trained economists find modern monetary theory difficult to grasp at first because they are so conditioned by their own gold standard training. The general public is even more baffled because they have been so conditioned by 30-second grabs on TV and radio and the experts they read in the newspapers who cannot see that 1 + 1 = 2, by all the rules of commutation that we learn in primary school.

How does the government which is the monopoly supplier of the fiat currency issue it? Well by spending.

The exact statement that was made in the summary on Steve Keen’s blog is that “As a matter of national accounting, the federal government deficit (surplus) equals the non-government surplus (deficit). In aggregate, there can be no net savings of financial assets of the non-government sector without cumulative government deficit spending.”

I don’t see the words “private” included. Government deficits do equal private savings if the external sector is in exact balance always. Not likely.

So the recommendations I make when trying to understand something is to first assume it is correct – that is, not jump into the fray looking for errors. Second, with your “eyes open” make sure you understand every nuance of the language being used and not substitute things you have learned from other paradigms or from the TV news. Third, ask questions if you are unsure to make certain that you have captured the essence of the argument being made. Fourth, make some assessments based on known methods of determining knowledge.

Which brings me to another comment that appears to be in that spirit:

I’m having a hard time getting my head around Chartalism. Is the argument that we are already in a de facto Chartalist system, and the central banks’ machinations are just adding an unnecessary layer of complexity?

By this explanation, “taxation acts to withdraw spending power from the private sector but does not provide any extra financial capacity for public spending”, is the argument that taxation is just a means of soaking up excess liquidity due to the previous spending? In that case, couldn’t government debt be seen as soaking up excess liquidity by taxing future taxpayers?

We are certainly operating in a fiat monetary system (excluding the individual Eurozone countries and certain other small nations) where the government is sovereign in its own non-convertible currency and relies on its capacity to impose taxes/fines to ensure that the non-government sector has a requirement to get hold of that (otherwise worthless) currency.

The central bank is part of government irrespective of what the political or ideological rhetoric might tell us. The so-called independence is a chimera.

The way we know it is an intrinsic part of the consolidated government sector is because its transactions with the non-government sector can create or destroy net financial assets. Transactions between non-government entities can never do that. More about which later. But you might like to read or re-read the following trilogy of blogs – Deficit spending 101 – Part 1Deficit spending 101 – Part 2Deficit spending 101 – Part 3.

Taxation initially functions to generate a demand for the otherwise worthless currency. The ability to force the non-government sector to get hold of the government’s currency allows the latter to conduct its socio-economic program (by spending). In addition, taxation is a way to destroy net financial assets held in the non-government sector if the government wants that sector to have less purchasing power. For example, to reduce inflationary pressures.

Now what about public debt issuance. First, the funds that are used to buy the debt were created by government spending in the first place. So the idea that government borrowing is using up funds that were accumulating previously by non-governmetn saving misses the mark badly.

Second, debt issuance just swaps bank reserves for a piece of paper (the government bond) but in doing so drains the reserves from the banking system.

Third, issuing debt today has no intrinsic implications for future taxpayers. I guess the point being made is that the debt has to be paid back and that will require tax increases in the future. Not at all. The government has the capacity to spend at any time irrespective of what it spent yesterday. Paying back debt is just the same process that the government uses in all its spending activities – bank accounts are credited and bank reserves increase. The sovereign government is not revenue-constrained.

It might increase taxes in the future because it wants the non-government sector to have less purchasing power. But that will not be inevitably related to its past debt issuance and never related to a need to accumulate funds to pay the past debt issues back.

So this discussion should allow us to see why this comment misses the point:

Certainly an interesting read. Mitchell presents some very controversial arguments. I’m not sure how he can so confidently assert that government debt (surplus) balances out private-sector surplus (debt). Are Australians somehow not allowed to transact with people from other nations? …

As an aside, my 1000 or so word primer on modern monetary theory is not what I would consider to be “very controversial”. It was mostly a statement of essential accounting rules and behaviours that follow from those stock-flow constraints.

Anyway, I covered the point about the national accounting identity above. But I did like this comment from fellow modern monetary traveller, Professor Scott Fullwiler:

A few have already questioned the government debt = non-govt surplus point made by Bill, so allow me to elaborate.

To begin, this is an accounting identity. Disagreeing with it is akin to disagreeing with gravity. That it seems so foreign to so many has more to do with the paucity of understanding of basic accounting that persists among economists, the financial press, and those that follow the writings of both groups.

Another common misconception is that modern monetary theory is inconsistent with endogenous monetary theory (which Steve Keen writes about among others). So there was a comment:

As a non-economist, the biggest difference I see between your analysis and this summary of chartalism is private credit creation. The chartalist view assumes that only the government can create money so this would imply a full-reserve banking system. Your analysis accepts the current regime of private credit creation being the dominant source of currency and determines the likely behaviour of such a system.

Personally, I find myself drawn to the Chartalist’s view of the world and support the idea that fractional reserve banking should be abolished. Money should be created, not borrowed, by the government.

It would help to read this blog – Deficit spending 101 – Part 3 – where a detailed analysis of what modern monetary theorists refer to as the horizontal relations in a monetary system is presented. We distinguish the horizontal dimension (which entails all transactions between entities in the non-government sector) from the vertical dimension (which entails all transactions between the government and non-government sector).

In simple terms, the horizontal dimension is equivalent (totally consistent) with the (properly accounted for) circuit theory and endogenous money models.

The leveraging of credit activity by commercial banks, business firms, and households (including foreigners), which many economists in the Post Keynesian tradition consider to be endogenous circuits of money, occur in private credit markets. The crucial distinction is that the horizontal transactions do not create net financial assets – all assets created are matched by a liability of equivalent magnitude so all transactions net to zero – always.

The other important point is that private leveraging activity, which nets to zero, is not an operative part of the stores of currency, reserves or government bonds. The commercial banks do not need reserves to generate credit, contrary to the popular representation in standard textbooks.

So whenever we are analysing horizontal transactions we always have to find an asset to match with a liability. In the vertical dimension, net financial assets can be created and destroyed by government. That is a fundamental difference between the sectors.

You can also see this in terms of stock-flow consistent macroeconomic models – see this blog to learn about this type of model.

To fully understand what the non-government sector is doing you have to ensure you fully specify the economy (at the sectoral level) to be stock-flow consistent using the accounting rules that govern stocks and flows that we all accept. If you leave out the government sector from the model when you are missing a “row” in the stock-flow matrix and so you will miss essential dynamics that exist between the sectors.

A properly specified model will show you emphatically that the horizontal transactions between household, firms, banks and foreigners (which is the domain of circuit theory) have to net to zero even if asset portfolios are changing in composition. For every asset created there will be a corresponding liability created at the same time.

The model will also show you that once all stocks and flows are reconciled as consistent then only the government transactions with the broad non-government sector create or destroy financial assets.

Modern monetary theory emphasises that you should start your learning journey at that point to fully understand what happens elsewhere in the economy – say at the credit money – bank leveraging domain.

We don’t say that all models have to introduce all element all the time. It is legitimate to study endogenous credit money creation at the non-government (horizontal level). But you will make errors if there is not an explicit understanding that in an accounting (stock-flow) consistent sense all these transaction will net to zero. In adopting this understanding you might abstract from analysing the vertical transactions that introduced the high-powered money in the first place, but never deny its importance in setting the scene for the horizontal transactions to occur.

Which means I totally agree with a comment that followed:

For what it’s worth, my sense is that Steve’s endogenous money model should be totally compatible with the Chartalist operational model. There are some wrinkles related to Steve’s interesting accounting for loan repayments, but I don’t think they contradict anything fundamental about the operational foundations for the modern monetary theory.

