Sunday, October 29, 2017

Zoe Williams — How the actual magic money tree works

Shock data shows that most MPs do not know how money is created. Responding to a survey commissioned by Positive Money just before the June election, 85% were unaware that new money was created every time a commercial bank extended a loan, while 70% thought that only the government had the power to create new money.

The results are only a shock if you didn’t see the last poll of MPs on exactly this topic, in 2014, revealing broadly the same level of ignorance. Indeed, the real shock is that MPs still, without embarrassment, answer surveys.
Yet almost all our hot-button political issues, from social security to housing, relate back to the meaning and creation of money; so if the people making those choices don’t have a clue, that isn’t without consequence....
The Guardian
How the actual magic money tree works
Zoe Williams

20 comments:

André said...

"85% were unaware that new money was created every time a commercial bank extended a loan, while 70% thought that only the government had the power to create new money"

Well, we don't have access to the survey, but I bet it is deceiving.

Do they define precisely the word "money"? Because it is so ambiguous that it can mean anything.

For example, if you interpret "money" as cash, it is indeed created exclusively by the government...

AXEC / E.K-H said...

In her Guardian Article ‘How the actual magic money tree works’ Zoe Williams repeats the argument that banks can create money. Fact is that bank cannot create money only bank money. This has been explained in detail already to other silly journalists and stupid economists in the following post.*

Basics of monetary theory: the two monies

Frances Coppola twittered on Oct 25 “He [Pontus Rendahl] says (I quote) ‘Banks can’t create money or we wouldn’t have had to bail them out.’ What’s the fallacy in that statement, Twitter?”

And Ann Pettifor echoed: “Pontus Rendahl: ‘disagrees banks can create money. Only true if CB complicit with this’ Extraordinary! We do not live in CB dictatorship.”

Lars Syll assisted “And to even for a second think that a visionless neoclassical economist like Rendahl should have anything to do with new thinking in economics is of course totally gobsmacking!”

Time to finally settle the theory of money.

Because economics is a failed science it has to be reconstructed from scratch. Walrasian microfoundations and Keynesian macrofoundations have to be scrapped.

As the new analytical starting point, the pure production-consumption economy is defined with this set of macroeconomic axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

Under the conditions of market clearing X=O and budget balancing C=Yw in each period the price is given by P=W/R, i.e. the market clearing price is equal to unit wage costs. This is the most elementary form of the macroeconomic Law of Supply and Demand. For the graphical representation see Figure 1.#1

The price is determined by the wage rate, which takes the role of the nominal numéraire, and the productivity. The quantity of money is NOT among the price determinants. This puts the commonplace Quantity Theory forever to rest.

Monetary profit for the economy as a whole is defined as Qm≡C−Yw and monetary saving as Sm≡Yw-C. It always holds Qm+Sm=0, or Qm=−Sm, in other words, the business sector’s surplus = profit (deficit = loss) equals the household sector’s deficit = dissaving (surplus = saving). This is the most elementary form of the Profit Law. Under the condition of budget balancing total monetary profit is zero.

What is needed for a start is two things (i) a central bank which creates money on its balance sheet in the form of deposits, and (ii), a legal system which declares the central bank’s deposits as legal tender.

Deposit money is needed by the business sector to pay the workers who receive the wage income Yw per period. The need is only temporary because the business sector gets the money back if the workers fully spend their income, i.e. if C=Yw.

Overdrafts are needed by the household sector for consumption expenditures if the households want to spend before they get their income. This time sequence is no problem for the central bank because the temporary overdrafts vanish with wage payments.

For the case of a balanced budget C=Yw, the idealized transaction sequence of deposits/overdrafts of the household sector at the central bank over the course of one period is shown in Figure 2.#2 The household sector’s deposits/overdrafts are zero at the beginning and end of the period. The business sector’s transaction pattern is the exact mirror image. Money, that is, deposits at the central bank, is continually created and destroyed during the period under consideration. There is NO such thing as a fixed quantity of money. The central bank plays an accommodative role and simply supports the autonomous market transactions between the household and the business sector.

See part 2

AXEC / E.K-H said...

Part 2

From this follows the average stock of transaction money as M=kYw, with k determined by the transaction pattern. In other words, the average stock of money M is determined by the autonomous transactions of the household and business sector and created out of nothing by the central bank. The economy NEVER runs out of money.

The transaction equation reads M=kYw=kPX=kPRL in the case of budget balancing and market clearing and this yields the commonplace correlation between average stock of money M and price P for a given employment level L, except for the fact that M is the DEPENDENT variable.

