Tuesday, February 19, 2013

JKH — ‘Loans Create Deposits’ – in Context

Introduction
Loans create deposits. We’ve heard it many times now. But how well is it understood? The phrase is typically invoked accurately, in conjunction with a rejection of the ‘money multiplier’ fable found in economic textbooks. From an operational perspective, banks do not “lend reserves” to their non-bank customers. “Loans create deposits’ is an operation in endogenous money. And where central banks impose a level of required reserves based on deposits, the timing of the demand for and supply of reserves in respect of such a requirement follows the creation of the deposit – it does not precede it. The money multiplier story is bunk. And ‘loans create deposits’ is correct as an observation.
Nevertheless, there is a larger context for deposits, which includes their fate after they have been created. Deposits are used to repay loans, resulting in the ‘death’ of both loan and deposit. But there is more. As part of the birth/death analogy, there is the lifetime of loans and deposits to consider. This sequence of birth, life, and death in total may be helpful in putting ‘loans create deposits’ into a broader context. There is potential for confusion if ‘loans create deposits’ is embraced too enthusiastically as the defining characteristic, without considering the full life cycle of loans and deposits. Indeed, we shall see further below that ‘deposits fund loans’ is as true as ‘loans create deposits’ and that there is no contradiction between these two things.
Monetary Realism
‘Loans Create Deposits’ – in Context
JKH
(h/t Kevin Fathi via email)

Money & banking 101. Very clear step by step exposition of what goes on in contemporary banking wrt to institutional arrangements, how the accounting works, and what the institutional implications are. A chief implication is that bank money involves risk and banking is therefore an exercise in risk management to great degree.


149 comments:

Unknown said...

"In another version of the same lending transaction, the lending bank presents the borrower with a cheque or bank draft. The lending bank debits the borrower’s loan account and credits a PAYMENT LIABILITY account. The bank’s balance sheet has grown. The borrower may then deposit that cheque with a second bank. At that moment, the balance sheet of the second bank – the deposit issuing bank – grows by the same amount, with a PAYMENT DUE asset and a deposit liability. This temporary duplication of balance sheet growth across two different banks is captured within the accounting classification of bank ‘float’. The duplication gets resolved and eliminated when the deposit issuing bank clears the cheque back to the lending bank and RECEIVES A RESERVE BALANCE CREDIT in exchange (IN PAYMENT), at which point the lending bank sheds both reserve balances and its PAYMENT LIABILITY".

Unknown said...

Reserves are not some "support mechanism", they are the means of final payment.

Detroit Dan said...

Excellent posting by JKH, of course!

Does anyone know what JKH is referring to with this:

"Other systems have been proposed, in which central banks intervene in some way ... to subsume this competition more comprehensively (e.g. the MMT Mosler plan)."

?

JK said...

This post by JKH is sure to cause a flurry of comments among the websites. Exciting.

Unknown said...

He's talking about this:

http://www.huffingtonpost.com/warren-mosler/proposals-for-the-banking_b_432105.html

Tom Hickey said...

Reserves are not some "support mechanism", they are the means of final payment.

A demand deposit is a bank's liability that involves the promise to settle in the currency as required, either in cash withdrawal at the window or in the government's payments system that only uses the government's money.

Since banks cannot issue currency they have to obtain it for settlement. Thus banks seek to attract deposits by borrowing from savers, which increases their reserve balance.

Otherwise, they borrow reserves in the interbank market, or get them directly from the cb either in exchange for securities or by borrowing.

So it is a tightly integrated system with govt money at the top of the hierarchy. The advantage is that there is a single currency, which increases efficiency and lowers risk, and the cb as LLR is able to ensure adequate liquidity to settle, while the private sector bears much of the risk and is responsible for risk management.

Under capitalism, profit is justified based on risk assumption, and bank profit is supposedly largely from assuming risk prudently in a competitive environment.

Unknown said...

Here's Bill Mitchell on "loans create deposits" and the role of deposits in funding bank operations:

http://bilbo.economicoutlook.net/blog/?p=14620

Tom Hickey said...

"Other systems have been proposed, in which central banks intervene in some way ... to subsume this competition more comprehensively (e.g. the MMT Mosler plan)."

Proposals for the Treasury, the Federal Reserve, the FDIC, and the Banking System

The Mosler Plan

VCP proposal for bankers

Fixing the small banks

Here are some others that are more situation specific:

Current Proposals (April 26th, 2008, after JPM buys Bear in mid-March)

Alternative Bank Liquidity Proposal at the time (2008) of the liquidity crunch.

Mosler TALF alternative/

Unknown said...

A good post to help clear up some questions about aspects of bank liquidity and the money multiplier, particularly for those who have had time to digest the very basics of MMT/MR and want more detail.

However I could see that same someone someone reading "deposits fund loans" might come away a bit confused. The process by which this happens needs to be more clearly delineated.

Dan Kervick said...

Detroit Dan, I think he is possibly referring to Mosler's proposal to do away with interbank lending and handle all of the banks' reserve management operations via the discount window. He proposes lowering the discount rate to the Fed Funds target rate, and then phasing out the interbank Fed Funds market over a six month period.

Detroit Dan said...

Thanks y, Tom, and Dan K for answering my question...

Dan Kervick said...

I made a comment over there on the "deposits fund loans" portion of the piece, which I also found unclear. When a bank acquires a new deposit it acquires an asset and an equal liability at the same time. So I'm not sure how this helps fund lending. However, perhaps what he has in mind is this: while the deposit increases the bank's liabilities, most customers hold a substantial portion of their deposit over time, so the corresponding increase in reserve balances for settlement allows the bank to increase their lending.

I'm not sure this is a very big deal in itself. The bank pays interest on at least a portion of its customers' deposit balances, and it has to pay interest for reserve balances acquired by other means too. In principle, it seems to me, a fully capitalized bank could do all of its lending without attracting a single deposit beyond those created via the lending itself.

However there are all kinds of fees associated with deposit accounts that make money for the bank. Two of the three traditional roles of banking are storage services and payment services. And that where they still make a lot of money. I think that's why the want to attract depositors.

Unknown said...

"someone reading "deposits fund loans" might come away a bit confused"

Bill Mitchell's article above:

"The role of bank deposits in MMT' (2011)

http://bilbo.economicoutlook.net/blog/?p=14620


also:

http://mmtwiki.org/wiki/Money,_Government_and_Banking#The_Loan.2FDeposit_Mechanism

Unknown said...

Dan,

"When a bank acquires a new deposit it acquires an asset and an equal liability at the same time. So I'm not sure how this helps fund lending"

Say Bank A makes a loan and creates a $100 deposit.

The borrower spends the deposit. The person receiving the spending has an account at Bank B.

Bank A now owes Bank B $100 in reserves (all else being equal).

If it can attract a $100 deposit from another bank, this cancels out Bank A's loss of reserves. The price it has to pay to attract the deposit, i.e. the interest it pays, is essentially the cost of funding the original loan.

A broader reason for why banks seek to attract deposits is that when people have accounts at the bank, more payments are made to that bank from other banks.

Tom Hickey said...

But to the degree that intrabank or interbank transactions are settled by netting, which increasingly this case as clearing houses become less costly than using FedWire, reserves are not needed to settle.

Ken said...

I don't think it's very complicated. Even though we talk about being in a zero interest rate environment, the real Federal Funds rate stays around .25 percent, because that is what the Fed is paying on excess reserves. Checking the FFR on bankrate.com confirms this.

If I go to Wells Fargo and check what they're paying on their highest yielding savings accounts, it is .03 percent.

So ... .03 percent vs .25 percent. It is cheaper to attract reserves by attracting deposits than it is to borrow them in the overnight markets. So that's what happens.

Dan Kervick said...

y,

When Bank A's borrower spends the $100, it does lose $100 in reserves to Bank B, but it has has $100 fewer dollars in liabilities. The borrower's deposit account is debited by $100 and Bank A's reserve account is debited by the same amount. So it seems to me there is no sort of net loss here that has to be made up.

Also, when it acquires a new deposit from a walk-in customer, it acquires a new asset and new liability at the same time. So again there is no net change. I don't see how these movements of deposit balances are funding anything.

justaluckyfool said...

"Loans create deposits"
Translated would mean "money created out of thin air that is 'backed by 10% of deposited currency' which the bank does not own but has in storage and safe keeping for some other depositor becomes a new deposit of 100% of the amount of the loan."
That believe it or not is counterfeit money; however while we the people were sleeping, we the people legislated that private for profit banks may do it.
Not only that they may 'print ' that counterfeit amount but also that they could charge compound interest and thereby gain as a profit legal currency in double if not quadruple the loan amount.
How long would it take you to become one of the 1% if you could "borrow" 10% of your neighbors money without having to ask for the actual money and then be allowed to make a loan for 10 times that amount "borrowed" charge 4% interest for 36 years and quadruple the loan amount?
This is the power we have given to the Private For Profit Banks (PFPB). A scheme to quote Frederick Soddy (The Role of Money), " To allow
it to become a source of revenue to private issuers
is to create, first, a secret and illicit arm of the
government and, last, a rival power strong enough
ultimately to overthrow all other forms of
government.
""Isn't it time for QE for the people ?"