As long as Steve operates within conventional accounting traditions and is stock-flow consistent then endogenous money theory is fully captured in the horizontal dimension of modern monetary theory. But in saying that I think Steve has “invented” some accounting rules which would not be normally accepted (by anyone else). More later.

Then there was this interesting comment (partly reproduced):

… Would it be true to say then, that banks are directly in competition with governments to ‘own’ the money supply – issuing loans (whereby the banks transform credit into gambling stakes and real assets) vs. government money creation? Government may spend first but banks loan a lot more? This would explain the malficient stranglehold Wall St. has on the US government – another mechanism that should be serialised on national TV?

There is no competition because the government is the monopoly issuer of the currency. By loans creating deposits, banks certainly create credit which can be used for any number of things. This is not a struggle over control of the money supply. It is clear that the government cannot control the money supply as the mainstream macroeconomic text books claim. This fact is one of the essential insights of endogenous money theory, which is the area of research that Steve is active.

The essential point – explained above is to understand the difference between vertical transactions between the government and non-government sector, which create/destroy net financial asset positions in the non-government sector; and, horizontal transactions within the non-government sector which have to net to zero.

Bank loans create deposits but the loan is an asset to the bank just as the deposit is a liability to the bank. Nothing net has been created.

Then Steve Keen himself entered the debate to clarify a few matters. He said (partially quoted):

I don’t question the accounting identity Scott,

In the spirit of n8r0n’s comments though, what I do question is its relevance to the data.

In a flow sense, a government deficit in a given time period corresponds to the net accumulation of private sector monetary assets in that period, if there is no other source of money or if those other sources create a balance of money and debt. Of course there is another source of money – money endogenously created by the private banking system – and on the data, there is not a balance of money and debt creation there (so that the two net to zero) but a surplus of debt creation over money, so that the two sum to a substantial negative.

Yet the system functions (albeit it’s c#cking up now): our actual monetary system appears to function with net negative financial assets. Using the broadest measure of money the USA ever published (does it rile you that the Fed has stopped recording M3? Sure annoys me!), total debt was 2.25 times M3 in the 1950s, and was 4.3 times M3 when the data collection stopped in 2006 (the ratios of only private debt to M3 were respectively 1.25 and 3.3). So even at a time when Minsky described the USA as financially robust, debt exceeded money: the system functioned well with net negative financial assets.

It therefore appears to me that what we need to explain is how a monetary economy can function with net negative financial assets – or more strictly, with monetary debts substantially exceeding money holdings.

I’ve done that with my Circuit models, in which debt exceeds money (when defined to exclude the banking sector’s own transaction accounts). I also have an extension I haven’t yet published where I have a non-bank financial sector, which creates debt without creating money.

I would like to know how the Chartalist perspective handles the empirical fact of net negative financial assets in a monetary economy.

From my point of view, one of the things the government does when it runs a deficit is reduce the excess of debt over money, which is an important policy measure to reduce financial fragility. But I don’t see the fact that only the government can create net financial assets as a crucial argument for the importance of a Chartalist perspective, because our system always seems to function with net negative financial assets – and it has occasionally secured full employment without government deficits as well.

So from Steve’s perspective he is asserting that the non-government sector can alter net financial asset positions independent of any government involvement. The fact is that it cannot – categorically – do that. Let me explain. I also had some input on this from Warren Mosler.

So we would agree that “in a flow sense, a government deficit in a given time period corresponds to the net accumulation of private sector monetary assets in that period” as long as we include residents and non-residents in the “private sector”. Modern monetary theory uses the aggregation – non-government sector to eliminate confusion about whether the private sector is resident or more general. This is important because foreign governments are equivalent to “domestic private” from the perspective of the home economy in that they cannot create or destroy net financial assets in the home currency of issue.

But Steve wants to add the caveat to this statement – that is, it holds “if there is no other source of money or if those other sources create a balance of money and debt”. We have to be very careful in using the term money as I will explain.

Steve then seeks to explain his position by noting that there is another “source of money” which is “endogenously created by the private banking system – and on the data”. He believes that “there is not a balance of money and debt creation … but a surplus of debt creation over money, so the two sum to a substantial negative”.

Well this might exist in Steve’s models but it is impossible in the real world where accounting principles rule. Why? Because bank loans create equal deposits as a matter of accounting (identities).

The bank has an asset (loan) and an equal liability (deposit). The borrower has an asset (deposit) and an equal liability (loan). If we consolidate over the entire non-government banking system then the sum of loans and the sum of deposits cancel out even though there is more “money” in the private sector hands as a result of the bank bank balance sheet expansion.

There can never be a substantial net negative upon consolidation. What this tells me is that either the usual (double-entry) accounting definitions are not being followed or the stock-flow model is not consistent (or both).

The point loans create deposits certainly but net out to zero. Only cumulative government deficit spending adds net finanical assets to the non-government sectors, just as budget surpluses destroy them.

Steve then invokes some data.

He says that “total debt was 2.25 times M3 in the 1950s, and was 4.3 times M3 when the data collection stopped in 2006 (the ratios of only private debt to M3 were respectively 1.25 and 3.3). So even at a time when Minsky described the USA as financially robust, debt exceeded money: the system functioned well with net negative financial assets”.

This also cannot be correct. All the dollar debt (always) has a corresponding dollar financial asset held by the borrower. You need to dig below the surface of the numbers to the conceptual level to fully understand the situation. This is the danger of taking a particular view of what money is.

Steve then says that his latest unpublished work has “a non-bank financial sector, which creates debt without creating money”. Once again this could not be the case if the usual accounting rules were followed and a fully-specified stock-flow consistent macroeconomic model was used.

Non-bank (corporate) debt creates non-bank financial assets, such as commercial paper, corporate bonds and the like. So dollar-denominated net financial asets cannot be altered by private sector activity. Only the government can add or subtract net dollar financial assets to the non-government sector.

But appealing to empirics like those above can only establish the “empirical fact of net negative financial assets in a monetary economy” if you use a definition of money that doesn’t include all the financial assets created by debt. Once you adopt the usual accounting rules to map out all these non-government transactions then it will never be the case that they create net negative (or positive) positions.

Steve finishes this comment by arguing that “I don’t see the fact that only the government can create net financial assets as a crucial argument for the importance of a Chartalist perspective, because our system always seems to function with net negative financial assets – and it has occasionally secured full employment without government deficits as well”.

All of the above reasoning should give you confidence that the government is the only entity than can create net positions in the non-government sector. Moreover, it is true that the non-government sector can operate – for a time – with negative financial assets (but then the government sector will be in surplus).

The non-government sector can achieve this state – negative financial assets if for that period of time there is a desire to reduce net financial assets by going into debt to pay taxes to a government running a surplus. But as we have seen, and Steve has shown categorically – this is an unsustainable growth strategy – the non-government sector cannot dis-save indefinitely and accumulate ever increasing levels of debt.

This reasoning should then tell us why the following comment also violates basic accounting sense (Steve also agreed with this example as a vindication of his position):

Steve, surely net debt greater than money is easily understood by:

bank A creates and loans 100$ to NBFI B at 2%.
NBFI B loans the 100$ to C at 3%.

Now the money in the economy is $100, but debt is $200. Why is this a problem? In fact it seems to me (apart from the issue of counterparty risk), that the above is equivalent to simply A lending to C at 3%.

To understand the net position you have to trace the assets and liabilities created here.

