Sunday, June 2, 2013

Paul Meli — Does Credit Drive the Economy?

Much of the commentary on the economy seems to assume that it is driven by credit. The statement often made in blogs and news articles is that 90% or more of the money in circulation is private debt, the rest coming through net government spending, so clearly credit (debt) must be the main driver of the system. It's obvious. A caveman could see it.
I believe this is a gross mischaracterization of how the system actually functions.
Where do these claims regarding credit domination of the system come from? Is it truth or fiction. From what I had seen it was nothing more than an article of faith, I had never come across any proof or support that this was actually the case.
Based on the claims, the "money supply" people must be alluding to is the supply of dollars in existence within the domestic non-government. This is pretty simple number to figure out…
The View From Mars
Does Credit Drive the Economy?
Paul Meli

38 comments:

Detroit Dan said...

This would seem to contradict Cullen Roche's thesis, so often presented at pragcap.com...

Detroit Dan said...

(email follow up comments)

Clonal said...

Paul has forgotten all about taxation. Net money creation by government = Expenditures - taxation.

Accumulated deficits are directly analogous to TCMDO. Government debt is government created money, and the remaining is bank created money

Unknown said...

"The total level of state money in the private economy should be equal to all public spending plus all private debt outstanding less federal taxes and net exports".

Are you defining private debt as state money?

'net exports' basically means debts of foreigners, either public or private, which could be denominated in the domestic currency, thus included as part of 'private debt outstanding', no?

Dan Kervick said...

I couldn't follow that piece at all. I mean, I couldn't even figure out what question he was trying to answer.

Unknown said...

"Why do we need FYGDPUB? Because TCMDO includes public debt, which we must subtract to get to the total private debt"

How do you know TCMDO includes public debt?

Unknown said...

Paul, you seem to be equating 'spending' with 'money supply'.

An increase in govt spending doesn't necessarily equal an increase in the money supply. Nor does an increase private debt necessarily mean an increase in the money supply.

Dan Kervick said...
This comment has been removed by the author.
Dan Kervick said...

Right. How can you draw any conclusions about stocks from sums that include flows?

Matt Franko said...

Clonal,

"Net money creation by government = Expenditures - taxation."

Where is that information published?

Are you talking about "G-T"?

rsp,

paul meli said...

"How can you draw any conclusions about stocks from sums that include flows?" - Dan

A stock is a sum of flows.

A stock has no existence until flows from somewhere accumulate to one…like the balance in your checking account.

The beginning balance of any stock in existence was zero at it's beginning, whenever that was.

You start with nothing and deposits (flows) less withdrawals (flows )accumulate to your checkbook balance. The balance is a stock.

The balance of dollars in the non-government is exactly like your checking account…equal to the deposits made by gross government spending (flow) plus spending as a result of borrowing (flow), less federal taxes (flow) and net exports (flow).

What's left is a stock…TCMDO plus some amount of net dollars that were printed without any issuance of bonds.

paul meli said...

"Paul has forgotten all about taxation. Net money creation by government = Expenditures - taxation." - Clonal

No, I mentioned taxation in the post…taxation affects the balance of the stock, not the ratio of the sources.

When someone says that 90% of the money in the economy comes from private debt, they are making the leap that taxes apply only to income from public spending, not to income from private borrowing.

That is an absurd argument, logically and mathematically.

The ratio of the sources of the stock to each other or the total are unrleated to the final level.

If you pour (spend) water (money) into a container from two separate sources at different rates, the total amount is made up of the parts.

Subsequent removal (taxation) of water (money) from the container does not have any bearing on the rate at which they were added.

Taxes apply proportionately to income that results from total spending over the period…the dollars from public spending and private borrowing are indistinguishable from each other.

paul meli said...

"Are you defining private debt as state money?" - y

It is state money. Go to the bank, borrow some money and read what is written on any of the bills they hand you when you take some cash.

"How do you know TCMDO includes public debt?" - y

from Z.1 Table L.1 Credit Market Debt Outstanding page 64 line 7:

https://dl.dropboxusercontent.com/u/33741/z1%20120612.pdf

Matt Franko said...