Money comes into existence on the balance sheet of the central bank as soon as the central bank enters an overdraft for the business sector on the asset side and a deposit of equal amount on the liability side (step 1). This deposit is then transferred to the household sector as wage payment (step 2) and returns in the form of consumption expenditures (step 3). For the graphical representation of the complete cycle see Figure 3.#3

Now the commercial banks are introduced. They can create and destroy ‘money’ technically exactly in the same way as the central bank except for the fact that it is bank money and not central bank money. The crucial condition for the functioning of the two-monies system is that the business sector and household sector accepts bank money as practically identical to central bank money. For a graphical representation it is only necessary to substitute the account titles in Figure 3 from Central bank to Commercial banks.

What happens if the households, which posses money in the form of bank deposits (step 1 in Figure 4,#4), demand real = central bank money? The commercial banking sector has to turn to the central bank which creates overdrafts and deposits out of nothing (2). In the last step (3) the commercial banks then transfer their central bank deposits to the households. The banking money vanishes completely from the system. This does, in principle, not hinder the commercial banks to create new bank money by handing out loans in various forms from overdrafts to long-term mortgage loans. This quantitative expansion, though, can be limited in various ways.

Conclusion: Pontus Rendahl is right, banks cannot create money only bank money which is in normal times and for all practical purposes functionally identical to central bank money. However, if the household or business sector demand money the commercial banks have to turn to the central bank because, in the final analysis, the modern monetary system consists of two tightly coupled monies. As always, the “new” thinkers Frances Coppola, Ann Pettifor, and Lars Syll have made blogging fools of themselves.

Egmont Kakarot-Handtke

* Link to source
http://axecorg.blogspot.de/2017/10/basics-of-monetary-theory-two-monies.html

#1 Wikimedia, Pure production-consumption economy
https://commons.wikimedia.org/wiki/File:AXEC31.png

#2 Wikimedia, Idealized transaction pattern, household sector, balanced budget
https://commons.wikimedia.org/wiki/File:AXEC98.png

#3 Wikimedia, Creation and destruction of transaction money at the central bank
https://commons.wikimedia.org/wiki/File:AXEC114.png

#4 Wikimedia, Switch from bank money to central bank money
https://commons.wikimedia.org/wiki/File:AXEC115.png

Neil Wilson said...

And the hot button political issues have little or nothing to do with money.

They have everything to do with stuff, and what it is currently being used for - if anything. It is that debate that the elite are trying to avoid having by shouting "money, money, money".

André said...

Neil, I strongly disagree.

The hot button political issues have everything to do with money - especially the federal money.

For example, people have to understand that a big (or unlimited) budget for a federal unemployment program is necessary for the social wellbeing that every nation wants.

Government needs to spend a lot of money to make such a program true. Federal programs need money to work.

We live in a money society. You can't go like the mainstream economists and simply pretend that money doesn't exist, that a real goods barter economy is a decent model for explaining the world...

Tom Hickey said...

What is at issue is the operation of a monetary production economy, that is, how finance, which is concerned with financial instruments, and economics. which is concerned with real resources, interact.

Even most economists don't understand this. How can the public?

Calgacus said...

The public can understand it because they already understand it. Most "economists" are people who have been "educated" to think 2 + 2 = 5 or whatever those who pay their salary want it to be.

I'm more with Andre, the political issue above all for the Bad Guys is that they want to be the paycheck monopolists, or in other words, the labor monopsonists. They do this by nasty government intervention - corrupting the government to make unemployment above its natural rate of zero, to prevent the ordinary person from freely exercising their property right to their own labor.

The Bad Guys don't want to get to the point where mainstream econ is roughly right, where things really are about tradeoffs and distribution of stuff. What they want is their reserve army of unemployed, where Marxian economics is roughly right. The old saw was that neoclassical econ explained the SU, the socialist world well, while Marx explained the US, the capitalist world well.

What, besides American ingenuity, explains Trumpy Bear, I have no idea.

Neil Wilson said...

"You can't go like the mainstream economists and simply pretend that money doesn't exist"

Who's pretending money doesn't exist. I'm saying that money isn't relevant to the issue.

I can get money in the current paradigm. You just tax rich people. But that won't work - because you haven't had the real political discussion about resource allocation.

The mistake you're perhaps making is the same one as the mainstream economists. You're assuming that money and stuff are the same thing - in a one-to-one relationship. They are not.

The job of the federal government is to start talking about stuff and resource allocation. From the currency issuer's point of view money just pops into being as required to settle the debts created by moving stuff around.

As the wag once put it. MMT is not really modern, not really about money, and certainly not a theory.


André said...

"From the currency issuer's point of view money just pops into being as required to settle the debts created by moving stuff around."

Yes, and that's why money is so important! It does move things around! Isn't it a real effect? You can't ignore that.

"As the wag once put it. MMT is not really modern, not really about money, and certainly not a theory."