Bank A creates loan of $100 – it has an asset of $100 (loan) and a liability of $100 (deposit). NBFI B has an asset of $100 (deposit) and a liability of $100 (loan). Nothing net created there.

NBFI B then loans and creates a deposit worth $100 to entity C. B has an asset worth $100 (loan) and a liability to C of $100 (deposit). C has an asset of $100 (deposit) and a liability of $100 (loan). Nothing net created there.

How you account for this depends on what you assume about NBFI B – does it lend by creating a deposit for C or just withdraw the $100 from its deposit at A and hand the cash over? You can imagine the latter if B was just a person as was C but the former if B is a NBFI. I have assumed the former (so the deposit B has with A remains at $100 and a new asset – liability to C (deposit) arises. If you assumed the latter then the B’s deposit at A goes to zero and no new deposit is created for C in B (an unrealistic example that reeks of money multiplier implications. Whichever way you account for it, all the transactions create a net position in financial assets of zero.

When all is paid back there will be an corresponding extinguishing of the assets and liabilities and again nothing net will be created. The problem again is not counting everything on both sides of the ledger (taking an narrow view of money as opposed to financial assets).

In this regard, I think Scott Fullwiler’s intervention was excellent:

… using the term “money” often confuses things. “Money” is always someone’s liability, so better to be precise about whose liabilities we are talking about than saying “money.” This also helps because some people consider “money” to be deposits only, and others consider it to be more broadly defined. You’ll notice perhaps that most of the chartalists have over time stopped using the word “money” as much as possible and refer to specific entries/changes to balance sheets.

If the government increases its liabilities, this is a net increase in financial assets for the non-government sector.

The non-govt sector actors can certainly increase the quantity of credit amongst themselves. Whether or not it increases someone’s definition of “money” 1 for 1 with loans, it DOES BY ACCOUNTING DEFINITION increase the quantity of financial assets and financial liabilities 1 for 1 in the non-govt sector. So, with private credit, there is BY DEFINITION no NET increase in private sector financial assets created.

The bank example commentator then said that “We need to distinguish between debt, and leverage. In my example the $100 created by the bank A is leverage. B is intermediating and spreading risk but has not created extra leverage/money. There is only one liability here belonging to C. If C defaults the liability passes to B. Still only one liability, not two.”

But Scott’s reply is spot on – “Leverage is defined as debt in the academic field of finance (that is, debt is a leveraging of equity). Otherwise, you’re making up your own definitions.” Clearly Bank B has a liability to A that is not extinguished by lending to C. If C pays up and extinguishes its liability to B, then B destroy the asset (loan to C) and can use the funds to extinguish its liability to A which, in turn, wipes out the asset it holds against the loan to B. Again, nothing net is created here.

I think JKH, who is a regular commentator on my blog as well summed it up well in a couple of comments which I conflate (in part):

I have a visceral negative reaction to the apparent econo-blogosphere virus of making up definitions that conflict with standardized double entry book keeping definitions that the creators of those conflicting definitions actually rely on in order to source the data that supports their new creation …

Moreover, the monetary system as a whole does not have negative net financial assets. That is logically incorrect. Every financial obligation is mirrored by a corresponding financial asset. This holds for money, debt, and equity. This is double entry book keeping …

If the common ground between Circuitism and Chartalism is that both camps understand how the monetary system works, that would be enormous common ground. I’m absolutely convinced that the Chartalists understand it, and that understanding is provable by operational fact and pure accounting logic. The accounting paradigm as between government and non government financial balance is absolutely indisputable in that sense. Conversely, if the primary distinction between Chartalists and the neo-classicals is on the same point, that is enormously important. It is enormously important because there is no way you can understand economics if you don’t understand how the monetary system works. It is a necessary condition. Otherwise, it would be like monkeys typing Shakespeare for the neo-classicals to get it right.

Then someone said:

As far as I’m concern it’s all nonsense. A different view of what is clearly wrong (neoclassical) could also be wrong.

Yes, a rival paradigm could be as wrong as the mainstream. But you need to be able to demonstrate why it is wrong by first of all understanding the assumptions and mechanics of the model in question. That would be better than dismissing rival work or any work as nonsense from the outset. We move on.

Another commentator expressed some problems understanding modern monetary theory (as depicted in my 1000 words precis on Steve’s blog). They said:

I’m still trying to get to grips with this stuff and (literally) don’t understand the following:

1. Bill Mitchell: “The modern monetary system is characterised by a floating exchange rate (so monetary policy is freed from the need to defend foreign exchange reserves) and the monopoly provision of fiat currency.”

Surely in a globalized world economy “the” monetary system(s) gyrating around floating exchange rates is a symptom of instability rather than a cure for it. Things haven’t got more stable since the US defaulted on its gold exchange rate in the 1970s?

How the economy has played out since the collapse of Bretton Woods is not the point of how the modern monetary system is characterised. The fact is that under a flexible exchange rate, monetary policy no longer has to defend the fixed parity and so fiscal policy does not have to get into self-defeating stop-go growth paths characteristic of external deficit countries under Bretton Woods. This constraint was one of the major reasons why the convertible currency system collapsed.

Then the commentary went into the modern monetary theory = communism nexus. When in doubt bring in the furphy that everyone will get emotional about.

Chartalism as I read it is pretty much what we have now; some may also refer to our current system as crony capitalism or socialism for the uber rich. All this searching for alternative systems plays into the hands of the controlling banking elite. Left wing pundits seem unable to understand that the scraps being thrown by way of stimulus is a smoke screen to mask the bailing out the banks by way of money printing.

Some of the phrases from the Chartalism discussion is scary in its simplicity; ones like: “Modern monetary theory provides a sound basis for understanding the intrinsic opportunities available to governments” – Wow, so the government should be given opportunities; why don’t they just do their job and enforce the rule of law by locking up the fraudsters.

Modern monetary theory is not left-wing just as much as it is not right-wing. It is an operationally-based characterisation of the way the monetary system operates and the way that the government sector interacts with the non-government sector. It is a stock-flow consistent framework.

The reality is that whatever the government does (using its opportunities) – big or small, surplus or deficit, whatever – will have implications for what the non-government sector does. If they run surpluses then the non-government sector runs deficits. We have to get down to that level of understanding and acceptance before we can discuss other matters that might reflect our values.

Then, what you do with this understanding by way of policy design reflects your ideological slant.

The same commentator continued:

… “In the absence of government spending, unemployment arises when the private sector, in aggregate, desires to spend less of the monetary unit of account than it earns.” – NO, in the absence of government people are industrious. Only when government gets involved does the system fall apart. The job of government is to uphold the law and lock up the fraudsters.

“The only danger with fiscal policy is inflation which would arise if the government pushed nominal spending growth above the real capacity of the economy to absorb it”. At least inflation is mentioned; however it should have been defined for what it is – a TAX.

The debate on the whole is centred around those who think that printed money creates the type of productive that is sustainable. Sure giving printed money to failed car companies enables them to make more cars but this is still fraud. We will continue to waste resources at the maximum possible rate so long as we don’t have a sound currency (and I’m not talking gold). It’s like giving fishermen printed money to fish when the fish stocks are depleted; it’s asinine. We need tough love and we need it badly.

There can be no unemployment in a non-monetary system. But in a state system (fiat currency) if the non-government sector desires to net save in that currency then unless the government sector fills that spending gap, unemployment will result. Sorry to disappoint but until you find an alternative to the monetary system that will be the reality. An emotional dislike of government will not help. That is just denial.