How many miles one has driven (a stock) can be computed by taking the integer of the rate of velocity (a flow) from t1 to t2...

Paul,

Economists seem to want to net out the govts position by subtracting taxes away from total govt spending in a given time period...

Why do they want to take the taxes away from the govts position rather than the banks position? Does this make sense?

If govt credits the bank account of a low income SS recipient, that is probably not even a taxable event...

While loan origination often carries direct Federal fees... seems to me they should subtract the taxes from the banks position...

Also, that FGEXPEND looks like it is understating reality by about 500B per year...

look at the year end DTS data and take total withdrawals minus Treasury Security redemptions and this number has been typically over $4T while that FGEXPEND has been running at around $3.8T per year... something is wrong with the data there looks like...

rsp,

Matt Franko said...
This comment has been removed by the author.
paul meli said...

"Paul, you seem to be equating 'spending' with 'money supply'. - y

Spending is where money comes from…at least that is how it gets into the non-government…the only way. There haven't been any helicopter drops or immaculate receptions in economic history.

Spending in state money at the point of entry to the non-government comes directly from public spending and credit (private debt) expansion. That's it…there are no other sources. The total of all the flows over history is the maximum amount (number, level) possible less federal taxation and net exports.

If it wasn't for those two sources there would be no state money in existence.That is the spending I have accounted for in this post.

"An increase in govt spending doesn't necessarily equal an increase in the money supply. Nor does an increase private debt necessarily mean an increase in the money supply" - y

y, when people talk about the money supply, and say that 90% of it is a result of credit, they are making the implicit statement (whether they know it or not) that the stock of dollars within the non-government came from the spending of money borrowed from banks and from money the government spends.

This post addresses that implicit statement.

I have presented the totals since 1970, which accounts for 99.99% of all the money that has ever been spent into the economy over history.

This is the only money supply that has any economic meaning to those of us that are the users of the currency, and it is equal to the penny to the total of all dollar balances on balance sheets in the non-government, without subtracting dollar liabilities.

We can't use the money supply that is commonly discussed in economics…that money supply is an accounting abstraction and those numbers don't exist on any balance sheets on the non-government side of the ledger.

paul meli said...

"Also, that FGEXPEND looks like it is understating reality by about 500B per year…" Matt

I don't doubt it…it's hard to weed out the subtle differences between all of the series available.

Of course, if this is true then the ratios I've presented are also understated and private debt accounts for even less of the total.

"Economists seem to want to net out the govts position by subtracting taxes away from total govt spending in a given time period...

Why do they want to take the taxes away from the govts position rather than the banks position? Does this make sense?" - Matt

I don't think there is any interest in making these data easy to understand.

I believe this confusion and obfuscation of what is actually a cave-man-simple system is a feature, not a bug to the powereful elites in charge of it.

This level of accounting and number-crunching in this post could be done with an abacus.

Ryan Harris said...
This comment has been removed by the author.
paul meli said...

"This would seem to contradict Cullen Roche's thesis, so often presented at pragcap.com…" Detroit Dan

Dan, listen to the data, the analysis, and most of all yourself, not the man.

That includes me…I'm not asking anyone to take my word for anything. I'm also not presenting an opinion…my work is there for everyone to see.

The analysis required nothing more than simple arithmetic and simple logic…comparable to what average people do with their checkbooks every day.

It's no more complicated than that,

Dan Kervick said...

A stock is a sum of flows.

No, it's not at all Paul.

Suppose some bank, business, household, or even a whole sector has an inflow of $X in financial assets during a given time period and an outflow of $Y during that time period. Then the net change to its stock of financial assets is $(X-Y).

What can we conclude about the size of its stock of financial assets? Nothing. We only know that it changed by the amount X-Y from the beginning of the period to the end of the period.

If X is $200 and Y is $100 during then there is a net inflow of $100 during that time period. If the initial stock of assets was $1000, then the final stock of assets is $1100. But if the initial stock of assets was $100,000, then the final stock of assets is $100,100.

No conclusions at all can be derived about the size of the stock of assets from information about flows alone.

Dan Kervick said...