Well, now I'm confused. I thought it was a theory of money. MMT claims the "tax drives money" theory is true. If it is not a money theory, then what is it?

André said...

Just to complete, the "modern monetary theory" or the "chartalist theory" assert that money value is derived from government decree. The government imposes taxes to be paid in the chartal token, and then supply that token to the population in exchange for goods, services and labour. So, as you can see, money is central to that theory. That theory has everything to do with money.

The "money as commodity theory" (which has a lot of other names) is not compatible with the "chartalist theory". They assume that money is a commodity. And so you can think of money as something that will make market exchanges more efficient, but you usually can safely ignore it and think the economy as a barter one. You wouldn't even need to talk about money or consider it in economic research papers.

As we now, dollar cannot be through as commodity anymore. So mainstream economists slightly changed the theory. Now money is some sort of psychological delusion, and its value is derived from expectations. But again, you can safely ignore it and treat the economy as a barter one.

I know you are not defending the mainstream view, because I have already read a lot of your posts and comments.

But I cannot understand what you are saying. I guess you are not communicating your message well. I mean, "political issues have little or nothing to do with money" doesn't really seems to be the real message you are trying to convey...

Matt Franko said...

You guys are quickly denigrating here into again trying to precisely define a figure of speech “money” ....

AXEC / E.K-H said...

Tom Hickey

You say: “What is at issue is the operation of a monetary production economy, that is, how finance, which is concerned with financial instruments, and economics. which is concerned with real resources, interact. Even most economists don’t understand this. How can the public?”

True. The task of economists is to explain how the actual monetary economy works ― not less, not more. But until this day, economists (Walrasians, Keynesians, Marxians, Austrians, and Pluralists) have no idea how the economy works, that is, they lack the true theory.

Why is economics a scientific failure/fraud? Because economists never had the intellectual capacity nor the time to do proper science. What they were busily occupied with instead was political agenda pushing. Agenda pushing is the natural choice for morons because one needs only an opinion, a big flap, and some acting talent.#1

Neil Wilson demonstrates here for everyone to see how easy it is to derail science by switching to politics: “And the hot button political issues have little or nothing to do with money.” André and Calgacus immediately jump on the bandwagon by telling their Bad Guy story. Thus, the whole discussion of what Keynes called the ‘monetary theory of production’ degenerates into a Pavlovian exchange of age-old political crap. It is the same pattern on all levels of economic discussion. There is no scientific substance in Krugman and Kelton and Hickey and all the rest.

What the representative economist has not realized in 200+ years is that politics is NOT his business: “A scientific observer or reasoner, merely as such, is not an adviser for practice. His part is only to show that certain consequences follow from certain causes, and that to obtain certain ends, certain means are the most effectual. Whether the ends themselves are such as ought to be pursued, and if so, in what cases and to how great a length, it is no part of his business as a cultivator of science to decide, and science alone will never qualify him for the decision.” (J. S. Mill)

From an economist, society expects scientific knowledge of how the actual economy works, just as it expects from engineers all the scientific knowledge that is necessary to get a huge metallic construct against gravity off the ground.

Economists have no such knowledge. They have wasted 200+ years since Adam Smith and Karl Marx with political blathering and agenda pushing. MMT is no exception.#3 Economics is a scientific failure/fraud, and MMT is part of it.

Egmont Kakarot-Handtke

#1 For details see cross-references Political economics
http://axecorg.blogspot.de/2015/11/political-economics-cross-references.html

#2 For details see cross-references Failed/Fake scientists
http://axecorg.blogspot.de/2015/11/failedfake-scientists-cross-references.html

#3 For details see cross-references MMT
http://axecorg.blogspot.de/2017/07/mmt-cross-references.html

André said...

Unfortunately, I guess we are.

But I cannot find any definition of the word "money" that excludes cash or government money.

And to say that government money is unimportant to the economy or to MMT theory seems wrong to me...

Tom Hickey said...

MMT shows how finance and economics overlap and interact interdependently in a monetary production economy. It is a continuation of the analysis of a modern monetary production economic that Keynes initiated explicitly, although it was implicit in classical economics. Neoclassical economics ignored the monetary aspect in focusing on a barter economy and viewing the monetary aspect as a neutral veil that was useful in resolving the necessity for "double coincidence of wants" in a pure barter system.

Keynes showed how that view was wrong and proposed a fresh way of looking at the problem. MMT builds on that project through Lerner and Post Keynesianism chiefly but also drawing on other sources.

MMT is a theory in the strict scientific senses as a causal explanation of a modern monetary economy based on flows that affect stocks. Economists use nominal values as prices entered on accounting statements in a unit of account that can be adjusted for inflation to arrive at real value for expressing these flows and stocks in order to generate a model that subsumes all the different financial and non-financial aspects of a modern monetary economy. Different economies using different units of account can be compared by applying the exchange rate at the time.