Further, the “at least inflation is mentioned” comment implies that we should always think inflation is the most important issue. Inflation can occur under the conditions specified but we should not get obsessed with it. It remains something that governments have to consider in their fiscal design. But it is neither inevitable or just around the corner.

References to “printing money” will ring out to regular readers of my blog. Governments do not spend by printing money. They credit bank accounts and create new bank reserves.

But being generous to the commentator – it is true that if the fisherman are the economy and the fish stocks are available productive capacity, then any further nominal spending (aggregate demand) by any spending source (government, consumption, investment, net exports) will be unable to be met by real production. Then inflation results. We are so far from that situation now that I wouldn’t be losing any sleep over it.

And finally, for me today, there was this comment, which takes us back to where we started:

Left leaning politicians must adore chartalist dogma. After all, it places Govt at the very center of all economic activity and outcomes. Which would not be a problem were Govts entirely transparent, ruthlessly efficient and entirely apolitical. But to me this just sounds like the rule of negative selection at work. Where well connected political hacks get to run pretty much my entire life and make choices about my wealth limitations behind closed doors.

Modern monetary theory does start with the broad sectors – government and non-government – because you cannot understand what goes inside the non-government sector (which includes foreigners, households, business firms and commercial banks) without first understanding how the government and non-government sector interacts.

Why is that necessary? Simply because the government is the monopoly supplier of fiat currency which is required by the non-government sector to pay its tax liabilities. You cannot assume that away because it motivates non-government activity and outcomes.

Further, the accounting statement the government surplus (deficit) is exactly equal to the non-government deficit (surplus) has behavioural underpinnings and so you have to understand that if the government is in surplus in any period, the non-government sector has to be in deficit. Then the question is what activities, decisions etc are manifest in that non-government deficit.

For a country like Australia that typically runs an external deficit then this accounting statement tells us another fact. If the government is in surplus then the private sector in Australia has to be in deficit – that is, running down its savings, selling previously accumulated assets, or, ultimately, as a sector, becoming increasingly indebted.

So to understand the dynamics of private indebtedness you cannot ignore the government balances.

Further, to make statements like “the solution is that the private sector saves more” one has to also make statements about what the government sector has to do (given that the external sector in Australia is typically in deficit). An understanding of the fiat monetary system leads you to the indisputable conclusion that the private sector (under these circumstances) can only save and reduce its indebtedness if the government sector “finances” that saving via deficits.

In the absence of this the private attempts to save will be thwarted by income adjustments (downwards as aggregate demand falls) as output and employment falls. The only way that the non-government sector can save and national income keep rising is for the government sector to fill the spending gap left by the saving – that means running a deficit.

So in relation to this comment, it is not a matter of liking or “adoring” modern monetary theory (neo-chartalism). What the electorate allows the government to do, or what the government does on its own bat – transparently or otherwise – fairly or otherwise – is a separate matter. That sort of consideration is the realm of political science. Modern monetary theory tells you (predicts) what will be the tendencies of any particular government or non-government behaviour.

You can establish the most libertarian society you can think off – getting rid of those “well connected political hacks” – but as long as the government that is in place issues the currency as a monopolist and taxes (fines) exclusively in that currency then your economy will be bound by the dynamics laid out in modern monetary theory.


I think the differences between Steve’s models and modern monetary theory are two-fold.

First, I do not think that Steve’s model is stock-flow consistent across all sectors. By leaving out the government sector (even implicitly) essential insights are lost that would avoid conclusions that do not obey basic and accepted national accounting (and financial accounting) rules. This extends to how we define money.

Second, I think Steve uses accounting in a different way to that which is broadly accepted. It might be that for mathematical nicety or otherwise this is the chosen strategy but you cannot then claim that your models are ground in the operational reality of the fiat monetary system we live in. I have no problem with abstract modelling. But modern monetary theory is firmly ground in the operational reality and is totally stock-flow consistent across all sectors.

If we used the same definitions and rendered Steve’s model stock-flow consistent in the same way as modern monetary theory then Steve’s endogenous money circuits would come up with exactly the same results as the horizontal dimensions in modern monetary theory. His results might look a bit different in accounting terms but most of the message he wishes to portray about the dangers of Ponzi stages in the private debt accumulation process would still hold.

After all, these insights are at the basis of modern monetary theory also and were written about by the leading exponents of that approach including myself at least 15 years ago.

Tomorrow: the G-20 hands over legitimacy to the IMF.

This Post Has 26 Comments

  1. Bill,

    What do you make of Italy proposing to withdraw from the euro, as advocated by berlusconi at the G20? I imagine that if we see a trend in this direction it will validate much of what you have been saying…

  2. Dear Scepticus

    All the Eurozone countries were mad to cede their sovereignty to an unelected body in Frankfurt. The sooner they pull out and take back their fiscal autonomy the better. Or, alternatively, collapse their borders completely and cede their fiscal responsibilities to a united Eurozone government. Given history, the former is more likely, but either would work to realign the monetary and fiscal functions geographically.

    However, if we don’t see a trend in either direction it doesn’t bear one way or another on the validity of modern monetary theory. It just shows how dull-witted the G-20 process, and, specifically, the Euro leaders are.

    best wishes

  3. Bill,

    I have some empathy to Steve’s example of Bank A, NBFI B and entity C. Even though nothing net has been created here, but as far as looking at the future is concerned, one has to be careful. In other words, Steve also wants to analyse the implications of corporate bonds issuance and all other kinds of debt and various other things. A situation S1 which is described by variables households savings, loans on the balance sheets of firms and banks and households may be similar to the situation S2 which is (S1+corporate bonds) as far as accounting at the national level is concerned, but may take different ‘paths’ in the future.

    What I am saying is that Steve wants to reach to a predictive model which may end up having 300 variables and which essentially has everything and he is willing to reconstuct his theory to include ‘government money’ and he is trying to say that absolute value of the sum of left hand side of balance sheets of the private sector also matters. The future course of economies will, in his view, not only depend on the government spending but also the sums of one side of the private sector balance sheets.

  4. Dear Ramanan

    Thanks for the comment. It was actually not Steve’s example but one he commented on. The points are that the net to zero is basic to understanding how these transactions work and to appreciate why government-non-government relations are crucial and different.

    Modern monetary theory never denies the importance of either side of the private balance sheets. Embedded in our approach is a concern for ponzi situations – we have been writing about this for a long time. But you cannot just say we need to reduce private debt without understanding what else has to happen in the system for that to happen overall.

    But Steve has built a model where the non-government transactions do not net out to zero – so even as an abstraction from the full model (and I think it is useful to abstract to simplify and get a point across) – this approach is missing something out – either it is because the accounting rules are different to those typically accepted or there is a mistake in the stock-flow consistency. That is what worries us – there is something in his model that violates given rules of consistency using usual definitions.

    You have to appreciate that to do that you need to increase government net spending (or reduce surpluses).

    best wishes

  5. Dear Bill,

    I have posted a comment (as “ak”) on Steve’s blog regarding the “non-government transactions do not net out to zero” issue. I believe the problem is not with stock-flow consistency but with the definition of money what implies in some cases different accounting rules.

    Could you please have a look at the post and if I am wrong correct me? I would like to at least correctly understand the basic principles of the economy at the macro scale (because I cannot afford to study the “economics proper”).

    Best Regards,

  6. Hi Bill,

    Thanks for your reply. I was just empathetic to one point of Steve. I have read many articles by Randy Wray mentioning Ponzi schemes. Plus have also read literature at where details of the balance sheet are taken into account and modeled. I just intended to say that Steve Keen may have missed it somehow.