We shouldn't confuse the private sector's money supply with the net financial assets of the private sector. If banks expand their balance sheets and make a massive pile of new loans, then the money supply will grow. But the net financial assets of the private sector need not change at all. It's even logically possible for them to decrease.

Suppose total commercial bank deposits is $3 trillion, and the total amount owed by depositors to banks is $3.5 trillion. And suppose total reserve balances are $1.5 trillion, and total amount owed by commercial banks to the Fed is $1.75 trillion. (And suppose for the sake of simplicity there there is no paper currency and there are no government securities.) Then we have:

- Depositor assets: $3 trillion

- Depositor liabilities: $3.5 trillion

Net: = -$0.5 trillion


- Commercial bank loan assets: $3.5 trillion

- Commercial bank deposit liabilities: $3 trillion

- Commercial bank reserve assets: $1.5 trillion

- Commercial bank liabilities to the Fed: $1.75 trillion

Net: + $0.25 trillion


- Fed assets: $1.75 trillion

- Fed liabilities: $1.5 trillion

Net: + $0.25 trillion


The net financial assets of the private sector are equal to the sum of the first two categories, and so are minus $0.25 trillion. But the money supply is $3 trillion, the balance in the deposit accounts.

(cont.)

Matt Franko said...

Dan,

Looks like Paul thinks he has about 99.9% of it covered from t1=1970 to t2=2013....

These are the types of judgements often made to simplify things to make them useful/simpler...

BTW, this FGEXPND is imo probably a pretty good barometer of 'Public Enterprise' .... Rsp

Dan Kervick said...

(cont.)

Now suppose the commercial banking sector expands its lending so that both its deposit liabilities and loan assets grow by 100%. And suppose it funds its increased need for reserve balances entirely by discount window borrowing so that its total reserves and its total debt to the Fed also grows by 100%. Then we have:


- Depositor assets: $6 trillion

- Depositor liabilities: $7 trillion

Net: = -$1 trillion


- Commercial bank loan assets: $7 trillion

- Commercial bank deposit liabilities: $6 trillion

- Commercial bank reserve assets: $3 trillion

- Commercial bank liabilities to the Fed: $3.5 trillion

Net: + $0.5 trillion


- Fed assets: $3.5 trillion

- Fed liabilities: $3 trillion

Net: + $0.5 trillion

The net financial assets of the private sector are now still equal to the sum of the first two categories, and so are minus $0.5 trillion, twice as large as before. But the money supply has grown to $6 trillion.

The money supply is not the stock of net financial assets.

This is a pretty crude model, one in which the government sector consists entirely of a central bank, and in which there is no government spending, no taxation and no government debt issuance, and in which the entire impact of the government sector on the private sector is due to discount window lending needed to accommodate private sector lending. But it at least illustrates the logical point that the money supply is a completely different concept than that of the net financial assets of the private sector, and that it is logically possible for the former to grow even while the latter declines.

Detroit Dan said...

I haven't had a chance to catch up with all of Dan K's comments here, but it seems to me that Paul has an ingenious insight here; i.e.

In terms of new money (purchasing power) creation, gross government expenditures should be compared to net private credit, since taxes come out of all money equally. This is huge in terms of the implications...

paul meli said...

"A stock is a sum of flows.

No, it's not at all Paul."

Dan, yes it is. Mathematically, accounting-wise and logically.

Another word for stock is balance, as in your checkbook balance. It goes up and down in response to flows in and out, but the balance is always a stock. Yor checkbook balance is equal to the sum of all flows into and out of it, accounting for sign, ie debits and credits. Your balance is a stock. A stock is a number representing a total at some point in time.

Examining stocks is not particularly important in economics…economies respond only to flows, but understanding what stocks are is fundamental to understanding flows…and people think stocks are important…stocks represent their savings…or lack of.

If there are no stocks (of money) then flow is not possible.

"What can we conclude about the size of its stock of financial assets? Nothing. We only know that it changed by the amount X-Y from the beginning of the period to the end of the period."

Every account (in accounting) has a beginning balance…a stock measured in dollars, so it's a number.

The stock can be zero. If it's negative you have real problems.

If ($X-$Y) is positive, the beginning balance will be increased by that amount. The stock will have a new balance.