Bernanke's dilemma is that he is living within a "Private For Profit Banks" controlled system while knowing that QE could take away the PFPB power and at the same time give that power back to the people. But where is the help from the people? Ben had proven that the Fed can purchase trillions of dollars of assets without any deficit spending. Assets that would double in amount of revenue raised. It's so simple,but he can not do it without the power of the people behind him. HOW simple is it? "QE 4 The People" Feds buy $100 trillion of bank loans outstanding. All residential and commercial loans. Modify those loans at 2% for 36 years. BINGO-$5.5 trillion revenue for the US Treasury per year for 36 years. End deficit-End FICA-End federal Income Tax. So what does this simple (Noble worthy) action do? It takes away from the PFPB the profit from ' printing' $100 trillion of so called " Loans = Deposits" and gives that $5.5 trillion as "taxation" collected to be used by Congress "for the people".
http://archive.org/stream/roleofmoney032861mbp/roleofmoney032861mbp_djvu.txt
THE ROLE OF MONEY-WHAT IT SHOULD BE, CONTRASTED WITH WHAT IT HAS BECOME.By FREDERICK SODDY ; Nobel Laureate ..

" READ: "QE 4 The PEOPLE" by Justaluckyfool (C Basilovecchio) Read how QE can give true meaning to the word "taxation" by changing its method of raising revenue by using INTEREST instead of INCOME.But ,why would we want a fair and equitable tax? Why; equality and prosperity ? Why take away from PFPB the ways and means that has earned them the $16 trillion owed to them ? Yes that $16 trillion is accumulated interest .
Read more: http://bit.ly/MlQWNs

Unknown said...

Tom, understood. I was keeping things as simple as possible.

Tom Hickey said...

Joseph Lalliberté clarifies "deposits fund loans" in terms of sources and uses of funds on the flow of funds statement in a comment on JKH's post, and JKH confirms that was his intention.

Jose Guilherme said...

So ... .03 percent vs .25 percent. It is cheaper to attract reserves by attracting deposits than it is to borrow them in the overnight markets. So that's what happens.

That means the U. S. is in he opposite situation to what's happening in the periphery of the eurozone, where banks are offering deposits at rates much higher than the ECB main official rate - in order, precisely, to attract and/or retain depositors sending their funds to northern Europe.

Ken said...

Jose ... if that is the case, I'm wondering why .... why retain more expensive deposits if they can borrow reserves at the official rate cheaper? Or perhaps they only have limited access to funds at the official rate, due to other factors?

Dan Kervick said...

Banks make fortunes off their deposits, don't they? The interest they pay out must be more than made up for with all the fees they charge.

Tom Hickey said...

Banks make fortunes off their deposits, don't they? The interest they pay out must be more than made up for with all the fees they charge.

Plain vanilla banking based on prudent risk management is not all that profitable when conducted according to the rules. Banks make fortunes by leverage their charters through risk taking and rent-seeking activities that go beyond plain vanilla banking. That is not banking. It's gambling, and the gamblers are backed by the government if their bets go horribly wrong.

Ramanan said...

Billy Blog: "Deposits do not fund loans."

:)

Tom Hickey said...

All depends on what is meant by "funds," as the comment thread at MR is showing.

While "fund" may be the correct terminology in banking circles that understand it in terms of sources and uses of funds wrt the flow of funds statement, as Joseph Laliberté points out in the comments there, it is already resulting in confusion among those not familiar with this terminology.

Bill Mitchell: "I hope that has answered all those queries which sought to integrate an undertanding of how loans create deposits with the role that deposits play in the funding of bank operations.

Deposits do not fund loans. But they are one source of funds that the bank has available to ensure that its role in the settlement process is not compromised which would require borrowing from the central bank.

Banks have no operational constraints on their lending which is not the same thing as saying they do not face constraints that arise from profitability considerations."

Jose Guilherme said...

@Ken

Good question.

I think there are two separate issues here.

First, Spanish banks did manage to survive deposit flight to the tune of more than $200 billion euros in mid 2012. This could only be because of mass advances of funds from the Bank of Spain, otherwise the dearth of reserves would have determined an incapability of honoring the instructions for transfers abroad coming from depositors.

Notice that the funding from the Bank of Spain was at the official rate of only 0.75%.

Yet, in spite of being able to survive the deposit flight by substituting funding from the NCB at 0.75%, the banks insisted on retaining and attracting every depositor they could - by offering rates way above 0.75%.

What was going on? I tried to raise the question at MR but - apart from a short reply from Ramanan - no one paid much attention.

It seems it's quite difficult to explain some of the features of the banking system even for the more realistic theories that are available.

Ken said...

Maybe something as simple as bank regulations? Are they required to "fund" (using that term cautiously) a certain percentage of their assets via deposits vice overnight or other short term loans, or risk being shut down?

Of course, a deposit really is an overnight loan ... I can withdraw my money any time from my bank, so my decision to keep it there is just a decision to roll over my loan to the bank every day. But perhaps deposits are treated differently by regulators.

Just guessing.

Jose Guilherme said...

Was it due to regulations?

May be.

But it's interesting to note that the government and central bank had to put a cap on the rates the banks were offering to depositors - because competition among the banks was sending them to unheard of levels.

Anyway, the connection between the interbank rate targeted by the NCBs and the rates offered to depositors seems to be shaky at best.

Dan Kervick said...

http://www.nbcnews.com/business/bank-fees-soar-free-checking-offers-decline-1B6068077

Tom Hickey said...

Jose, sounds to me like a back room deal among the eurocrats. They did not want the German banks to get top heavy with deposits. What the ante was is apparently secret.

Tom Hickey said...

Ken, banks have to manage LHS and RHS. The RHS is liabilities and equity so they can always increase equity. Usually increasing liabilities by attracting deposits is less costly. But banks do sometime go the equity route.

Matt Franko said...

One could probably look at the dividend rate banks pay on Preferreds vs the deposit rate...

I'd guess the preferreds are over 5% vs deposit rates near zero... No contest.

Matt Franko said...

Jose,

It would seem that interest rates are simply higher in those deficit nations so accordingly the deposit rates are higher for a given spread from country to country over there....

Banking may even be more profitable in the deficit countries I might even think.... As the perceived risks are higher when in reality they are not as banks have always gotten 'forbearance' of some sort from the govts throughout all of this....

Rsp

Unknown said...

Jose, the banks have to post collateral when borrowing from the CB. Not so with customer deposits.

Jose Guilherme said...

the banks have to post collateral when borrowing from the CB

Yes, that was also Ramanan's point.

But in fact, when facing a situation of massive deposit flight from one eurozone country to another the NCB will be forced to relax the collateral rules so much that they will become meaningless.

And, in that situation, banks will effectively access funding from NCBs at a rate of only 0.75%, whereas deposit rates are higher - sometimes, much higher.

Dan Kervick said...

How often do these collateral constraints actually come into play? How often are banks unable to borrow reserve balances wholesale because they cannot post sufficient collateral?

justaluckyfool said...

As Frederick Soddy stated (1926)
When banks loan money it is always "Heads they win, Tails you lose"

Tom Hickey said...

How often do these collateral constraints actually come into play? How often are banks unable to borrow reserve balances wholesale because they cannot post sufficient collateral?

Crisis occurs when collateral becomes suspect. Then the government has to step in to provide liquidity to prevent the financial system from freezing up.

Jose Guilherme said...

How often do these collateral constraints actually come into play? How often are banks unable to borrow reserve balances wholesale because they cannot post sufficient collateral?

In the eurozone the banks have to be allowed to borrow reserves even if collateral is weak or close to non existent - that's necessary for banks to always be able to send their depositors' funds to other countries in the eurozone.

In practice, the ECB has always relaxed the collateral
rules when that was needed to preserve the liquidity in the
system.

Unknown said...
This comment has been removed by the author.
Unknown said...

Jose,

maybe the problem is that the banks' loan books were also collapsing? They were facing mass outflows of deposits to other countries' banks, as well as a massive fall in debt repayments from borrowers.

Basically everything was going out and nothing was coming in. By holding on to depositors, they would have more payments coming in from other banks to those depositors' accounts, less payments going out, and more intrabank payments - i.e. a more balanced situation overall.

Tom Hickey said...

maybe the problem is that the banks' loan books were also collapsing?