    And of course, I have been a bit skeptical about Steve Keen’s accounting consistency and the self-consistency of his definitions. However, I think he may manage to get stock-flow consistency automatically if he makes his accounting self-consistent. (And I think that will lead him to embrace Modern Monetary Theory of yours!). In his paper The Dynamics Of Monetary Circuit, page 164 he mentions SFC. He can get it because d/dt (Stock) = (Sum of) Flows.

  7. Bill,

    I have been following Steve’s blog for a while and think he is doing some excellent work, especially in his explanations of endogenous money creation and its effects on the economy. His dynamic modelling and empirical emphasis bring some much needed scientific rigour to economics, however they do lack the mathematical completeness of something like modern monetary theory.

    I am sure the discussion you have started here will be far more interesting than the conference of economists he is attending just now. I’m afraid I’m no economist and never usually dare to speak up in the heated comments on his blog, but I thought I might throw out a few ideas here.

    Firstly, the main difference I see between you is his emphasis on dynamic modelling. For you there seems to be an achievable goal of “full employment” if you can get the balance of government deficit and non-government surplus right according to the “desire to net save”. Steve is trying to produce a dynamic model which can model increasing and decreasing unemployment by looking at simpler quantifiable measures rather than this rather nebulous “desire” of the non-government sector. Dynamic modelling like this can only improve the Chartalist models.

    However, where you score a big win over him is in modelling the complete economy through your adherence sound accounting priciples and stock-flow consistency. The simplifications he makes in order to have computable and understandable models leave a few leaky holes which may or may not be of significance.

    I would encourage both of you to think slightly out of the box so that you can come up with constructive improvements to both theories rather than settling into the more typical neoclassicial mudslinging arguments.

    For example, it may not be necessary to apply the usual accounting definitions in order to provide completeness and stock flow consistency to his models. You emphasize the government/non-government division of an economy, and so by definition a surplus in one must equal a deficit in the other. However Steve seems to be more interested in the banking/non-banking division of an economy (as in his wonderful Roving Cavaliers of Credit article) and I’m sure a stock-flow consistent model could be made divided along those lines.

    While you may argue that you deal with the banking system adequately by your distinction between horizontal and vertical transactions, in my opinion there is something not quite right with this. Since government spending is primarily achieved by crediting bank accounts rather than tendering cash, the banking system acts as a further vertical level of the economy sitting in between the money creating government and the wider economy. As such, government deficits and surpluses may have no effect on the wider economy if the banking system acts as a buffer by building up or reducing their reserves. As Steve has shown so well, the growth and contraction of the bank created credit in ther wider economy can occur irrespective of any fiat currency reserves.

  8. Bill:

    Excellent blog summing up all the responses as always. I am getting a feeling that Steve is almost there just about to become a believer in modern monetary theory. As you and many others here have observed, he just has his own definitions. looking forward to the G20 blog. I think its a very very very bad idea to have peer review. The last few times IMF dictated policy in countries, those countries were badly destroyed.


  9. Interesting perspective, this chartalism. Yesterday, at Steve Keen’s blog, was the first I’d heard of it. I haven’t yet seen much discussion of currency exchange rates. Also, I haven’t seen any discussion of China, which pegs its currency to the U.S. dollar, and other Asian countries which maintain large U.S. dollar reserves, in part to protect against a recurrence of the Asian financial crisis of 1998. Can anyone direct me to some chartalist perspectives on these issues?

  10. Cross posted to Steve Keen’s blog, regarding his related paper on Circuitism:

    I have some preliminary comments, mostly conceptual rather than quantitative, regarding your paper “Dynamics of the Monetary Circuit”:

    The following points are what really stand out for me in the sense of the conceptual organization of the model. I’ve spent some time on the equations, but not enough to comment on that level of quantitative detail here.

    I can’t comprehend the monetary circuitist “conundrum” in respect of the inability of firms to pay interest or create profits in a monetary economy (page 162). The ability of firms to do this seems intuitively obvious to me. They simply take out a bank loan to pay for the cost of goods sold and payments to the factors of production, including capital. The bank loan creates the money to pay for the cost of goods sold, wages, interest, and dividends. Those payments and that money in total are then sufficient in turn for somebody to purchase the output of the firm. Then the firm repays the bank loan. And the next production cycle starts. Sum up all such activity over the entire economy, and this represents a steady state, no growth condition. All profits are paid out in dividends because the firm requires no additional capital to grow in a steady state economy. You do say that the appropriate modelling seems deceptively simply. This is how I would model it verbally. I can’t fathom why higher mathematics would be required to confirm this idea, or why Circuitists other than you would not relate to this.

    Alarm bells start to go off when you refer to Moore’s “line of credit concept” (page 165). You refer to this as the source of endogenous money growth. This is a problem in that a line of credit is considered a contingent asset in a financial accounting and risk management framework. It is an off-balance sheet item. It can be interpreted as a derivative, in that the bank has written a put option to the firm enjoying the line of credit. The firm can draw down funds unannounced according to the conditions under the line of credit. This exposure for the bank also represents liquidity risk, in the sense that the bank has the obligation to find funding or sell assets in order to finance the asset put back to it, if and when the borrower or a payee of the borrower deposits the money proceeds in another bank.

    You say you treat debt as a data record of the legal obligations of a borrower to a bank, rather than “negative money” (page 165). I can’t imagine a bank anywhere that doesn’t treat it as a legal record. And I’m not sure quite what “negative money” means, but I feel confident it has no relevance to any standard financial accounting framework. Similarly, I don’t know what the notion that “money used to repay debt goes into a debt account” means. More specifically, “goes into” has no apparent meaning in a financial accounting sense.

    There is no question that the repayment of a loan with money from a deposit causes the value of that deposit to decline in exactly the same amount as the amount of the loan repaid. Yes, money is absolutely destroyed by way of such a financial accounting record; Graziani and Minsky are aligned with normal financial accounting.

    I’m afraid I disagree entirely with your three arguments as to why you believe the repayment of debt doesn’t destroy money used to repay the debt (page 166):

    a) There is no incongruity at all in treating money as indestructible when used in transactions and destroyed when used to repay debt. Money circulates when used to pay for transactions. It comes out of circulation when used to pay off debt. From a financial accounting perspective, it remains present while in circulation and doesn’t when out of circulation. It is destroyed from a financial accounting perspective. It is definitely a dead parrot in this sense.

    b) You ask would it make sense for the bank to destroy returned notes if a pure credit banking system only issued notes as money. This is an interesting one, as the Chartalists often resort to the example of the government destroying notes when taxpayers use them to pay their taxes. And beyond that, there is no incongruity here. The bank can store redeemed notes and use them again. That has no bearing on whether or not debt is still outstanding or has been retired. If notes have been used to pay off debt, those notes are taken out of circulation, at least temporarily, and no longer constitute a liability of the bank for as long as that is the case. It is essential here to define money as an outstanding obligation or liability, represented in double entry book keeping both as a liability of the bank and an asset of the note holder. But a note held in inventory in the sense of your thought experiment represents no such obligation to any external counterparty of the bank. Accordingly, the money orientation of the piece of paper has been destroyed. The fact that a piece of paper that when reissued may constitute money doesn’t mean money wasn’t previously destroyed. It is the counterparty liability and asset relationship around the note that constitutes the creation and presence of money, not the continued existence of the same piece of paper itself. And the notion of notes in inventory in your thought experiment must not be confused with notes in inventory in the actual monetary system we have today, since those actual notes we have today remain obligations of the central bank whether held by the public or in bank vaults. Money is a financial asset subject to double entry book keeping. There is far too much fuss and debate about whether money is a “liability” or not. This is particularly the case with base money. There is much wasted effort on connecting non-convertibility with non-liability. Some go further and attempt to make the case that base money should be viewed as some sort of equity. These are theoretical off ramps from a required logical double entry book keeping. Keep the terminology and the conceptual apparatus simple by allowing reference to money as a liability. In fact, base money is always convertible into a different form of base money (bank reserves versus currency); it is easy to argue this conversion option is a liability of the government.