If ($X-$Y) is negative, the beginning balance will be decreased by that amount. The stock will have a new balance…unless ($X-$Y) is greater than the beginning balance…in which case you will be overdrawn.

Look at it this way…

Public spending and private debt issuance fills the economy just as two water hoses fill a swimming pool with water…

The level in the pool is the stock, the water coming from the hoses the flows…

BTW, the public spending hose provides 60% of the water filling the pool, the private debt hose 40%.

As the hoses fill the pool the level is constantly changing…but it is still a stock.

The pool has a drain also…it lets water leak out, another flow. It's a leakage or potential leakage.

The drains in the economy are taxation and net exports, but there are also behaviors that are functionally equivalent to those drains…leakages…ie savings desires or hoarding.

Dan Kervick said...

Paul,

It seems to me that you have completely changed your position now. All you are saying now is the obvious point that the change in some agent's stocks during some time period is equal to the sum of all flows in and out for that agent during that time period. But it doesn't at all follow from that the stock is itself the sum of the flows.

paul meli said...

"We shouldn't confuse the private sector's money supply with the net financial assets of the private sector. If banks expand their balance sheets and make a massive pile of new loans, then the money supply will grow." - Dan

Dan, I didn't make any claims about the level of net financial assets in the economy.

The point of the post was to demonstrate that of all of the dollars, physical or electronic, that exist on balance sheets in the domestic non-government, 60% of them were put there by public spending and 40% by private debt since 1970.

That accounts for 99.99% of the dollars in existence, with no reference to liabilities craeted by debt, as it is not relevant to the discussion.

Those dollars exist as entries on private-sector balance sheets, and nothing can change these numbers without some external action (spending from thin air, taxation or net exports).

I specifically stated that the money supply I was referencing was the one implied by the statement "90% of the money supply is from credit".

That claim was the basis of the post.

paul meli said...

"But it doesn't at all follow from that the stock is itself the sum of the flows." - Dan

Of course it follows from that…from where does a stock originate?

Stocks of state money did not suddenly appear in the economy…someone put them there.

The first one was a flow. The first stock was equal to the sum of the first flow with zero. That became the beginning balance.

Every rise or fall of a stock of state money from that point forward has been the result of flows being added or subtracted to that beginning balance (for individual transactions and in the aggregate).

That looks like a sum of flows (positive or negative) to me.

This is an example of a closed system or circuit.

Tom Hickey said...

Think of it in terms of accounting. The balance sheet records stocks, and the income statement and flow of funds (sources and uses) record flows.

Flows that affect equity on the balance sheet, that is, that result in profit (loss) are recorded on the income statement, while flows that only reflect changes in composition are recorded on the flow of funds statement.

These statements give a complete picture of stock-flow consistency.

Dan Kervick said...

OK, since I don't follow the discussions at PC maybe I just have little idea where you guys are coming from.

Anyway, I see now that what you are doing is computing a running total of flows over time, and then adding those running totals per year to a stock of debt in that year, rather than adding the stock to the flows themselves.

Ramanan said...

The post desperately attempts to prove something that is not.

Private Expenditure plus net exports is far in excess of government expenditure in any quarter or year.

That is not to take away the importance of the government and it is silly to say that since one is greater than the other (either comparing stocks or flows), it is superior etc. Silly ways to argue.

In other words, Keynesianism rules.

Finally it is fiscal policy which guides economies except in recent times led by private debt creation.

But back to the post:

"…The total level of state money in the private economy should be equal to all public spending plus all private debt outstanding less federal taxes and net exports."

It is better to use standard terminology rather than coming up with own definitions and make anything equal to anything else.

Matt Franko said...

"It is better to use standard terminology"

The Academe of Economics has major problems imo Ramanan... they follow "the deficit" (which is less than even 'rear view mirror driving'),

And talk about 'terminology', they use metonymy all the time instead of precise terminology: see the use of the word "money"... (Wray wrote a book "Understanding Modern Money": he is finished right at the title, read no further...)

and false metaphor all the time: see "printing" from Nobel Prize Krugman...

