I’ve struggled for some time to find a way to explain the difference between private bank debt and government-issued cash in a way that avoids the mental traps that years of indoctrination in the “standard” economic ideas led to. My feeling has always been that if it can’t be presented in a crystal-clear manner that works logically and fits real-life evidence–it’s probably wrong. So here goes:Political Reality
Some thoughts on money
Zap
24 comments:
There is no difference between bank money and government money. They are the same thing. If people borrow from a bank the circulation pays the wages of the bank clerks covered with interest payments. If the government borrows from the central bank, the circulation pays the wages of the Treasury clerks covered by taxation payments.
It’s the circulation that matters.
Neil is right. Zap falls for the myth (popularised by Paul Grignon in his videos) that interest on debt ruins us all. The truth is that if someone borrows from a commercial bank to fund a project that makes economic sense, then the project will fund the interest payments. No problem.
On second thoughts, Neil isn't quite right to say that commercial bank money and central bank money are the same thing. As numerous MMTers and others have pointed out, commercial bank money nets to nothing since for every $ of commercial bank created money, there is a dollar of debt. In contrast, central bank money is a net asset as viewed by the private sector.
It is the spending of bankers than funds bank interest. Bankers are human (well nearly) and consume too!
When you remove the sectoral splits everything in the currency area sums to zero.
Central bank money is a net asset to the private sector because the private sector supplied something to government sector in return. In this case the effort of the Treasury clerk working out where the government money should be spent.
And it is only a net asset to the private sector until it is spent to destruction by taxation. Just like a bank deposits is only an asset to the private sector until it has been around the circle enough times to pay off the initial loan.
It's all about maintaining the circulation. The circulation is all.
Government is only special because nobody has standing to tell them they can't 'borrow' any more money - despite decades of monetarists trying desperately to impose the necessary central bank autocracy to bring that about.
But of course all that does is turn the central bank into the government, and it becomes the entity that ends up buying things from the private sector. Which is what the Market Monetarists now want it to do - buy things with no democratic oversight.
Commercial bank money is redeemable on demand for central bank money. Modern central bank money is not usually redeemable on demand for anything but more central bank money. That asymmetry in redeemability on demand established the value of commercial bank money.
Think of it this way: Suppose Bank of America announced this tomorrow:
"Customers, you may not have noticed, but there is some fine print in your deposit agreements which establishes that BOA is not required to redeem your deposit balances into US money. All we are formally required to do with your BOA account balance is allow you to transform it into a different type of BOA balance."
"Of course, for years we have been redeeming those balances into US dollars upon request, and making payments for you in US dollars. But that is not something we are required to do. It is an optional customer service that we have provided."
If this happened, I suspect there would be a run on BOA accounts.
"Neil is right. Zap falls for the myth (popularised by Paul Grignon in his videos) that interest on debt ruins us all. The truth is that if someone borrows from a commercial bank to fund a project that makes economic sense, then the project will fund the interest payments. No problem."
Only if the bank returns all of it's interest to circulation in new loans, and doesn't lock any of it up in gambling. That will create a kind of a shaky, fragile balance.However leakage is quite real and this beast doesn't exist in the wild. The only entity that can "afford" it and *not require payback* is the government. It can spend money that it *never needs to get back* which means that anything built with it does not ever need to be liquidated (in case of crash) to pay back principal + interest.
Additionally, "the project will fund the interest payments"--with what? the bank did not issue new money to cover it's own interest. So, as was pointed out in the article, either the interest has to come from somebody else's bank loan, or it has to come from government--which can fund the same project for free, if it chooses to do so. Bank interest accumulates over time and eventually crashes the system--this is the very well-known "business cycle". Government funding has no such burden.
Dan Kervick is correct about the differences in credit. Let's forget the use of the ambiguous term "money." Banks create bank credit, which under present conventions is convertible at par with tax credits that only government can create as it own liabilities.
Government may or may not guarantee bank credit or a portion of bank credit to create confidence in bank credit.