That's why collateral because suspect. Banks know what they were holding and assumed that other banks were in the same leaky boat. So no one is willing to lend to the other guy. IN that case, the cb has to pick up the slack with "whatever it takes," or the financial system goes down.

Jose Guilherme said...

guy. IN that case, the cb has to pick up the slack with "whatever it takes," or the financial system goes down.

Right.

And as Ramanan pointed out elsewhere, some Greek banks even started posting profits when they lost depositors and had to seek funding at the NCB (at much lower rates).

In this case the loss of depositors had a positive impact on the banks' bottom line. :)

Unknown said...

Tom, even if the CB lends to the banks to keep them afloat, they're still just going further and further into unsustainable debt and eventual bankruptcy if (a) they can't hold on to their depositors (who receive payments from other banks) and (b) their revenue from loans and other assets (and the value of those assets) is collapsing.

Tom Hickey said...

y, governments are very powerful, so when they step in to rescue the banks with liquidity provision, they also recognize that there is a solvency issue and so they simultaneously create conditions for banks to make "free" profits through spreads and other arrangements to recapitalize them without a straight up equity infusion.

Unknown said...

"some Greek banks even started posting profits when they lost depositors"

Do you have a link to the relevant post/info?

Dan Kervick said...

OK, that's fine. But JKH's discussion is not about crises, as I understand it, but about ordinary operations. Ram was suggesting that banks need to attract deposits to fund their lending because of collateral limitations, but I don't think that is the case.

Tom Hickey said...

There's the general case in banking, in which the LHS and RHS have to balance.

That can be met with only equity on the RHS. E.g., to obtain reserves by borrowing the bank can borrow against asset collateral like tsys that it owns as equity. There is no operational requirement for deposits in banking. It's a profitability issue.

There may be special cases based on different requirements imposed by different jurisdictions.

Unknown said...

"deposits fund loans" makes it sound like banks get deposits from somewhere and then put them into a borrowers account, thereby "lending them out". But that doesn't really make much sense, does it?

Ken said...

Yes, but if the bank makes a loan by creating a deposit, say for $1000, there is a high probability that this money will be instantly withdrawn and deposited with another bank. Which means that this 1000 must be available in the bank's reserve account so that the receiving bank can get it. Thus it must be "funded" in the reserve account. One way (not the only way) to cause money to flow into the bank's reserve account is to attract a deposit. Thus the deposit has "funded" the loan.

It's just like you having to have money in your checking account to fund your purchases. The Fed is the banker's bank,and the bank's reserve account is the equivalent of your checking account.

If everything stayed within the same bank, there would be no need to discuss "funding". Similarly, for the banking system as a whole, there is no need to discuss it.

But when you look at the perspective of an individual bank, it is relevant.

Seems to me so simple ... why is everyone making it so hard?

Tom Hickey said...

JKH has made it petty clear that he is not talking about funding reserves (as I understand him anyway).

Ken said...

Actually, I think that is what he's talking about. That's what I got out of it anyway.

If there was only one bank in existence, they could create loans/deposits to their hearts content and there would never be a problem. Since they'd be the one clearing all the checks. Sort of like the fed in our actual system.

So the only time that "funding" could possibly be an issue is to account for payments to other banks. And that means reserves.

Unknown said...

"Thus the deposit has "funded" the loan."

But it hasn't actually funded the loan. It has provided the bank with reserves which were lost (in the example) when a payment was made to another bank.

They are actually two distinct things.

Tom Hickey said...

Ken, see this comment. Not reserves, as I read it.

Unknown said...

"The loan has created the deposit, although loan and deposit are domiciled in different banks. The system has expanded in size. The growth is now reflected in the size of the deposit issuing bank’s balance sheet, with an increase in deposits and reserve balances. The lending bank’s balance sheet size is unchanged from the start (at least temporarily), with loan growth offset by a reserve balance decline.

Money Markets

In this latter example, it is possible and even likely, other things equal, that the lending bank additionally will seek to borrow new funding from wholesale money markets and that the deposit issuing bank will lend funds into this market. This is a natural response to the respective change in reserve distribution that has been created momentarily for the two banks. Without further action, the lending bank has lost reserves and the deposit bank has gained reserves. They may both seek to normalize these respective reserve positions, other things equal. Adjusting positions through money market operations is a basic function of commercial bank reserve management. Thus, this example features the core role of bank reserves in clearing a payment from one bank to another. The final resolution of positions in this case is that the balance sheets of both banks will have expanded, indirectly connected through money market transactions that follow on from the initial ‘loans create deposits’ transaction. However, this too may be a temporary situation, as the original transaction involving two different banks will inevitably be followed up by further transactions that shift bank reserves between various bank counterparties and in various directions across the system."

Seems to be a lot about reserves.

Ken said...

Ok then, well my paycheck didn't actually "fund" the purchase of my computer. It just provided me with the needed checking balances which were lost when a payment was made to Fry's. ;-)

Ken said...

I read that comment. Not 100 percent sure what he means there, but of course it's true banks don't lend out reserves. Because by definition, only entities which have reserve accounts at the Fed can hold reserves. Just by definition.

But if you take your newly created "bank money" and move it somewhere else, your bank is on the hook to another bank, and the bank's reserve accounts are the equivalent of my checking account. That reserve account has to be sufficiently funded to account for the above transaction.

Jose Guilherme said...

What so banks lend then?

Either (1) deposits created out of nothing or (2) previously existing deposits.

Neoclassicals say it's only proposition (2) that is valid.

This is clearly expressed in the following sentence from Whelan (for the usual textbook example with 10% reserve ratio) that I posted on MR:

“People sometimes think that individual banks are somehow able to take in $100 and then make an additional $900 in loans from this, creating funds out of nowhere. This would be fraud—lending funds you don’t have. That is not what happens…

In each case, banks lend 90 percent of their deposits and retain the rest. They don’t lend out amounts above those provided to them by depositors, which is their role as financial intermediaries".

I think PK economists would say (1) - though after what I've read following JKH's posting I don't feel that sure anymore :)

Tom Hickey said...

Here is a clear statement of the MR position from Brett Fiebiger in answer to a comment at MR:

Geoff
February 20, 2013 at 7:19 pm

Excellent stuff by Soddy and a great post by Dr. Brett. My first exposure to the idea of endogenous money was the essay “What is Money” by Mitchell Innes, written in 1913. I know Innes is recommended reading by certain MMTers like Mr. Mosler, but it seems to fit MR like a glove.


BF
February 20, 2013 at 7:46 pm


Thanks Geoff. Innes was in the Chartalist tradition. He wrote some interesting analysis that was perhaps appropriate for the monetary system in which he resided. Certainly, little has changed regarding the efflux of bank money (creation) followed by reflux (destruction), though with the US Federal Reserve System Act of 1913 (and with the Fed operative in time for the war) it soon became inappropriate to use similar language for State Money (except in explicit reference to the activities of the central bank undertaken typically for monetary policy purposes).


Obviously, as the federal government is a now currency user (with its budgetary operations requiring dual-clearing in central banks and private bank monies), it is highly misleading to suppose that federal government spending creates money while taxation payments destroy money. It could be argued that such ventures increase or decrease the stock of money circulating outside of the government’s coffers; nonetheless, as the Treasury’s deposits at the Fed are “money” the language of efflux/reflux or creation/destruction make little sense. A claim that federal budget deficits lead to ‘net credits to bank reserves’ (with T-bonds sold to drain excess reserves) is alas a failure to do or to appropriately understand the balance sheet accounting of the US Federal Reserve System.


Soddy does not fit MMT like a glove. The former described the monetary system for what it is (i.e. a virtual-monopoly of private banks and private interests). Respectfully, I hope the comments section does not degenerate into something about MMT; when the post is about Soddy getting endogenous money (which cannot be said for Keynes and not always for Minsky).




link

So they are now full -on circuitists who think that Chartalism doesn't apply meaningfully to the present monetary regime.

Tom Hickey said...

MODERN MONEY THEORY: A RESPONSE TO CRITICS

Scott Fullwiler, Stephanie Kelton, L. Randall Wray

Tom Hickey said...

OK, I asked JKH specifically what he means by "loans fund deposits." The comment thread begins here. His answer is here.

Nothing to do with reserves.

Basically the LHS and RHS have to balance, so if a loan is created as a bank asset on the LHS, then an entry has to be created on the RHS and the predominant set of entries the way "funding" in this sense works is under deposits.

JK said...

Tom,

How recently was that MMT: A RESPONSE TO CRITICS issued?

Tom Hickey said...

January 2012

Here's the link.

Jose Guilherme said...

...I asked specifically what he means...Basically the LHS and RHS have to balance

Assets = Liabilities + Equity

Well, we already knew that before the debate started. :)



David said...