"The words "metonymy" and "metonym" come from the Greek: μετωνυμία, metōnymía, "a change of name", from μετά, metá, "after, beyond" and -ωνυμία, -ōnymía, a suffix used to name figures of speech, from ὄνῠμα, ónyma or ὄνομα, ónoma, "name."[4] Metonymy also may be instructively contrasted with metaphor.[5] Both figures involve the substitution of one term for another. In metaphor, this substitution is based on some specific similarity, whereas, in metonymy, the substitution is based on some understood association (contiguity)."

http://en.wikipedia.org/wiki/Metonymy

The academe of economics is a haven of chaos....

Somebody has to start to come up with models/terminology accurately depicting what is really going on... it will not be the academe of economics... ALL corrupt.

rsp,

paul meli said...

"The post desperately attempts to prove something that is not.

Private Expenditure plus net exports is far in excess of government expenditure in any quarter or year. "

Private expenditure is not a part of the equation...

We're talking about the ratio of the sources of dollars spent into the economy from thin air.

Private expenditure and net exports are uses of this money.

Neither has any bearing on the topic.

Detroit Dan said...

Paul-- Again, this is excellent and has very important implications with regard to MMT and macroeconomics in general.

Money created by private debt is subject to taxation and repayment. Money created by government spending is subject to taxation but not repayment.

It seems that Cullen Roche has taken Monetary Realism off course. It will be interesting to see how he addresses this...

Matt Franko said...

Lets say that govt reimburses a non-profit health care system for Medicare claims for $1M.

This is not a taxable event.

At the same time, lets say two hedge funds using bank credit trade against each other and the one fund "wins" the trade.

This IS a taxable event for the "winning" fund... say the taxes due are $500k...

But then, economists will say that the govt "only spent 500K" because the Hedge fund paid taxes while the non-profit health care provider which was the direct recipient of the govt spending didnt pay any taxes on the govt spending... meanwhile the two events are unrelated....

So economists will say the govt only spent 500k while in fact they spent 1M....

So this type of thing doesnt make sense to me...

rsp,

paul meli said...

"the non-profit health care provider which was the direct recipient of the govt spending didnt pay any taxes on the govt spending… "

Well, taxes are paid on income that results from the govt. spending…

The non-profit likely had employees that received wages and paid taxes…

They bought stuff that created income for others and they paid taxes…

The non-profits vendors are likely not non-profit, so they paid taxes and so on.

This dynamic continues until the spending dissipates like ripples in a pond to saving.

This should be another example of why deficits are not under our control…uncertainty.

If we stop spending we end up with another kind of deficit…a deficit of life-support.

paul meli said...

Detroit Dan,

Your observation re taxation/repayment is is an important distinction...something I hadn't thought of.

Detroit Dan said...

Thanks.

The implication is that government spending (not deficits) and private credit creation are of roughly equal impact in year one, with both injecting new income and purchasing power into the economy and both being subject to taxation. But private credit creation is a drag in subsequent years as the loans are repaid.

We are now in our 7th year of monetary policy which attempts to stimulate the economy by reducing government interest payments and thereby encouraging private credit creation. The current year effects are likely overwhelmed by the contractionary effects from the past six years of implementing this policy.

The cumulative effect of six years of lower government interest payments is that government spending on interest has been greatly reduced in the current year(deflationary).

In addition, loans that were enabled by lower interest rates in the past 6 years have borrowed from the future in a cash-for-clunkers type manner. Many loans would have eventually been made anyway, but were made more attractive sooner because of the lower rates. So there are fewer low hanging fruit today in terms of loans, and the pay back of the loans from previous years is a powerful contractionary force.

Still, stock markets rise on the prospect of further "central bank stimulus", heedless of the fact that such "stimulus" is contractionary beyond the current year.

And the data seem to confirm this logical view, as disinflation proceeds apace and GDP growth has stalled. But this has been going on for years, the bulls argue, and the stock market keeps going up and we haven't slipped into recession. What is new this year is dramatic fiscal tightening.

It's a recipe for another perfect storm, as stock prices climb while the underlying economy stagnates. When the stock market falls back in line with the underlying economic fundamentals, then the very real and substantial wealth effect will go into reverse. At that point, there will be an opportunity for significant political change...