Bank credit and credit created by the government are essentially different in that reside on different sets of books, one set within government, other sets in the banking sector (which can be consolidated as the banking sector), and another set at the central bank as the interface between government and the financial sector. It's the latter than allows bank credit to function as tax credit, since banks can use their own credit to obtain tax credits as needed at the cb at par. This enables banks to convert their own credit to tax credits on customer demand. This is the essence of contemporary banking that results in bank credit being the same as tax credits for all practical purposes.
That bank credit is not essentially the same as tax credits was shown, however, by the recent financial crisis, when the central banks had to intervene in the ordinary course of operations with extraordinary policy and programs in order to support global financial systems in which bank credit plays a key role and where bank credit was collapsing due to liquidity problems (cash flow shortfalls) and possible insolvency (liabilities greater than assets). Using these policies and programs, along with forbearance, the central banks were able to prevent the financial system from crashing, resulting in global depression.
This should forever resolve the issue of whether bank credit and tax credits are "the same thing" and that banks create "money" just like the government does, i.e, with no difference. If they could do this, then the crisis would not have happened, and the central banks would not have had to intervene with extraordinary policy that still continues globally.
There could be two separate systems, I.e., government issuing its own credit and banks issuing their own credit with no convertibility at par facilitated or guaranteed by government.
Or, there could be one credit system of different types, either state credit only or bank credit only. There have been different examples of these historically.
The take-away is that "money" is somebody's credit and in a modern economic system there are institutions, usually legal, that establish the relationships among different credit originations, if different origination is permitted (usury laws).
Credit, of which "money" is a subset of particular manifestation(s), is a complex institutions that arose out of custom and convention, and was codified into law. "Modern money" is chiefly a legal institution rather than principally an economic one. This means that credit functions somewhat differently in different legal contexts.
Whatever else David Graeber may have attempted in Debt, the most important thing he accomplished was establishing the outlines of the development of credit as a cultural artifact that subsequently grew into a prominent and influential socio-economic institution. In doing so, he showed the many ways that credit can manifest in different contexts.
Reiterating on what 'Unknown' and Tom are saying...
You need more credit to fund current liabilities when you add up leakages and interests payment.
It's all about inflation, not only about circulation; you can fund or not liabilities depending on the inflation rate (INCOME inflation, that is; if you have increasing prices but not increasing incomes you are in for serious trouble). You can never have a non-growing (like current) economy with bank money, you need state money, and if only because of that, it's already a demonstration of the different nature of both types of 'credit' even if they are denominated the same way.
No, spending the money is not enough unless you spend it all and you don't have to pay interests on existing loans. In that sense state financial assets are different because the state does not have borrowing constraints which the rest of the economic actors in the system have. Let's not pretend that we can increase our credit cards balance forever, that we have no saving, and that we don't have to pay interests.
Then ofc you can see that not every assets is created equally, the collapse of shadow money (in the form of various credit derivatives) price necessitates an increase of government collateral to cover the unfunded liabilities (in the form of OM operations, balance sheet expansion, and demand for treasuries). If 'credit' issued by banks was as good as currency issued by the government this wouldn't happen, but no all dollars are created equal.
So on a superficial level, accounting units are the same. But on a deeper qualitative level, specially when not everything is wine and roses, state currency and bank credit come as not exactly the same thing. It's all about circulation, yes, but circulation is all about the quality, and the quality is all about the price.
I think that Unknown is correct about the flow to saving as demand leakage. As Keynes observed against the neoclassical who presumed that general equilibrium was based on saving causing investment, the causality runs the other way. Most credit comes from bank lending with interest so that in a system in which income = expenditure, if all all the income in the is not spent on consumption and investment, all that is capable of being produced won't be, and there will be idle resources and unemployed labor.
The private sector cannot net save financially, since bank credit nets to zero, and with interest imposed, less than zero. That is, net borrowing is required. Without going into details, this has proven to be unsustainable practically.