So they are now full -on circuitists who think that Chartalism doesn't apply meaningfully to the present monetary regime

This is quite interesting. They are now using Soddy to make the case for their view of the money system. It was precisely this view that Soddy and the monetary reformers who follow him found an intolerable reality. Soddy advocated a hierarchy of money with state money on top, as is being claimed MMT does. Soddy also liked 100% reserve banking. I'm guessing the MR folks won't be following him there.

Ken said...

Well, if it has "nothing to do with reserves", why would you, as a bank, need to match loans and deposits? Deposits are a liability. If you loose one, you shed a liability, so you come out ahead, right?

Who cares if RHS and LHS match in that case? May all my liabilities go away and just leave me with assets! Woohoo!

Well, you do care, and the reason you care is because when that deposit goes away, reserves go with it, and if that keeps happening without attracting fresh deposits in to balance that loss, you run out of reserves and you can no longer clear payments. Just like me running out of funds in my checking account.

Reserves are the bank's "money in the bank".

JKH sounds like a banking guy and maybe he doesn't think of it in those terms, but as a point of logic, I don't see how it could be any other way. I think he's making everybody more confused rather than less.

Unknown said...

I think Brett Fiebiger's basically attacking MMT from the Monetary Reform/ Stephen Zarlenga perspective. Brett mentions Zarlenga in the comments, btw.

Zarlenga's AMI also has a 'critique' of MMT:

http://www.monetary.org/mmtevaluation

Unfortunately Fiebiger's critique of MMT demonstrated that he simply did not get parts of it.

But at least he's on the right side. He doesn't appear to think that JP Morgan and Goldman Sachs protect the people and democracy from Big Government and Socialism, unlike some other person.

Unknown said...

JKH says in a comment:

"the standard classification of taxes as government revenue"

"revenue" is a French word which simply means "return".


Jose Guilherme said...

y,

Fiebiger's critique of MMT demonstrated that he simply did not get parts of it

What parts of the Fiebiger critique do you object to, specifically?

vimothy said...

MODERN MONEY THEORY: A RESPONSE TO CRITICS

Scott Fullwiler, Stephanie Kelton, L. Randall Wray


Hey, Tom--Is this the paper that you mentioned in the thread on Palley?

Tom Hickey said...

Hey, Tom--Is this the paper that you mentioned in the thread on Palley?

Yes.

vimothy said...

But it doesn't appear to address a single point that "the critics" have made. As far as I can see, they don't even mention Lavoie or Fiebiger. Is it a working paper version?

Tom Hickey said...

Yes, that is the complaint made against it. The MMT economists response it that shows what our position is and your criticism is not of our position. Please understand our position before you attempt to criticize it. One may not like that response but that is all they are willing to give.

vimothy said...

Your comment is slightly ambiguous, Tom. Is there a double standard here? If people criticize MMT, then they are required to cite numerous papers, but when MMTers write about the criticism, they're not required to cite or even address in any way the papers that they are ostensibly responding to?

Unknown said...

Jose,

I want to apologize for being rude in our previous discussion.

"What parts of the Fiebiger critique do you object to, specifically?"

He just ignores the MMT argument that government liabilities, when returned to the government, can not logically "fund" further government spending.

Rather than addressing this argument, and saying "I disagree with this for xyz reasons" he simply ignores it and says "I don't know what they mean! It's nonsense!"

Unknown said...

Ken,

"Ok then, well my paycheck didn't actually "fund" the purchase of my computer. It just provided me with the needed checking balances which were lost when a payment was made to Fry's."

A bank could make a loan/create a deposit, and then keep all the subsequent transactions "in house".

In this case there would be no need for the bank to obtain deposits or funds from other sources to 'fund the loan'. Only when the borrower makes a payment to another bank does the problem arise of how to offset that outflow.

So it's not about funding the loan itself, but rather about how to compensate for payments made by the bank's customers to accounts at other banks.

These are different things.

Unknown said...

JKH says:

"I think that idea of zero rates is a huge operational and strategic risk in the sense you describe – i.e. in the sense of the risk that it would self-implode as a sustainable policy and vaporize the credibility of the fiscal/monetary authority in that particular respect – plus all sorts of yield curve speculation of that happening – just like betting against an unsustainable currency peg"

It would be v. interesting to have a full JKH article on this particular subject.

Ken said...

I agree with everything you said, y, except I don't think it's all that different.

Ok ... somewhat different in that I just use my checking balances to pay for my own stuff, and don't in turn issue my own system of IOUs ... but I could, if I could get people ... perhaps my circle of friends ... to accept them. In that case I could use by checking balances to facilitate transactions one of my friends wants to make with someone outside the circle.

My bank uses its reserve balances to buy anything the bank wants for itself (real property, gov't bonds, commercial paper, whatever) just like me with my checking balances, but also uses them to settle transactions for their customers who wish to trade with someone outside the bank.

So they are completely symmetrical but in practice I don't tend to do the former, while for my bank doing it is part of their core business.

Tom Hickey said...

@ vimiothy.

What are they supposed to sa, you are attacking a straw man? They are supposed to respond to objections that aren't their position? The answer was implicitly very clear.

Ken said...

Should read:

"...my checking balances to facilitate transactions one of my friends wants to trade with someone..."

Tom Hickey said...

According to JKH, this is a technical sense of "fund" widely used in banking and finance that isn't listed in the dictionary as a meaning of "fund."

Ken said...

Yeah, I can see that. If you want to calling matching of liabilities to assets "funding", and if that's the way it's widely understood in the industry, than that's fine. So long as we understand the word is being used in a specific way.

But I think the point of MMT is to lift the veil of jargon and special uses of words and figure out what's really going on. For example, the guys at Treasury who sell the gov't bonds I am sure believe they are "funding" the gov't. We, of course, know they are doing no such thing. They are, in fact, creating a reserve drain so that the fed can control the interbank interest rate. But I'll bet if you tried to tell them that to their face, they'd look at you like you were nuts.

Jose Guilherme said...

y,

No need to apologize for anything :)

I interpreted Fiebiger in a different way. I don't think his points are "incompatible" with MMT. He's simply reacting, in my view, to the fact that that the language used by MMTers - while very effective at attracting a wide following for MMT, an undeniable success that had eluded all the currents of PK economics until then - is sometimes hard to conciliate with a pure accounting description of how the system works.

I think the following passage from Marc Lavoie - a PK economist and sympathetic observer who has unambiguously stated that "the neo-chartalist analysis is essentially correct" - sums up the very well how many unorthodox thinkers are still left puzzled by many of the claims of MMTers:

There is nothing or very little to be gained in arguing that government can spend by simply crediting a bank account; that government expenditures must precede tax collection; that the creation of high powered money requires government deficits in the long run; that central bank advances can be assimilated to a government expenditure; or that taxes and issues of securities do not finance government expenditures

Since differences over these expressions have practically no impact on what matters most - the policy level - my suggestion would be to agree on the accounting and move over on the "language" issue.

Btw, that's also the reason I felt so frustrated about the JKH posting that started this thread.

IMO, it's useless, sterile and counter productive to waste time and energy in endless debates over issues of semantics such as deciding whether deposits can "fund" loans. The accounting is very clear: simultaneous entries for loans and deposits, in every case. The reality is also clear: banks can create deposits "out of nowhere" just by deciding to grant a loan to a third party. So, the whole discussion left me thinking at times of the most absurd aspects the scholastic debates of the dark ages: much ado about nothing!.

Tom Hickey said...

Marc Lavoie: There is nothing or very little to be gained in arguing that government can spend by simply crediting a bank account; that government expenditures must precede tax collection; that the creation of high powered money requires government deficits in the long run; that central bank advances can be assimilated to a government expenditure; or that taxes and issues of securities do not finance government expenditures

I suspect that Marc is speaking as an economist here, but as other economists are saying that MMT has discovered nothing we didn't know already.

But the point is that no one actually put it together into a pitch that could be used to influence policy. As a result most of what economists were saying was worse than useless politically, it was damaging but supposing the status quo.

MMT admits that the only thing original about it other than combining a buffer stock of employed with a price anchor in the MMT JG is original to MMT. The way that they put it together is original.

Moreover, while it may possibly be true that others understood cb-Treasury ops and how the govt interfaces with non-govt in terms of monetary economics just about no one was saying it. Warren's "Soft Currency Economics" was important because it made something clear that economists had either not properly understood or had not made known outside of a rather limited circle of specialists occupying only a small corner of the field.

The reason that MMT took off is because activists got behind it once they understood how a correct understanding of monetary economics was not only useful for policy formulation but also "to save the world" from the clutches of darkness.

Those economists should be aware that that silence is consent. It was just about only the MMT economists and allies like Hudson and Black that were willing to go public with this knowledge. As as far as I am concerned the other economists have earned the scorn of the people that they betrayed..