MMT's "theory" of money is an operational description rather than a causal explanation. The operational is needed to ground the causal. Since the operational description is institutional, the economics of a modern monetary economy is necessarily institutional and therefore historical rather than "natural." Hence, the attempt to portray economics as natural science is doomed.

Tom Hickey said...

The "money as commodity theory" (which has a lot of other names) is not compatible with the "chartalist theory". They assume that money is a commodity. And so you can think of money as something that will make market exchanges more efficient, but you usually can safely ignore it and think the economy as a barter one. You wouldn't even need to talk about money or consider it in economic research papers.

Right. The thinking of classical economics was based on money as gold and silver, which are commodities. The idea is that economies are based on barter and certain commodities with special characteristics are used as a numeraire to value other commodities and escape the need for double coincidence of wants that makes barter inefficient. Like other commodities, the value of the numeraire depends on the cost of production. It is an real asset of the miner rather than a financial instrument generated in a transaction.

This was natural for the classical economists since they were living under mercantilism and the central focus of economics was on trade, the focus of which was acquisition of gold and sliver through international trade.

Neoclassical economists simply imported the assumptions of this model into their account of a modern monetary economy.

André said...

Tom, I guess your views are aligned with mine.

MMT is a monetary theory.

And I also claim that economics and "hot button politics" have everything to do with money...

Tom Hickey said...

And I also claim that economics and "hot button politics" have everything to do with money...

Most people and elites ("influencers") especially are concerned with social status (network position), power (control over experience and environment), and wealth (financial and non-finanacial assets).

Economists other than institutional and Marxist/Marxian tend to overlook or minimize the social and political in their emphasis on the economic.

But the economic aspect of life in society is bound up with the social and political aspects. and these aspects contribute important causal factors to the mix, to the degree that ignoring or minimizing the social and political vitiates the analysis.

André said...

Tom, I was thinking more simply.

The federal budget is an example. It's a money extremely relevant for economics and politics.

Tom Hickey said...

The federal budget is an example. It's a money extremely relevant for economics and politics.

Right. And the federal budget is the outcome of a political process in which the major participants are the elite and their cronies and minions, whose priorities are advancing their common interest, which involve social status, political power, and distribution of income (flow) and wealth (stock).

The way the legislative process works in the US, the voters elect representatives who then follow the instructions of the party leaders. Power is concentrated in the US legislature in a very few (elite) hands.

AXEC / E.K-H said...

Tom Hickey

You say: “MMT shows how finance and economics overlap and interact interdependently in a monetary production economy. It is a continuation of the analysis of a modern monetary production economic that Keynes initiated explicitly, although it was implicit in classical economics. Neoclassical economics ignored the monetary aspect in focusing on a barter economy and viewing the monetary aspect as a neutral veil that was useful in resolving the necessity for ‘double coincidence of wants’ in a pure barter system.”

It is true, of course, that orthodox economics in general and orthodox monetary theory, in particular, is provably false yet insufficient: “The moral of the story is simply this: it takes a new theory, and not just the destructive exposure of assumptions or the collection of new facts, to beat an old theory.” (Blaug)

In other words, orthodox economics has to be fully replaced, in methodological terms, economics needs a paradigm shift, in technical terms, the neoclassical axioms have to be fully replaced and ALL of economics has to be reconstructed based on consistent macrofoundations.

Keynes initiated the move from microfoundations to macrofoundations but failed. He failed because he did not understand macroeconomic profit: “His Collected Writings show that he wrestled to solve the Profit Puzzle up till the semi-final versions of his GT but in the end he gave up and discarded the draft chapter dealing with it.” (Tómasson et al.)

This failure not only proves the utter scientific incompetence of Keynes but also of those who came before and after him. Economists do until this very day not understand the foundational concept of their subject matter. Which means that ALL economic policy guidance since Adam Smith and Karl Marx is misleading or disastrous or at best ineffective.

This is well-known among heads-of-state. Napoleon claimed “… that he had always believed that if an empire were made of granite the ideas of economists, if listened to, would suffice to reduce it to dust.” (Viner) Because of this, politicians do not take economists seriously, they employ them as useful idiots.

MMT profit theory, as embodied in the balances equations, is false and by consequence, the whole theoretical superstructure is false and by consequence MMT economic policy has no sound scientific foundations, just like neoliberal policy and Keynesian policy and Marxian policy.

What the spokespersons of MMT, Mitchell, Tcherneva, Mosler, Wray, Kelton, Fullwiler, Forstater, Hickey etcetera, are in effect doing is political agenda pushing without one jot of scientific competence. And, clearly, it is NOT the agenda of We-the-people.

Egmont Kakarot-Handtke