Macro deals with heuristic models based on assumptions that function as heuristic rules or rules of thumb, so to speak, in that the assumptions have to simple enough to make the math tractable. In addition, imprecise measurement limits the accuracy of macro data on a timely basis and make accurate measurement with any degree of precision difficult to impossible.
Neoclassical models are based on these kinds of heuristic assumptions that allow for a tendency to general equilibrium. However, the assumptions are also heavily unrealistic and so the model is unlikely to be accurately representational since it is so stylized for tractability and data only estimated.
The reality seems to be that saving does result in demand leakage and as a general rule (heuristic) the wealth save more both in real terms (accumulate real assets) and also financially (accumulate financial assets). Net saving in financial assets can only come in closed system from other cohorts dissaving.
This means that if the private domestic sector wishes to net save, then some other sector(s) must dis-save, that is, either government or the external sector.
Here's where interest comes in. Private sector saving is mostly by the rich and the rich are by definition the principal owners of capital, which is what being rich means. As a general rule, owners of capital and high earnings workers whose earning are taxed more as capital rather than income receive revenue more from rent than productive income, that is, income from actual work in the economic sense of producing goods and services.
Financial rent, monopoly rent, and land rent accrue to the wealthy, who also tend to save financially instead of either consuming revenue or investing it productively. Interest is one example of what is chiefly gained financially and saved financially.
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So unless another sector dis-saves, then the desire to net save financially by the domestic private sector will result in unsustainable dissaving by the less wealthy in the long run. Such as system is inherently unstable.
The external sector cannot offset all desire to net save financially either, since the global economy is a closed system and current account surpluses by some nations must be offset by current account deficits by other nations. This too is unsustainable in the long run.
so the conclusion is that a capitalistic modern monetary system only works if governments offset the saving desire of nongovernment by creating the requisite net financial assets through "borrowing," that is, running deficits.
If a government offsets its fiscal deficit with interest-bearing securities, then the "borrowing" seems obvious, but the really is that government is providing the funding for payment of interest and principal itself, at the cost to the private sector of transferring real resource for public use.
If the government issues the currency directly without providing-interest bearing securities, the only difference is in the transfer of interest as economic rent to nongovernment savers, foreign and domestic. Eliminating issuance of interest-bearing securities would eliminate that transfer of interest (rent), which being operationally unnecessary constitutes a subsidy to savers. The question then becomes whether the subsidy is in the public interest and serves public purpose. If not, it should be eliminated as superfluous.
Wow, I have to thank you, Tom for linking to my post, this thread is wonderful. I'm Zap (I should have mentioned before--your comment whizbang doesn't seem to allow for quickly changing the nick.)
The post grew out of numerous attempts in IRC channels (mine and others) to find a way through the psychological thicket created by the neo-classical indoctrination that everyone soaks up in their high-school civics classes (as near as I can tell.) Whoda thunk that the language of economics and accounting could be so loaded? The term "debt" is especially difficult, because essentially, government debt is not debt in any sense used anywhere else in the economy. It's an accounting device, a sort of distributed spreadsheet, as described by Randy Wray, et al. The "books" you also refer to.
How to get past the anti-government crowd's knee-jerk "but it's borrowing! Deficit!! Benghazi!!!" reaction to get to some point of understanding has been difficult. So I decided to try to avoid the loaded language by shifting to the other side--government isn't "borrowing"--it's buying your stuff and paying you, which is also more accurate. Banks don't buy stuff--they lend and expect more back than they gave you. I deeply appreciate having other people take a crack at it and showing me where it can be improved.
It seems to me that most our economic trouble comes from this basic misunderstanding (as the famous quote about "dead economists" suggested.) And the real problem is not so much with the policy makers--they'll go with whatever is politically useful to them, obviously. The problem is the voters that have no clear mental picture of reality and so cannot judge the politicians' blandishments accurately. And, hey, if one meme can stick so tightly, another similarly simple one should also be able to.
I did test it in a channel the other day..and by golly it worked. On one guy. ;)
Nice to have you here, Zap. I thought that Unknown might be you.