    c) As noted above, I disagree strongly with the premise that debt must be defined as “negative money”. Your third argument is a good reason why it shouldn’t be viewed as such. Debt held as an asset by a bank (i.e. credit) is exactly that – an asset. It can be augmented if the bank chooses by lending the borrower the amount of interest owed, or it can be reduced if deemed necessary by writing the asset down to a lower value. In both cases, there is an offset (double) entry to the bank’s equity account. The fact that loans create deposits doesn’t mean that only deposits or other money can extinguish loans. That is what happens in normal contractual course. But any intervention of realized risk means that risk capital (i.e. the equity account) must also come into play as at least a partial accounting offset.

    Your point on the confusion of previous Circuitists over modelling stocks and flows (page 170) makes me think that those other Circuitists could be the economists’ equivalent of the investment bank quantitative modellers that have more than once (1998 LTCM; 2007 CDO’s) brought the financial system to its knees, as a result of being long on arithmetic and short on judgement. It’s beyond me how an entire school of thought could be making these kinds of conceptual errors about banking system money flows. Are they aware that the stock of money has velocity when used as a flow?

    The fact (in financial accounting terms) that money can be destroyed when debt is repaid should have absolutely no implications for modeling capability. Loans that are repaid can be followed by new loans. Indeed, a line of credit is often called “revolving” for that very reason. The same effect happens with sequences of different borrowers. The net result is that bank balance sheets tend to expand over time, notwithstanding a non-trivial velocity of loan repayments and corresponding money destruction. My sense is that your paradigm of indestructible money is just a different way of recognizing what results from sequences of money creation and money destruction in the usual sense of financial accounting for loans and deposits. Accordingly, one can model either steady state systems or growing systems, using either your paradigm of indestructible money or the usual financial accounting framework of sequences of creation and destruction. Mathematically, I suspect it would be quite possible to generate (an infinite set of) mappings between equivalent cumulative patterns of indestructible (your model) money lending/relending sequences and destructible (as per financial accounting) lending sequences. The cumulative financial accounting result would be the same, regardless of the destruction interpretation.

    You say, “The repayment of debt keeps bank assets constant, but alters their form from active loans to passive reserves. Once the bank has reserves, they can be relent …” (page 170)

    This again is not a part of financial accounting in any sense. It is also inconsistent with generally accepted modes of risk analysis. The closest thing I can compare it to is the normal risk management technique of allocating capital to support the incurrence of risk associated with the business of banking. If a loan is analyzed to have a certain quantum of credit risk, and that loan is repaid, then that repayment will free up the amount of risk capital originally allocated to support that loan. Such a risk capital allocation is not part of financial accounting; but it is very much a part of bank risk management and capital management. It is a specific internal quantitative partitioning of equity capital across the full range of bank businesses. This risk allocation process has nothing to do with the fact that loans are repaid with money or how the effect of such repayment is interpreted in the sense of money destruction or not. This is an internal risk analysis and capital assessment. But the result is that when such a loan is repaid, it will result in reduced risk and surplus capital, other things equal. So, in summary, my sense is that your concept of a reserve here is conceptually intertwined with the more normal analysis of risk and capital, notwithstanding whatever liquidity or money interpretation you may wish to attach to it otherwise.

    Your concept of the “creation of money” (page 173) seems to be defined to fit with your views on money destruction. To the degree that you don’t believe in the destruction of money in the conventional sense, a given quantity of money in your model will tend to support a steady state banking system. And a consistent view of money creation would suggest that such creation results in a growing banking system in your model. This is easily translatable to a conventional financial accounting framework simply by introducing net money creation (net of destruction).

    I’ll leave the paper there for now.

    My sense is that you may have your work cut out for you when you eventually attempt to backward integrate a fiat system into your stand alone endogenous system. Both Chartalists and Circuitists understand that the operation of the fiat system responds to the operation of the endogenous system, in the sense that the fiat money producer satisfies the requirement for reserves attributable to the lending and deposit activity of the endogenous system. This of course is the correct operational causality, as opposed to the erroneous neoclassical textbook portrayal of loan and deposit multiplication based on prior reserve availability.

    The strategic causality is another matter. By that I mean that the fiat money producer (the state) is the one that rules the roost in terms of the rule making and the ultimate architectural integrity of the entire monetary system. It is the fiat architecture that allows the operational causality. This design obeys yet a higher authority, which is the required overarching logic of consistent double entry bookkeeping. This means mutually compatible fiat and endogenous components. Such a requirement is why it could be somewhat challenging for an independently designed circuitist endogenous system to effect the reverse takeover of a bolt on fiat component. In my view, it is also why the Chartalists have the one up in terms of the monetary model sweepstakes, based on the order in which they have chosen to portray the logic and detail of the entire monetary system.

  11. Hi Bill,

    I believe Steve’s contention is that any agency may, with proper trust and/or authority, create a form of monetary unit. For a bank as much as for a government, a the liability concurrent with a loan need not be recognized until the liability is called upon…that is, nothing stops a bank from, like a government, spending first. The accounting, of course, covers this…as it does for a government accounting sheet, I think. Or am I mistaken in that the net balance for a government balance sheet cannot be made to be 0 also? Obviously, this, as you noted, depends upon following certain accounting rules.

    As a point of clarification, are the “accounting rules” discussed rules of a model describing financial states, or rules dictated on how one assembles a balance sheet, or both (or some other answer entirely)?

    That is, I think Steve feels his description is more general in that he considers a government to be a special form of a credit issuing agency, rather than an entirely different sort of entity. What follows is, first, he doesn’t need to make a “vertical” vs. “horizontal” distinction at all, and, second, that non-government spending can also be revenue independent (it is likely I am putting words into his mouth and would be more accurate for me to say that I myself am wary of the government/non-government distinction).

    As a thought experiment, would it be possible for a non-government agency to issue loans, in whole or in part, in a different unit than the fiat currency, which it could then accept as a valid means of repaying any outstanding loans? It feels like a credit card, to name an example, is a thing of this sort. That is, as long as the entire cycle of financial liabilities begins and ends on the issuers balance sheet, it has no need of any fiat currency reserves (except as an externally defined requirement, such as reserve requirements). That seems to be precisely the defense of the government’s spending not being revenue constrained: that the financial cycle of government liabilities and assets begins and ends on the government’s balance sheet.

    Which leads us to the reason for a balance sheet upset: an aggregate change in the cycle flows that upsets the issuer’s balance sheet (and thus it’s ability to function in its capacity as spigot and drain). I’d suggest the failure derives from the fact that managing flow is not costless. The issuance of debt, or the creation of assets, costs money. A failure in demand for debt means that the structure put in place to create debt can no longer be afforded, while a failure in the supply of debt (caused due to a failure in debt repayment, which causes the equivalent of inflation due to the “drain” function stopping), ultaimtely causes a failure in the continued creation of new assets, due to an ultimate depression in demand for newly created debt (which then leads to the aforementioned problem).

