Outside the neoclassical realm, ‘endogenous money’ is not heterodox. A response to the ideas of Krugman.

From commenter Londoned:

Many years ago I was once in what was then Dillon’s university bookshop in Mallet Street, London, and looking at Kuhn’s book and Karl Popper walked up to where I was standing and noticed what I was reading and said: “Scientific revolutions my ass” and stormed off.

Paul Krugman takes up the challenge and criticizes ‘fringe economics’ or, as he calls it, ‘heterodox economics’. But the whole point is of course that outside of the realm of neoclassical economics, ‘fringe’ economics are not heterodox at all. Let’s take the ‘heterodox’ idea of endogenous money, which gives a much larger role to households and non-financial companies and banks and a smaller role to the central bank and the government when it comes to creating and defining money, liquidity and money-like means of payment. Spoiler: I do not even mention the trillions of Euro’s which were created to finance ever higher prices of existing houses, with these same ‘thin air’ prices as collateral…

A) The work of economic-historians is totally consistent with ‘endogenous money’, which gives a much larger role to households and non-financial companies when it comes to creating means of payment. To cite a recent article about this:

“Nevertheless, as the eighteenth century progressed the importance of credit in the daily functioning of the economy gradually diminished. More wages were paid in cash, retail purchases became increasingly impersonal and monetary, and the number of households possessing coins upon the time of death grew rapidly. The ascent of what Marx called the ‘cash nexus’ gradually diminished the immediate or obvious embeddedness of economic relations in the social structure of modern society” (W. Ryckbosch and E. Decreane (2014), ‘Household credit, social relations, and devotion in the early modern economy’, Tijdschrift voor sociale geschiedenis 11-1, pp. 1-28).

This idea of course also points to an important reason for the rise of banks (which, at least according to my data, in a province as rich and commercial as Friesland (part of the Netherlands) were next to non-existent as late as 1749, though the Leeuwarden orphanage was allowed to run a pawn shop): households shed their part of their financial and banking function to banks, which in the long run meant that ‘commercial credit’ (payables) provided by households was replaced by banknotes and deposit money. Households nowadays promise the banks instead of other households to pay back their mortgage and this collateral is kind of securitized by issuing deposit money. Important aside: in the olden days, commercial household contracts were always signed by both spouses, to hedge against mortality risk).

The Graeber book tells you more about this. It’s criticized for being less then accurate about Microsoft, but though I would have loved to add additional detail I could not find fault with his description of seventeenth and eighteenth century economies – and the quote above fits 100% into the Graeber thesis.

B) The real world is consistent with the idea of endogenous money. Household credit as a means of payment has become less important. But has far from disappeared. The as always splendid Frances Coppola about this (long quote, but as this is about conceptual issues it’s important to make the idea clear):

I am a bank.

Honest, I really am. This is not a joke.

You see, I lend people money. Or, more accurately, I allow them to run lines of credit, which I create for them out of thin air.

Let me explain. My day job is teaching singing, much of it to teenagers in secondary schools. These teenagers’ lessons are paid for by their parents. I invoice them for 10 lessons at a time and they are supposed to pay for the whole series of lessons before the series starts.

In practice, hardly anyone does. About half will have paid by the 5th lesson and the remainder have to be chased. The vast majority do pay by the end of the series of lessons, but there are a small minority who have to be cajoled, threatened or even sued. Some negotiate with me for payment in instalments and then forget to make those payments.

No doubt because of their own financial difficulties, the proportion of people who pay late is rising, as is the proportion of people who don’t pay at all. In the last year I have sued two people at the County Court for non-payment of fees, one of whom didn’t reply and has had default judgement served against them – but I still haven’t been paid. The other has offered to pay off the fees and associated charges at £20 per month, which is all she reckons she can afford…..but if that is true then she couldn’t afford the lessons in the first place, because the fees for 10 lessons between January and March were £135. In effect she is expecting me to extend her an interest-free loan.

But she is not the only one. In fact every single one of the parents who pays late is effectively expecting me to lend them the money to pay my fees.

Which is why I say I am a bank. But unlike a normal bank, I am expected to lend to them interest-free – parents get very angry if I start imposing interest on late payments, although the law does allow me to do this and even recommends a rate. If I upset parents, they may take their business elsewhere – and student numbers are falling at the moment because poorer parents are finding it difficult to maintain their childrens’ musical activities at the moment. So I could end up even worse off if I insist that parents have to pay up front.

I am by no means alone in this. Most small businesses are forced to extend lines of credit interest-free to customers, particularly large and rich ones who have the leverage to squeeze them out of business if they complain. Most small businesses, therefore, are unofficially acting as banks

Read the whole thing.

C) The idea of endogenous money is consistent with manuals on monetary statistics which, using the ‘quadruple accounting method’ (your debt is my asset)  explain how money is measured. Here, an ECB example. The monthly press release of the ECB is in fact consistent with ‘endogenous money’ idea. ‘Quadruple accounting’ is supposed to be ‘Post Keynesian’. Help. It is just basic, plain accounting, this most basic,  method of keeping track of debts. It’s not the problem of the heterodox that neoclassicals did not master this. The idea that ‘credit’ is in fact a very complicated and tangled net between ‘agents’ which does not only define the relation between these agents but also affects their ‘reputation’ and therewith the agents themselves may be somewhat disturbing to the world of freely floating neoclassical atomicons – but again, that’s not the problem of the so called ‘heterodox’.

D) The idea of endogenous money is consistent with the national accounts. Below, a graph which shows that, in the Netherlands, the ‘stock’ (i.e. the balance sheet value) of commercial credit (post F71 in these accounts) has become less important but still is as large as the total amount of m-2 money… The decline has probably something to do with lower real interest rates. But that’s not the point. Commercial credit is a legal means of payment (when you buy something using credit you can sell it again, well, unless it’s a singing lesson of course but even then you can use the power of the state to enforce contracts). Caveat: the Eurostat data show that there are very large differences between countries, which makes one doubt the data a little.

E) From the comments: a 2002 quote from a book by Paul Davidson (here hoisted from the comments), which again stresses the creativity and activity of households and companies (as well as the associated risks)

“Recent trends in the growth of mutual funds and other nonbank financial intermediaries have encouraged saver households to reallocate their saving portfolio from holding less (government insured) bank deposits toward holding more liabilities of non- bank financial intermediaries. This has permitted a significant expansion of debt obligations on the part of debtor households and enterprises. This suggests that a sudden switch by many households to a fast exit strategy at a future date could cause a horrific liquidity problem, unless the central bank is alert to the need of pouring as much liquidity into the system as needed, quickly and promptly into the system. The experiences of October 1987 and September2001, suggests that the Federal Reserve bank has, on an unsystematic ad hoc basis responded adequately to individual financial market liquidity crisis. It is not clear that the central banks of other nations or currency unions will respond similarly, or that the Federal Reserve might fail to respond adequately in some future crisis. It does suggest that a more systematic response to such liquidity experiences should be built into the organization of central banks.”

Many years ago, Angus Maddison told us how, when he attended a Karl Popper class in Cambridge, Ludwig Wittgenstein dropped in and the two fellow Austrians started a heated argument about the ‘essence’ of a particular chair. Ifter quite some time, they called the janitor and asked him ‘is this a chair or isn’t it’?! And the Janitor looked at them and answered: “it all depends”.

Exit Popper.