While the surface the debate is over the "correct" way to state the case about money creation, on a deeper level we are all searching for an effective way to get ordinary folks to see aright through an explanation that is clear, concise and precise, and, ideally, fun to read and easy to understand, too.
The challenge is to state the issues simply but with enough nuance to convey the underlying complications and complexities that stand in the way of simple explanation. The course has to navigate between oversimplification and wonkishness.
In addition, there are a lot of prior misunderstandings that result in cognitive-affect biases that prevent people from seeing what is actually happening operationally, even when it is pretty simple operationally. And there are also powerful vested interest whose goal is to deter people from seeing what is happening behind the veil.
I've enjoined reading your efforts to meet this challenge and hope you take what is said here by way of constructive criticism.
I like to think of bank money along the lines of Mosler's "banks as Govt agents". Which is made clear by the implicit legal and contractual enforcement through Govt judicial systems, and explicitly through Govt guarantees of convertibility. Its like we are on the US Currency standard and the Govt is guaranteeing a fixed exchange rate but instead of to gold, to bank credit.
Its very clear when thinking about the evolution of early American banking (pre-Fed) when banks were issuing their own de-facto currencies and had exchange rate fluctuations and problems clearing and accepting checks from banks in different regions and size etc.
But even though the Govt imprimatur is real and extremely valuable, the banks and economic propagandists have done a masterful job of convincing the public that banks (at least the deposit taking and settlement depts) are purely private actors. Just another example of privatizing public services.
Kind of similar to the way UPS and Fedex piggy-back off the USPS.
It’s the obviousness of everything that ‘gets’ me (even for a lay-reader). If capitalism is 200 years old (?) then it is obvious how much real wealth has been created over that time and who owns it. It is obvious how much $NFA have been created (trillions) and who owns it. It is obvious how much credit (debt) has been created and who owns it and how it is used. It is obvious how much poverty and suffering has been created and who it is imposed upon. It is obvious how much force has been created (military and police) in order to maintain the imbalances. Despite the advances in technology and education. In the face of all of the world’s religions who all claim there is but one G.O.D. whose Nature is Peace! There are more people suffer and more ignorance than ever before. There are more wars and violence than ever before; more greed. There are more people homeless and dying unnecessarily of diseases than ever before. This planet is more than capable of producing enough food, clothing and shelter for everyone in an environmentally responsible way. It is a human dilemma. For me, it is a matter for the human heart.
Peace is a necessity of life; as fundamental as food and water and sleep. There is more fear in the world than ever before, more inertia, more servitude, more stress, and more escape into fantasy …. These are the attributes of mind without peace. We are human; it is a matter for the human heart.
Auburn, my impression is that most people think that government creates the money and banks just loan out savings. They have no idea that banks can create "money" out of thin air that government backs up. Even Krugman seems to think this.
No doubt about that Tom. I was referring to the somewhat blurry distinction between bank money and Govt money that's being talked about up-thread.
"In addition, there are a lot of prior misunderstandings that result in cognitive-affect biases that prevent people from seeing what is actually happening operationally, even when it is pretty simple operationally. And there are also powerful vested interest whose goal is to deter people from seeing what is happening behind the veil.
I've enjoined reading your efforts to meet this challenge and hope you take what is said here by way of constructive criticism."
I absolutely do. I feel this communication issue with the general public is vital.
I think much of the cognitive bias comes from the gold-standard tradition. It's a cognitive leap from the concrete image of a pile of gold bars to the amorphous image of "backed by the goods and services of the nation" or even as "tax credits"--which is a bit of a trigger for people, I've found.
If you look at it from the POV of *equality*, government spending fiat is the *most* egalitarian you can get because it's broadly production-and-services oriented. And yet, all across the political spectrum, it's treated as though it's some diabolical plot to steal our money!
Of course, few of us get to benefit directly from it now because spending is controlled by Congress, which is currently the most corrupt in our history. By limiting the supply, they leave little to cover the demand leakage of private interest debt except the through the dividends paid on Treasuries, which, as you pointed out above, are mostly owned by the rich. Obviously, the decision to funnel new funds through channels owned by the wealthy is entirely a political decision.