    My first question is, am I incorrect in thinking that a government may fall prey to the above mentioned balance sheet upset? And second, since I am pretty sure you feel I am wrong in thinking that a bank can act as a issuer and final redeemer for a financial unit, where have I gone wrong?

    Thank you, and I’ll be reading more of the linked articles on your blog.

  12. JKH . . . absolutely marvelous analysis . . . sent it around to a number of people and all were very impressed.


  13. Chaps – I’ve reposted this question from the ongoing debate at debtwatch here, since I feel it is an important one.

    I want to ask some questions now about employment.

    Is it the contention of chartalism that

    1. The government can secure full employment such that potential output gaps are removed.
    2. when 1 occurs, the loanable funds IS-LM model will finally be a valid construct. If so, what can be said about interest rates (I believe you guys have a ‘natural rate is 0′ concept)?

    The initial objections that are already forming in my mind are that:

    A. the government must secure full employment at a wage which does not compete with the private sector, otherwise I think private sector wages will rise to a point where there are no profits to be made.

    B. if A is true, then an arbitrage in the labour market is being deliberately perpetuated, in which case I’d suggest that the IS-LM model is still not reliable.

    If the IS-LM model is not reliable, then we need an alternative theory to predict the interest rate under a full employment chartalist economy.

  14. Great post, JKH. I hesitate to pollute your insights with mine, but I’ll blunder on anyway:

    It seems to this naive observer that Steve’s belief that loan repayments don’t destroy money rests on a simple confusion between base money and promises to pay base money (customer deposits). It is indisputable that the latter are destroyed by loan repayment to a bank, while the former is not (at least directly). So the conclusion that money is or is not destroyed when a loan is repaid to a bank rests entirely on whether we are talking about base money or bank credit (promises to pay base money). Repayment in cash would simply reduce outstanding currency and increase bank vault cash, with no net change to base money.

    Steve is correct to say that money is not destroyed on loan repayment, provided he means only base money. But this shouldn’t be a revelation, since horizontal transactions don’t create or destroy base money.

  15. ParadigmShift,

    Quite right – alleging that loan repayments don’t destroy base money would be perfect, and joyfully demonstrable by financial accounting logic and evidence.

    I expect Steve is quite familiar with this, but has created a deliberately different concept for the duration of non-base money within his model. I’d be more comfortable with it if he positioned this sort of construct as a sort of model accounting system one level down from financial accounting, with transparent and ongoing reconciliation between the two systems.

  16. Am a lay-reader wanting to understand more about the nexus (if any – I hope I’ve got this right) between the vertical transactions of the government and non-government sectors which appear on a balance sheet as surplus (deficit) or assets (liabilities) – and the horizontal creation of credit by authorised participants in the non-government sector through loans, which on the balance sheet sum to zero; if someone could help please?

    1) Can the non-government sector authorised participants create loans if they have a zero balance or deficit with the government (or only if their balance is positive)? Or is their vertical balance immaterial to their credit creating power?

    2) Is not the horizontal zero balance of loans and deposits immaterial: currently I am wondering why the material concern should not be that (obviously?) horizontal credit has the power to appropriate, perhaps even force the creation of vertical assets or a government deficit, overriding whatever vertical constraints may exist? Banks go down, the government deficit goes up? Who is in control?

    If you ask me on what evidence I base these concerns I can only answer the self-will side of human nature! People seem to find their way around systems … makes sense as it is people that create conceptual worlds like economies, politics, philosophy and religion – everything changes!

  17. “Toxic debt today was good debt yesterday in most cases. The difference is today the holder of the debt has just lost their job and can no longer maintain payments. The real problem in this case is not the debt but the lost job.” I was aboard with your theoretical direction until you made this assertion. One would have to be completely unaware of (or selectively disregarding) the nature of the subprime, alt-a, and option-arm mortgages constituting the toxic debt portion of MBS, as well as the LBO blowouts and general deterioration of CRE and business debt over a period of years to assert that this was “good debt”. Could you discuss, theoretically or otherwise, the difference between such “good debt” and “bad debt”? I know you are too sophisticated to categorize it as “good debt” simply because of the ratings it was given. And I assume you are aware that it was precisely this debt – before unemployment had risen to a point it could be mistaken for a cause of defaults, rather than an effect of the financial crisis and asset deflation – which, through the magnification of leverage and the magic of CDS, led directly to the bankruptcy of Bear Stearns and Lehmann Bros. and the whole subsequent series of financial crisis/recession events. There is nothing theoretical about the results of extending so much bad debt – it is a recently-observed empirical fact. In this regard, Keen’s analysis seems more grounded in reality than yours is.

  18. Let us specify that you are right (and Keen is wrong) in that “debt cannot exceed money”. Then, my question is, if only the government can add net money to the economy, how come the rate of increase of aggregate debt has been higher than the rate of increase of government debt for years?

  19. Final thought: “Chartalist”? “Circuitist”? Come on, you guys are never going to get your ideas attended to very broadly with names like that. Are you economists or Jesuits?

  20. O.K., one more: It appears the “first principle” of chartalist theory is that double-entry bookkeeping is always net balanced and bookkeeping itself is a valid and accurate description of the creation, flow, and destruction of money and credit in an economy. Although the first part is true and I agree that no theoretical approach which disregards this fact can be useful, the second part is very much open to question and needs to be demonstrated rather than integrated within an axiom. For example, if a mortgage broker wants to close a profitable loan and induces (by well-documented means) an appraiser to value the property at $1m, when the property and all comparable properties were selling yesterday for $0.5m, all of the bookeeping entries from the loan documents to the MBS to the government-created reserves will balance and the chartalists will say no net debt, asset, or money was suddenly created. The accounting balances between the old “value” on the books of the property and the new “value” will be noted on the books of old owner and the new owner and everyone else in the monetary chain, and it will all balance. But in the real economy which ultimately determines profits, employment, bubbles and crashes something has just happened which the bookkeeping captures but does not explain, and any theory that claims that real world outcomes (such as “full employment”) can be derived straight from bookkeeping principles is not very convincing.

  21. Michael . . . no chartalist EVER said something as silly as “debt cannot exceed money.” Money is by definition a form of debt. Yet another misinterpretation that refuses to die.

  22. Posted at Steve Keen’s blog as comment # 188:'s-hard-being-a-bear-part-sixgood-alternative-theory/?cp=all#comments

    This is a response to Mahaish’s questions # 134 and # 151. It is a macro accounting explanation of the concept and measurement of household net worth, in the context of the Chartalist accounting model. It is not intended to address issues beyond that.

    The top-down Chartalist sector balance sheet decomposition is that of government and non-government sectors. Although this breakdown could be applied globally, one typically would choose a particular national balance sheet to model, and then anchor the model with the corresponding government sector.

    So let’s take the United States and the US government.

    The entire United States balance sheet can then be modelled according to government and non government sectors.

    The non government sector decomposes further into the private sector and the foreign sector. We can alternatively refer to the private sector as the domestic private sector, or the domestic non government sector.

    The private sector decomposes further into the household sector and the non household sector. The non household sector is mostly incorporated and unincorporated business, including financial institutions.

    The US household sector balance sheet as at June 30, 2009:

    (Numbers rounded)

    Total assets $ 67 trillion
    Tangible assets 25 trillion
    Financial assets 42 trillion

    Liabilities 14 trillion
    Mortgages 10.5 trillion
    Consumer Credit/other 3.5 trillion

    Net Worth $ 53 trillion

    Household tangible assets of $ 25 trillion include about $ 20 trillion in real estate and $ 5 trillion in consumer durable goods.