Unknown said...

"According to JKH, this is a technical sense of "fund" widely used in banking and finance that isn't listed in the dictionary as a meaning of "fund."

JKH's main argument re. MMT seems to be "I don't like the way you guys use words. You should use words in the way the mainstream uses words".

vimothy said...

But you shouldn't think that, by changing the meaning of words, you change anything of substance. That's just nominalism, isn't it?

Unknown said...

perhaps "the mainstream" is using words in the wrong way? Is that possible?

vimothy said...

And if you use words in the "right way," what are the substantive changes?

Unknown said...

"There is nothing or very little to be gained in arguing that government can spend by simply crediting a bank account"

But the government *can* spend by simply crediting a bank account.

Most people are amazed/confused/outraged/repelled when this is made clear.

Clearly *most* people do not have the slightest idea of how things work. They get their info from the general media, which is often useless.

As "geeks" we can discuss these things until the cows come home, but we have to realize that there are larger things at stake.

Whilst we ask ourselves whether we should use this or that word, the majority of people are being fed a cartload of nonsense by "respectable" sources of info.

Unknown said...
This comment has been removed by the author.
Unknown said...

"...that government expenditures must precede tax collection"

How can the govt's own liabilities "fund" its expenditures?

You have to suspend your own innate capacity for logic to believe that they possibly could.

Or else you have to go down the "independent private central bank" road...

vimothy said...

Say that, under your defintion of the terms, deposits do not fund loans. Well, as far as everyone else is concerned, they really do fund loans. So you haven't said anything about the phenomenon that everyone else is interested in. Ultimately, it's irrelevant. Or say that taxes do not fund government spending. Bt, in the sense in which everyone else understand's the terms, taxes do fund spending.

Unknown said...
This comment has been removed by the author.
Tom Hickey said...

See Randy Wray, Paul Samuelson On Deficit Myths: Time To Drop That Old-Time Religion

“I think there is an element of truth in the view that the superstition that the budget must be balanced at all times [is necessary]. Once it is debunked [that] takes away one of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have anarchistic chaos and inefficiency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in a way that the long-run civilized life requires. We have taken away a belief in the intrinsic necessity of balancing the budget if not in every year, [then] in every short period of time. If Prime Minister Gladstone came back to life he would say “uh, oh what you have done” and James Buchanan argues in those terms. I have to say that I see merit in that view.”

After Lori Tarshis was pilloried as communist for writing a textbook true to Keynes, Samuelson stepped in and sanitized Keynes through the Keynesian-neoclassical synthesis that came to be known as "Keynesianism."

Fredrick Soddy was dismissed as a crank for presenting an accurate view of monetary economics showing how bankers were in control. Soddy was not an economist but a Nobel prize winning chemist working in the chemistry of radioactivity. But he had economic interest relative to policy. He was told to stick to his own field, even though some prominent economists learned a lot from his writings.

Now the push is on to dismiss MMT economists as bunch of cranks, too, now that they have emerged from marginalization due to the efforts of political activists and policy wonks rather than economists.

Same old, same old.
:

Jose Guilherme said...

Now the push is on to dismiss MMT economists as bunch of cranks, too

I think that's a misrepresentation of the situation.

Lavoie made some criticisms of MMT (btw, why should MMT - or any school of thought for that matter - be immune to criticism?); yet he also said that the neo chartalists get it essentially right. People who get it right aren't exactly what we'd call "cranks".

Warren's "Soft Currency Economics" was important

Lavoie certainly agrees:

The proponents of modern monetary theory have forced post-Keynesians to dwell into the details of the clearing and settlement system, and to take into consideration the role of government in the payment system, whereas before post-Keynesians had focused almost exclusively on the relationships between commercial banks and the central bank. Modern monetary theory is thus certainly an improvement...

I'd say that MMT can only gain by welcoming well-meaning criticims, such as those by Lavoie.

Tom Hickey said...

I don't think that was Lavoie's intention, but I think he is being interpreted that way, i.e., being represented at an opponent dismissive of MMT because he made some minor criticisms.

Jose Guilherme said...

I think he is being interpreted that way, i.e., being represented at an opponent dismissive of MMT because he made some minor criticisms

Would you say then, that people should abstain from making criticisms (incuding minor ones) of MMT, because there is the risk of said criticism being misinterpreted?

Tom Hickey said...

y, it's like arguing that govt debt is not debt. This is the way people in the field talk. It's a convention. Nominalism, if you will, that is not inherently connected with the reference. In banker-speak, loans on the asset side are "funded" by the liability side.

Unknown said...

"How can the govt's own liabilities "fund" its expenditures?"

(What I meant is: how can the govt get additional funds by receiving its own liabilities in payment?)

Unknown said...

(btw vimothy, when I said "gold" I was joking)

Tom Hickey said...

Would you say then, that people should abstain from making criticisms (incuding minor ones) of MMT, because there is the risk of said criticism being misinterpreted?

Not all. I can't speak for the MMT economists but they expect other economists to digest their work before they criticize straw men.

But the mainstream economists do much the same thing when they are criticized for not being in accord with reality. They say that models are never fully representational and we never claimed they were (except in policy formulation — wink, wink).

Tom Hickey said...

"How can the govt's own liabilities "fund" its expenditures?"

Because it has the tax power and can require its liabilities as sole payment vehicle for liabilities that imposes on non-govt by law (rules).

When you go to a casino, you have to get their liabilities to play because them's the rules.

It's all in who makes the rules and the power to enforce them.

Unknown said...
This comment has been removed by the author.
Jose Guilherme said...

How can the govt's own liabilities "fund" its expenditures?

How can the banks´own liabilities fund their assets? :)

More seriously: suppose the tsy account at the Fed has a zero balance.

That account is then credited with say $1 million in tax payments.

Tsy then spends said $1 million.

Would you accept it as normal that some people might think that taxes are "funding" govt spending?

Tom Hickey said...

Jose, it's intuitive that an asset (+rb from tax payments) "funds," in the sense of pays for, expenditure ( - rb to credit nongovt accounts). The + and - cancel in the Treasury books leaving a balance of zero in those accounts. So to say that taxes don't fund expenditure is counter-intuitive and needs explanation.

However in the case of bank loans the loan just sits on the LHS and the deposit on the RHS and there is no canceling of accounts unless the deposit is used to pay down the loan. So that is a different non-intuitive use of fund. So this needs explanation to non-bankers.

Jose Guilherme said...

So to say that taxes don't fund expenditure is counter-intuitive and needs explanation

Govt receives $1 in taxes and then proceeds to spend $1. Intuitively right, and according to Lavoie "really" right: taxes do fund govt spending.

A bank creates a loan to a third party and a deposit to the same third party; "out of nothing", both.

I'd say it's "intuitive" that the deposit (liability) is not "funding" the loan (asset) in this case.

Unknown said...
This comment has been removed by the author.
Tom Hickey said...

There's an asset on the Treasury book of tax liability in amount $X as a payable. That payable is cancelled by receipt of a tax payment equal to $X. Poof. Just like a loan being paid down.

Now Treasury as an asset of rb $X on its book that can be used to fund expenditure in amount $X.

Before tax Agent 1 had $X in a deposit account. After spending Agent 2 has a deposit of $X.

Before taxes the Treasury had zero rb and after spending has zero rb.

Unknown said...

"Govt receives $1 in taxes and then proceeds to spend $1."

govt receives its own $1 liability in payment of taxes, thereby "destroying" that liability. Govt receives zero "funds" from the tax payment.

Govt then spends $1 by issuing a new $1 liability, but can spend no more because it is prohibited from doing so by certain rules and conventions.

Unknown said...

"How can the banks´own liabilities fund their assets?"

the bank's liabilities are basically a means to acquire assets that they can not create, it seems to me.

Jose Guilherme said...

Liabilities (sources of funds) enable an entity to buy assets (use of funds). Therefore the use of the word "funding" to describe that situation.

But buying an asset does not enable an entity to get a liability. Assets do not "fund" liabilities. Funding travels (so to speak) from RHS to LHS - but not from RHS to LHS.

Except, that is, in the case of banks when they grant new loans: their loans (assets) fund their deposits (liabilities) and their deposits fund their loans. Causation runs both ways in this case.

Jose Guilherme said...

There's an asset on the Treasury book of tax liability in amount $X as a payable. That payable is cancelled by receipt of a tax payment equal to $X

No need to get payables into the picture.

Say that tsy needs $1 and decides to confiscate that $1 from your bank account. It calls that a "tax payment".

Before that tax receipt tsy could not spend (its account at the Fed was zero); now it can spend.

Therefore the $1 tax funded tsy's $1 expenditure.