And our old 'gold ideology' hangup is how they make it stick. We switched to fiat, but continued to talk about it as if it was still tied to gold. "Borrowing" was "against gold" originally, but now it's just "borrowing.." something. Before, there was a danger of having more currency than gold. Now, the only danger is having more currency than productive capacity--a much, much more valuable commodity. So we now have this wonderful method to ensure that every citizen can participate economically and benefit from it, but then we reject the very idea of it.
Ultimately, of course, all economics is political. If people understood how badly they're being burned by accepting these outdated ideas, there might be quite a sea change in what we tolerate from Congress. --Zap
Yes, Alan Greenspan admitted that they run the system "as if" it were a gold standard, and he recently said that he regards gold as currency and fiat not. So go figure.
Well, he wasn't so hot on markets, but he did know how they ran the bank. He was a believer, you know. If he believes gold is currency, then he would fully approve of faux-gold as well. Commodity money favors the rich, and he admired them deeply. --Zap
they would be doing poorly at running the system if it were under a gold standard.
even under a gold standard, running surpluses leads to recessions,
so naturally the gold standard had to be taken back behind the shed and old-yellerd.
"So, as was pointed out in the article, either the interest has to come from somebody else's bank loan"
Which as I pointed out at your place, and pointed out again here *is the wrong belief*.
The money to pay interest comes from the consumption of bankers.
There is a model here that shows how it all works in a private circuit *with no government at all*
The private circuit can operate just fine on its own as long as all the saving is spent in a timely manner. If the length of saving gets longer than the required turnover time then the system starts to run short of money.
This is where the unfortunate term 'leakages' comes from. There is no leakage at all. All that happens is that the oil that should be going around the engine has gone into the sump.
And the way you fix that is either to ban/discourage longer term savings, or have an entity in place that provides longer term savings and is able to replace money in the flow.
"The money to pay interest comes from the consumption of bankers."
If that was the case, this crash could not have happened. Bankers simply aren't consuming enough.
As Nick Hanauer has pointed out very effectively it isn't even possible. The number of wealthy people that are holding the accumulated interest is so small that they cannot purchase enough to match the demand of hundreds of millions of people. Obviously the demand leakage is quite real.
Additionally, all chartered banks operate from Reserve accounts. Since banks don't all charge the same rate of interest, interest received is not necessarily offset by interest paid by other banks. Dividends on Treasuries offset some of it, but not enough, of course.
Additionally, the existence of derivatives and shadow banking really throws a wrench in the works since they do not operate in the Federal Reserve system. Each time loans pass through another set of hands, more interest charges and fees are added. This adds to the aggregate debt burden, and is effectively segregated from the real economy, swirling in ever-tighter circles in the shadow financial world. It amounts to a kind of legal black market, it seems to me.
"The private circuit can operate just fine on its own as long as all the saving is spent in a timely manner. If the length of saving gets longer than the required turnover time then the system starts to run short of money."
Yes. Until you add in savings or generate loans in such volume that they exceed the size of the money available in circulation to cover the debt burden. Loans create deposits, but they don't create the interest to pay them. It has to come from other deposits in the banking system or an outside source. Ultimately, the only outside sources of replacement money, gap-filler money, and new-growth money is governments. So far. Until someone comes up with a better bitcoin.
In our financialized universe now, that is what's happened. More loans and attendant interest debt has been generated than there's real money to pay them. Bank money is temporary. Allowing debt issued to outstrip GDP growth guarantees collapse. There can be no other outcome.
This is really the crux of the matter. Wealth requires maintenance, people must eat, and so a certain amount of currency must remain in circulation permanently, and real growth demands more of it to prevent deflation.
I suppose you can say that all money issued returns home eventually like so many homing pigeons, but in the real world--some of them are getting eaten by predators. And of course those dead pigeons get returned to the ecosystem in some form eventually.. but it's not immediately useful. :) --Zap
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