    Against financial assets of $ 42 trillion we net $ 14 trillion of liabilities (which are of course financial) to arrive at:

    Household Net Financial Assets $ 28 trillion

    This household net financial asset total is significantly larger than the total level of non government net financial assets for all sectors. The conceptual and numerical difference is explained below.

    Any household financial asset that is not a direct obligation of the government must by definition be the obligation of another non government entity.

    E.g. a corporate bond held by the household sector is the liability of the corporate sector.

    Therefore, although the corporate bond contributes to both the gross and the net financial asset position of the household, it does not contribute to the net financial asset position of the entire non government sector, due to cancellation of the household asset against its corresponding representation as a non government liability.

    This relationship holds for all financial claims of non government entities on other non government entities.

    Importantly, this includes equity financial claims. This can seem a bit counterintuitive. Equity claims represented in the usual way on a balance sheet are not categorized as liabilities. However, the essential double entry book keeping characteristic is that they are on the right hand side of the balance sheet. The right hand equity entry directly offsets the corresponding asset entry on the balance sheet of the equity claim holder.

    E.g. common stock held by the household sector is that sector’s financial asset. It is not technically a liability of the corporate sector. Nevertheless, it is a financial claim issued by the corporate sector in the sense that the owner of the stock has the right to benefit from all cash flows and valuation effects that accrue directly to the stock (dividends and marked to market stock price changes). This benefit reflects a comprehensive valuation of the operation of the issuer, including its deployment of real assets, its use of liabilities, and its ability to generate profits, etc. The point is that even though common stock is not categorized as a balance sheet liability, it is a financial claim issued by the corporate sector and a financial asset held in this case by the household sector. Common stock and equity claims in general are treated as a financial asset of the holder and a financial obligation of the issuer (cash flow and marked to market evaluated), and because of that essentially net to zero when consolidating the net financial asset position of the non government sector. The residual as a result of this equity netting includes the real assets of the issuer that are instrumental to the generation of such gross equity value. Depending on the objective of a given measurement exercise, those real assets obviously can also be valued separately from their representation as value embedded in the liability and equity structure of the issuer’s balance sheet. They are excluded from direct representation in the measure of net household worth because their implicit valuation has already been transmitted via the direct debt and equity valuation of the enterprise.

    The household sector, in addition to holding direct financial claims in such forms as bonds and stocks, also holds financial assets in the form of mutual funds, pension funds, life insurance, and unincorporated business equity. Again, these positions are all represented as obligations of the issuer, and therefore all net out on consolidation with the household sector’s corresponding assets in the calculation of non government net financial assets. From the asset perspective alone, they constitute a large component in the gross financial asset position of the household sector.

    One could similarly work through the balance sheets of the non household domestic private sector (incorporated and unincorporated business, including financial institutions) and the foreign sector. The business sector has a substantial net negative financial asset position, reflecting the corresponding net tangible or real asset position referred to above. The foreign sector has a positive net financial asset position, reflecting the result of a cumulative US current account deficit, with certain balance sheet items valued on a marked to market basis.

    If one then nets the net financial asset positions of all these sectors against each other, the result will be an aggregate net financial asset position equal to the government net liability position, as per the Chartalist overview. Financial claims between non government entities net to zero. But government to non government financial claims don’t. The primary reason for this is that governments tend to issue more claims to non government than vice versa. The latter direction is quite possible of course. That is what has happened to a limited degree in the case of the US Federal Reserve accumulating private sector credit assets, and in the case of the US Treasury injecting TARP capital into the banking system. But such unusual US government financial asset activity has been mostly offset at the same time by the issuance of additional excess reserve base money by the Fed and additional bonds by the US Treasury. Beyond that is the aspect of outstanding and expanding US Treasury debt that reflects the more typical creation of net government liabilities due to government deficit spending. It is this latter net mismatch that results in the corresponding vertical net financial asset accumulation of the non government sector.

    Two concluding points:

    First, the net worth of US households was calculated at $ 53 trillion as at June 30, 2009. This includes “real” assets of $25 trillion and net financial assets of $ 28 trillion.

    This net financial asset measure of $ 28 trillion is one of deceptively wide scope.

    One may ask where the real assets of business can be found in this calculation. Where is the measure of plant and equipment investment value in the United States? Where is the left hand side of the business balance sheet?

    The answer already alluded to above is that the real assets of businesses are reflected implicitly in the value of their financial obligations, which are included comprehensively in the value of household and foreign sector gross financial assets. This includes as well business liabilities and issued equity claims that are held indirectly through such household financial assets as mutual funds and pension. All business assets are reflected in this way. This is double entry book keeping hard at work.

    Second, although this describes the connection between non government net financial assets and household net financial assets, one must delve deep into the various sector gross positions in order to extract the exact location of government issued liabilities held as assets by the non government sector. It’s there. You just have to look for where the government bonds are, as well as Federal Reserve currency, and finally central bank reserve balances.

    (BTW, those who are interested in the consolidated treasury/central bank government position can find expert commentary from the various Chartalist oriented economist bloggers, including Scott Fullwiler, Randall Wray, Warren Mosler, and of course Bill Mitchell. But in summary, the net balance between government and non government includes the gross effect of central bank reserve balances issued to the banking system, central bank currency issued to the non government sector, and treasury debt issued to the non government sector.)

    The bonds in particular are all over the place. For example, foreign central banks own trillions of US treasury bonds and bills, most prominently in China and Japan. Those central bank bond holdings are part of the gross US financial assets held by the foreign sector. In turn, the foreign sector in total has a net positive financial asset position with the US as counterparty (again the result of the cumulative US current account deficit).

    The foreign sector thus includes a net asset position with the US government sector, embedded within its larger gross financial asset position with the US, and in conjunction with its total net financial asset position with the US. When one recognizes that the net horizontal asset position of the non government sector must sum to zero, one can then attempt to identity the location of the net vertical asset positions embedded in each defined horizontal sector. The foreign sector clearly has a net positive vertical position according to its bond holdings and some currency. The household sector actually has a modest vertical position relative to its size, consisting of bonds and currency. The rest of the vertical position exists in the non household private sector. Ironically, although this sector has a large net negative financial asset position, most of the net positive vertical position can be found in the gross assets of financial institutions and pension/life insurance investment funds. Against this would be netted the effect of Fed Reserve private sector credit and Treasury TARP funds. Thus, one may decompose sectors according to their positions in net financial assets, as well as their positions in net government assets. The sum in both cases will be the same, according to the overarching Chartalist axiom of aggregate net financial asset equivalence, with the government deficit equal to the non government surplus.

  23. Scott,

    I probably misinterpreted the following from Bill’s blog:

    “Steve then invokes some data.

    He says that “total debt was 2.25 times M3 in the 1950s, and was 4.3 times M3 when the data collection stopped in 2006 (the ratios of only private debt to M3 were respectively 1.25 and 3.3). So even at a time when Minsky described the USA as financially robust, debt exceeded money: the system functioned well with net negative financial assets”.

    This also cannot be correct. All the dollar debt (always) has a corresponding dollar financial asset held by the borrower.”

  24. Michael . . . right, Bill’s critiquing Steve’s definition of the term “net negative financial assets” as debt being greater than money. The comment just above yours by JKH at 4:24 very carefully and eloquently describes the correct definition and application of the term “net financial assets.”


  25. How does Chartalism work in a small open economy where the export sector is a large percentage of the economy? Do political constraints on spending typically kick in sooner due to concerns over currency competitiveness/ volatility?

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