Tom Hickey said...

What actually happen is that govt imposes a tax liability which it will only cancel by receiving its own liability. Obviously, that liability (tax credit) has to come from govt, since only govt issues its own liabilities, in this case cash or rb. So some with bank money has to get cash or use a bank as an intermediary, since only banks can get rb. Govt receives either cash at a payment office or else rb from the taxpayer's bank.

Cash payment is negligible and can be disregarded, since it is accounted for as rb. The Treasury account is marked in rb by the amount of taxes and that can then be transferred by to non-government to meet its liabilities to non-govt. Some of those involve transfer of assets to govt and some are transfer payments.

All this is reflected in the accounting. It is a mistake to think of rb as money thing like cash. The existence of rb is not real, but rather numbers that appear in different accounts according to accounting rules and institutional arrangements established by law and regulation.

The part I am not clear on is the relation of the bank's reserve account at the Fed and it's books that record transaction with non-govt. Are these separate books that just mirror each other (JKH) or is there a relationship between them. E.g. how do reserves as bank assets show up on the bank's books, and how does the accounting that involves reserves and bank money work?

Tom Hickey said...

No need to get payables into the picture.

The difficulty I have with leaving the payable out of the pictures is that one of the govt's greatest assets is left out of the picture, namely, to create tax liabilities. These are certainly assets of the state once created, comparable to loan creation by banks, which mirrors them. But banks cannot impose loans on the private sector the way that govt can impose taxes. Moreover, just a govt imposes the requirement to pay only in its liabilities so does the bank, which accepts only govt liabilities in payment of liabilities to it, i.e., cash at the window or rb in the interbank market.

One could say that circuitism sees the system from the POV of the banks and govt is either in the loop like a customer or else as an "exogenously mirror." whereas Chartalism sees everything in terms of govt with banks as delegated agents of govt handling risk management, using govt liabilties for payments.

Jose Guilherme said...

E.g. how do reserves as bank assets show up on the bank's books,

They show up as precisely that: "reserves at the central bank" on the asset side of the commercial bank A's balance sheet.

And as a liabilty on the NCB's books: deposits of Bank A.

When bank A transfers a deposit to bank B there is a credit to an asset account (minus reserves) and a debit to a liability account (minus deposit).

Of course, bank B shows a debit to an asset account (plus reserves) and a credit to a liability account (plus deposit).

Total bank deposits at the NCB don't change, so its books will simply debit bank A's deposits and credit bank B's deposit account.

Jose Guilherme said...

that one of the govt's greatest assets is left out of the picture

Government has the power to levy taxes precisely because it needs them to fund its expenditures.

To levy or not to levy is not an option. Government must levy if it wants to spend.

If it abdicated from the power to levy taxes government would have to resort to deficit spending - exclusively. It would have to be either a very small government or a larger government with an inflationary economy.

Imagine the U.S. govt. spending trillions without levying taxes: an inflationary nightmare would ensue.

Taxes destroy private sector spending so that the govt. may spend in its place. They channel resources from the private sector to the state.

This as as it should be: taxes exist to fund govt. expenditure.

Tom Hickey said...

OK. Thanks.

This is relevant to the circuitism v Chartalism debate. (Some) circuits state that govt uses bank money under the present system in the US. E.g. people pay taxes with bank created money.

Chartalists say, no, banks use govt money (bank reserves = rb + vault cash), since this is what they promise to deliver when they settle. Otherwise bank money is just entries on a bank's spreadsheet. E.g. one's deposit account is recored in bank money, but when one uses it either by withdrawing cash or drawing a check to deposit outside the bank, then the bank as agent has to supply the govt money to clear.

Tom Hickey said...

According to MMT, in theory govt could just issue money to spend without taxing.

But that would be problematic for two reasons. First, there would be no compelling reason to use it or demand for it without needing it for taxes, and secondly, there would be no way to control inflation by withdrawing money, too.

Jose Guilherme said...

Chartalists say, no, banks use govt money (bank reserves = rb + vault cash

Chartalists are right.

When the private sector pays taxes, this is what shows up on the commercial banks' balance sheets:

Minus reserves, minus private sector deposits.

And on the NCB's books:

Minus commercial bank deposits, plus tsy accounts.

So taxes are really paid with reserves (aka, base money or central bank money or govt. money).

Then the tsy spends back those reserves into the "real" economy.

Tom Hickey said...

This as as it should be: taxes exist to fund govt. expenditure.

MMT says govt money exists to transfer private resources to public use by purchasing these resources in markets (rather than just confiscating them as was often the case historically, but it was very unpopular). This clearly involves expenditure.

But govt could just issue the money and make it legal tender with refusal to accept it being a serious, even capital offense. Guaranteed it would be accepted since it would literally involve a "head tax." To keep your head you have to use the govt's money. In fact, this is the way it used to be at times historically.

Taxation is just a softer way of doing this. IN this sense taxes drive money.

I admit that this is not a pretty story, but it is where we stand at this time. People can make up pretty stories to the contrary, but that is the situation. Need to obtain the govt's money is not voluntary. And when just about everyone uses the govt's money, other media of exchange involves higher transaction costs so are not used much even if permitted.

Jose Guilherme said...

there would be no way to control inflation

Exactly.

So, in the real world govt. cannot just "issue money to spend without taxes".

IMO, MMTers should refrain from such bombastic comments because they only serve to undermine their credibility.

And it's difficult to understand the appeal of said statements among the MMT crowd. Taxes - just like money - are an expression of sovereignty. Why then is "money printing" cherished while taxing power is despised? Go figure...

Tom Hickey said...

according to MMT, controlling inflation is only part of the story and not the most important part either, which is getting the private sector to give up resources for govt money in markets where people want to acquire financial claims on resources priced in the unit of account determined by govt using the govt's money as the medium of exchange.

And I believe that MMT is right about this.

Whether than needs to be featured is another question. But it is a crucial part of a complete account. Otherwise it is just a feel good explanation.

Jose Guilherme said...

by purchasing these resources in markets (rather than just confiscating them

Or rather, by first confiscating (taxes) and then purchasing from markets with the previously confiscated resources.

Again, this is as it should be. Say the private sector wants to buy a thousand extra cars at $10,000 each. But the govt. needs those cars to help the victims of an earthquake. The govt. confiscates (taxes) the private sector and thus gets the $10 million needed to buy the cars from GM. Without causing inflation in the price of cars.

Confiscating is not a pretty sight, but then the world is not a pretty place either. "No taxation without representation" should help mitigate the more tyrannical and arbitrary aspects of the government's power to tax.

Tom Hickey said...

by first confiscating (taxes)

Taxation is different from confiscation and currency issuance is different from counterfeiting because both are undertaken iaw law passed in a democratically elected assembly. Equating them ignores the liberalization and democratization of society historically.

On the other hand, I see most of the monetary problems the US is facing as resulting from the diminishing govt power to tax the rich through the political process, since govt has effectively fallen into the hands of an oligarchy of wealth, power, and privilege similar to feudalism.

JK said...

Maybe someone can comment on my thoughts…

Here is why it seems to me that 'creating money' and 'destroying money' are reasonable conceptions for deficit spending:

For both situations, assume that the Fed performs the neccessary OMOs to maintain it's target FFR….

Situation #1: The Treasury obtains a balance in it's account before it spends. Here we can say the U.S. government 'borrows first, and spends second'

In this situation it seems that the U.S. government is redistrbuting money already in circulation.

Situation #2: The Treasury spends without obtaining a balance in it's account. Here we can say the U.S. government 'spends first, and borrows second'

In this situation it seems that the U.S. government is creating money and spending it into circulation.

My point: in both situations the 'economic effect' on the real economy is exactly the same. Clearly in situation #2 the U.S. government is creating money when it spends, but it's not so clear in situation #1. Yet, for all intents and purposes, they are the exact same thing, just don't in opposite order.

So why is unreasonable to call this money creation?

justaluckyfool said...

@Tom Hickey:"Taxation is different from confiscation and currency issuance is different from counterfeiting because both are undertaken (v)ia law passed in a democratically elected assembly.
Justaluckyfool says, "Making it legal does not change what it is.
Taxation is not 'per se' evil or bad when properly administered and it is necessary for the control of the quality and quantity of the currency. Also a great means for redistribution of the currency from the whole social group to sectors of the group.
As for issuance: (Quote Soddy), "It was recognized in Athens and Sparta ten centuries before the birth of Christ that one of the most vital prerogatives of the State was the sole right to issue money. How curious that the unique quality of this prerogative is only now
being re-discovered. The" money-power " which has been able to overshadow ostensibly responsible government, is not the power of the merely ultra-
rich, but is nothing more nor less than a new technique designed to create and destroy money by adding and withdrawing figures in bank ledgers, without the slightest concern for the interests of the community or the real role that money ought
to perform therein."
While "the people" slept on their rights and duty, counterfeiting by banks was pronounced as legal.
BUT EVEN MORE DUMB, "we the People" allow them to charge us compound interest on that counterfeit money. Get this,we repay them with "GOOD MONEY".
Justaluckyfool say, 'Beware Gresham's Law' !
In 2008 when the housing bubble was pricked, I ask, would the currency have collapsed if the
"BAD MONEY" issued by the TBTF banks was not backed up by "Good Money" from the Feds ? Would any other bank have accepted electronic transfers from the TBTF banks? Is this what is meant by "systemic failure" ?
Please help this fool with any profound answer.

Tom Hickey said...

In 2008 when the housing bubble was pricked, I ask, would the currency have collapsed if the
"BAD MONEY" issued by the TBTF banks was not backed up by "Good Money" from the Feds ? Would any other bank have accepted electronic transfers from the TBTF banks? Is this what is meant by "systemic failure" ?


The issue was interbank lending when most banks were technically insolvent or suspected to be. The banks would not lend to each other, so the payments system froze for lack of liquidity. Then the Fed stepped in by opening the discount window to all and instituting the many programs it did after that. That intervention kept the system going.

What would have happened otherwise. The TBTF would have been declared insolvent by regulators and by put into resolution after which they would have emerged with new ownership and new management like is supposed to happen in capitalism. Basically the govt did not follow the law because of cronyism according to knowledgeable critics like Bill Black.

justaluckyfool said...

Would that be a "YES"
Banks would not -lend to each other.
Translated: Would not accept their 'legally printed counterfeit'
and maybe even the 'Invisible Hand'
doesn't know how much that is. The Fed had to "print" $16 trillion, just to keep the doors open. (OCC.gov not only verifies the amount but names who got what).
So why do we not address this "known flaw" of American capitalism?
As Wm. Black and Michael Hudson prove over and over.
Why do you not wish prosperity for yourselves and your children?
"QE 4 The People" End issuance taxation by the private for profit banks (PFPB).

Jose Guilherme said...

@ Tom,

Would you say then, that people should abstain from making criticisms (incuding minor ones) of MMT, because there is the risk of said criticism being misinterpreted?

I thought you were going to answer my question :)

Jose Guilherme said...

@ Tom,

Would you say then, that people should abstain from making criticisms (incuding minor ones) of MMT, because there is the risk of said criticism being misinterpreted?

I thought you were going to answer my question :)

Tom Hickey said...

@ Jose

I did

"Not all. I can't speak for the MMT economists but they expect other economists to digest their work before they criticize straw men."

MMT economists have decided that their time is better spent than responding to criticism they see as frivolous. That included erecting straw men because the person criticizing either does understand the MMT position correctly, either for lack of economic chops or failure to do the research. Or else is trolling.

I suspect this why Warren shut down his comment section. To much time wasted dealing with frivolity. I notice that others shutting down their comments, too (Barry Ritholz) and others just flush many of the comments (DeLong).

justaluckyfool said...

@ ALL MMT advocates.
How do you expect to have people believe you are correct when you consider valid questions as frivolous and or simple ignore any questions?
Even believers have difficult defining what is MMT belief?
Will Wray, Mosler, and dozens of others agreed to the same answer?

1. Must a Monetary Sovereignty be the sole issuer of the sovereign currency?
2. A Monetary Sovereignty can issue all the currency that it needs or desires, but is constrained by moral hazard, or by its ability to control the quantity or quality of that currency?
3.Must all sovereign currency be fiat (as the actual value-goods and services are not per se electronically transferable)since the currency is merely a legal representation of all goods and services of the entire social group?
Can you get a definitive answer from 51% or more of believers, or even get a website where the questions can be asked?

Tom Hickey said...

Well, you should ask the MMT pros. Mosler is out the loop now that comments are shut down at his place, but the rest of the MMT economists blog at New Economic Perspectives.

1. Must a Monetary Sovereignty be the sole issuer of the sovereign currency?

Every sovereign govt is sovereign in its currency, unless it chooses to use another currency by treaty, as in the EZ, where the common currency is the euro, or by voluntary choice, e.g., Ecuador has chosen to use the USD as the unit of account and medium of exchange. Since the govt cannot issue the currency it gives up currency sovereignty for as long as that choice lasts.

Convertibility and fixed rates limit the capacity of the sovereign to control its currency, i.e., limit currency sovereignty. The govt accepts conditionality in the use of currency that limits currency sovereignty.

The currency sovereign can also delegate all or some of its authority to agents, such as an independent central bank that is privately own and to private commercial banks. when govts do this they usually maintain control through imposition of law and regulation. These choices of the sovereign are always reversible since sovereignty is absolute. As long as the govt maintains control over the currency its remains fully sovereign. To the degree it subjects itself to conditions, it limits sovereignty.

Govt may also decide to limit its sovereignty by allowing other money things to be used in payment of taxes. If it accepts other money things rather than its own currency in payment of taxes it has forfeited sovereignty as long as this lasts.

The choices the currency sovereign makes in this regard affect the policy space available to it. Limitations on sovereignty limit policy space.

2. A Monetary Sovereignty can issue all the currency that it needs or desires, but is constrained by moral hazard, or by its ability to control the quantity or quality of that currency?

The limitations on issuance are availability of real resources for purchase in the currency, price stability, and the fx rate.

3.Must all sovereign currency be fiat (as the actual value-goods and services are not per se electronically transferable)since the currency is merely a legal representation of all goods and services of the entire social group?

Everything but use of commodities, e.g., bullion weight, in exchange for commodities involves fiat, which means "let it be," e.g. if seigniorage is involved. So a government can declare a metal coin to be valued at face value instead of the value of the metal. IN this sense, "fiat" currency means any unit of account the government declares necessary that for payment of taxes of which it is the sole provider, although it can delegate this power to agents, such as a central bank, under terms that it controls.

Central banks are only independent to the degree that chooses and only for as long as govt chooses. For example, the Bank of England was privately owned until it was nationalized in 1946. But Britain still had a sovereign currency.

Generally speaking tho, "fiat currency" means currency that is not convertible into a real numeraire like gold or silver at a fixed rate of exchange, i.e., has no "real" (commodity) backing.

Tom Hickey said...

See Randy Wray, MMP BLOG #6: WHAT IS A SOVEREIGN CURRENCY?


Tom Hickey said...

BTW, it is interesting to note that in the US, the sovereign states agreed to limit their sovereignty when they joined the federation, which is different from limiting sovereignty by treaty. As sovereign state remains sovereign in making treaties and can withdraw from them as an exercise of sovereignty. However, as the Civil War showed, once sovereignty is limited by joining a federation it cannot be used to withdraw unilaterally.

The US Constitution, article 1, section 8, gives the "money power" to the federal legislative branch, while article 1, section 10 gives the states certain limited money powers.

justaluckyfool said...

@Tom Hickey, thanks for the reply.
I hope that this blog will continue to allow these post, and the questions and answers.
1.. Is a MS limited as to the amount of currency it can print?
Is your response,"The limitations on issuance are availability of real resources for purchase in the currency, price stability, and the fx rate." correct? It states there is a limitation?
Isn't that contrary to it MMT ?
2."Everything but use of commodities, e.g., bullion weight, in exchange for commodities involves fiat, which means "let it be," e.g. if seigniorage is involved. So a government can declare a metal coin to be valued at face value instead of the value of the metal." IF the MS 'declares its value' it is fiat currency and no longer a commodity since its value is now dependant upon redemption by the 'good faith and credit of the sovereignty.
Most important, after having read: MMP BLOG #6: WHAT IS A SOVEREIGN CURRENCY? one must go back to the question, Why are legitimate questions un anawered ?
Excerpt:

"The sovereign government, alone, has the power to determine which money of account it will recognize for official accounts (as discussed, it might choose to accept a foreign currency for some payments—but that is the sovereign’s prerogative). Further, modern sovereign governments, alone, are invested with the power to issue the currency denominated in its money of account.
If any entity other than the government tried to issue domestic currency (unless explicitly permitted to do so by government) it would be prosecuted as a counterfeiter, with severe penalties resulting.
Please note comments and questions .....unanswered.

Anonymous | July 13, 2011 at 10:48 am | Reply
"If any entity other than the government tried to issue domestic currency (unless explicitly permitted to do so by government) it would be prosecuted as a counterfeiter, with severe penalties resulting."Is the monetizing of private bank debt created on a ledger accounted for in the MMT model?My understanding is that banks issue checks denominated in the sovereign's currency by creating the money from nothing but the asset/liability basis of the debt instrument and the collateral, summing both together to zero on their account. This is a privilege granted by the sovereign government to a private entity which endangers economic stability. When money supply is diminished by saving during a recession by paying up debts, while at the same time issuance of new money is dependent upon the banks judgment that new borrowers have sufficient collateral and income to assure their profit, money supply becomes dependent upon these private banks. How is the seigniorage of a “trillion dollar coin” not issued through bank debt accounted for? Does MMT show a public benefit to treasury issued money, not passing through a private bank system, but spent directly into circulation?
...cont.

justaluckyfool said...

READ MORE: http://bit.ly/MlQWNs
**** “Believe nothing merely because you have been told it…But whatsoever, after due examination and analysis,you find to be kind, conducive to the good, the benefit,the welfare of all beings – that doctrine believe and cling to,and take it as your guide.”- Buddha

Tom Hickey said...

The limitations on issuance are availability of real resources for purchase in the currency, price stability, and the fx rate." correct? It states there is a limitation?
Isn't that contrary to it MMT ?


MMT describes the current monetary system in general and also special cases in the different jurisdiction that have modified the general case (base case) politically.

The general case is that that governments that are currency sovereign and exercise full currency sovereignty without political restraints that create special cases still operate under the real constraint of available resources. Obviously, the govt cannot purchase with its currency what is not for sale. It is must have it, then the alternative is doing without if it doesn't exist or confiscation or imminent domain if it does but the owner is unwilling to sell.

Governments that are full currency sovereigns in the sense that they do not impose political restriction on the exercise thereof still have to operate within the confines of acceptable levels of price stability and foreign exchange rates. So while in principle there is no absolute limitation on the size of a fiscal deficit a government can run, if the deficit exceeds non-govt saving desire at full employment, then deficit will result in inflation. Similarly, the exchange rate affects firms that export driven.

The MMT economists never said that that there are no operational constraints or politically imposed restraints. They have always set forth what these are.

Tom Hickey said...

My understanding is that banks issue checks denominated in the sovereign's currency by creating the money from nothing but the asset/liability basis of the debt instrument and the collateral, summing both together to zero on their account. This is a privilege granted by the sovereign government to a private entity which endangers economic stability. When money supply is diminished by saving during a recession by paying up debts, while at the same time issuance of new money is dependent upon the banks judgment that new borrowers have sufficient collateral and income to assure their profit, money supply becomes dependent upon these private banks.

Banks can only create credit. they cannot create currency. When currency is required for settlement, they have to obtain it from govt at the cost the govt sets, the interest rate, in the US the FFR.

IN the most general case or base case of non-convertible floating rate currency of which the govt is the sole provider, only govt issue money on it own terms. In such a case all transactions in the unit of account are conducted in the govt's money-thing. This is exogenous to non-govt. Credit can be created privately that is denominated in the unit of account, but not by banks as agents of govt with direct access to the currency issues, e.g. a central bank.


Under capitalism, however, govt delegates the power to create credit denominated in the govt's unit of account to banks, giving them access to the currency issuer for liquidity in settlement, and govts also agree to provide liquidity in the currency for final settlement. The govt can also delegate interest rate setting to the private sector as the UK opted for with Libor, which was set by the banks.

This arrangement of delegating money creation powr through bank credit creates the possibility of financial instability through imprudent extension and use of credit. Govts are supposed to limit this in the public interest through bank regulation but banks often evade this limitation as a result of moral hazard created by govt through special treatment like guarantees, explicit and implicit, as well as due to cronyism and corruption.

Money supply only becomes dependent on private banks to the degree that govt authorizes it and permits it. At any point govt can change the institutional arrangements (rules), even to the point of nationalizing banking.

Govt can also inject funds directly into non-govt through transfers, think Bush's sending everyone a Treasury check, and withdraw funds by taxes and levies.

Just as govt can delegate powers, it can change the rules and also take back the powers it delegates.

Historically the amount of control over credit money creation that govt delegates banks expands and contracts depending on circumstances. An expansionary phase led to the crisis and the US is now in a contractionary phase. Same thing happened leading up to the Great Depression and afterwards. It's cyclical as MInsky observed.

Tom Hickey said...

“Believe nothing merely because you have been told it…But whatsoever, after due examination and analysis,you find to be kind, conducive to the good, the benefit,the welfare of all beings – that doctrine believe and cling to,and take it as your guide.”- Buddha

"Question authority."

justaluckyfool said...

"Banks can only create credit. they cannot create currency."
I find this statement to be false.
If the TBTF banks had $36 trillion outstanding in residential and commercial real estate loans in 2007 and payment stopped coming in and the banks were forced to modify those loans at fair market value, say $29 trillion, would they have left $7 trillion in redeemed sovereign currency (base money)?
For when they 'loaned' the $36 trillion they clicked that amount into the accounts with a condition that "when used if would be legal tender". Please tell me who would borrow and pay interest on money that could not be spent?
As for the bank they use this "to be used money" to make a profit of double, even quadruple what they 'loan' Yes $36 trillion at av. 6% for av. 36 years allows them to appropriate $144 trillion from the people and get to use REAL BASE MONEY for their own special interest, maybe even to buy a government???

justaluckyfool said...

Where we went wrong:
While we were sleeping on our rights, we allowed private for profit banks to have legislation passed that allows the PFPB to 'print' temporary currency and to TAX that currency via compound interest. A scheme that must stop or it will allow the PFPB to "gain the entire wealth of the world" and still be owed servitude.
CHALLENGE, IMPROVE, POST !
"Justaluckyfool" (GOOGLE)

Tom Hickey said...

IN the US, currency is defined as coin minted by Treasury, Federal Reserve notes, and reserve balances at the Fed. Banks cannot issue any of these. They have to obtain them from the govt or from other banks that obtained them from the govt for final settlement, either in interbank settlement system operated by the Fed in which all transactions are in rb or at the window through cash withdrawal.

Bank money is a promise to settle in the government's money on demand, the fact that many intra and interbank transaction settle by netting notwithstanding.

Tom Hickey said...

All that you say about the extension of "forbearance" to the banks by the Fed as the govt's bank is true. Randy Wray and Bill Black have written extensively about this. Write it off to cronyism and corruption.

justaluckyfool said...

"Bank money is a promise to settle in the government's money on demand."
Yes and a loan from a bank is 'bank money ' given to a borrower who wishes to use that promise to be able to exchange for "goods and services"
IF the borrower doesn't pay back one cent after 'spending ' the loaned amount, DID or DID NOT that 'vertical' money become redeemed as 'horizontal ' money??
If the borrower pays the loan ('vertical' money) back in full,if interest were $16 trillion-good number to use since it is the debt via accumulated interest- DID or DID NOT that "vertical" money take away from the sovereignty the " horizontal ' money ($16 trillion)and give it to the PFPB ?
Oh well, like Wm Black says, "The best way to rob a bank is to own one."

justaluckyfool said...

" Write it off to cronyism and corruption."
Why would anyone wish to write off total servitude of the 99% by the 1%?
Why would anyone not..."after due examination and analysis,you find to be kind, conducive to the good, the benefit,the welfare of all beings – that doctrine believe and cling to,and take it as your guide.”- Buddha

Tom Hickey said...

IF the borrower doesn't pay back one cent after 'spending ' the loaned amount, DID or DID NOT that 'vertical' money become redeemed as 'horizontal ' money??


The bank loan creates a deposit (bank money). The borrower withdraws the amount of the loan in cash (which the bank got as vault cash from the Fed in exchange for reserve balance). The borrower spends the cash on goods and services, or blows it in the casino, whatever. The borrower then goes bankrupt with no assets to serve as collateral, so the loan is a total loss to the bank. The bank deducts the loan amount from assets and also from equity. The cash is still in circulation as a non-govt asset and govt liability. All books balance, and the bank's equity holders are poorer.

If the borrower pays the loan ('vertical' money) back in full,if interest were $16 trillion-good number to use since it is the debt via accumulated interest- DID or DID NOT that "vertical" money take away from the sovereignty the " horizontal ' money ($16 trillion)and give it to the PFPB ?

How does this diminish the sovereignty of the currency issuer who has chosen to use banks as agents in risk management, capable of extending credit that govt provides liquidity to settle? I don't see that horizontal and vertical affect sovereignty. The govt allows banks to leverage its money (HPM) through credit extension and to charge for assuming the credit risk. Thus the banks are agents of the govt to whom govt has delegated credit extension and the attendant risk, while remaining the sole provider of the currency. In doing this, govt also assumes risk, since it has to ultimately stand behind the system in case of market failure.

Tom Hickey said...

Why would anyone wish to write off total servitude of the 99% by the 1%?

Free people have essentially two recourses. First, to work through the electoral process toward the desired change. Secondly, if the state has been captured by a cohort to the degree that the electoral process has been subverted, then revolt is the only recourse that remains.