Tyler Cowen is flat out wrong about the nature of fiat money
On his Marginal Revolution blog Tyler Cowen states:
High debt means higher payments to banks and other intermediaries, and so that money need not disappear from the stream of aggregate demand. Investment is AD too, and more generally AD theories based on short-term changes in the distribution of wealth have not generally succeeded in the past (with apologies to Michael Kalecki). It is true that wealth redistribution will induce sectoral reallocations, perhaps significant ones, but then a debt-collapse theory requires a lot of the predictions of sectoral shift theories. At least for the recent crisis that is not obviously going to do the trick, even if sectoral shifts have been underrated by a lot of Keynesian commentators
That’s vaguely right when you’ve borrowed from a pension fund or your dad.
That’s flat-out wrong when you’ve borrowed from an MFI, a ‘Monetary financial Institution’ or a bank with a government license to create money. To be precise: with a licence to create money with an implicit 1:1 exchange rate with legal tender as you can use it to pay your taxes or to buy paper money at this rate and as the law stipulates that this money can be used at a 1:1 rate to pay down all Euro nominated debts – Euro’s created by Deutsche Bank can be used to pay down debt owed to Banco Santander or to Bol.com at a 1:1 rate.
When you pay back your debt to an MFI the asset side as well as the liability side of the balance sheet shrinks with the same amount as respectively the liability side and the asset side of the household or company which pays back the debt. And the money has gone – into thin air. In the case of a pension fund, however, only the composition of the asset side changes as ‘debt’ assets are changed for ‘money’ assets.
Normally, this enables the bank to lend more as it has a ‘shorter’ balance sheet. In times of balance sheet recessions and deleveraging, however, households and firms want to borrow less. And banks want to lend less. And the government imposes stricter rules (no 120% but ‘only’ 105% ltv ratio mortgages in the Netherlands for instance…). Which means that the bank does not lend more which means that the decline of the amount of money is not compensated by new loans. The amount of money decreases. The money does disappear from the stream of aggregate demand. To be more precise: it does disappear from the MFI balance sheets which has a negative influence on the flow of funds which has a negative influence on aggregate demand, remember that final expenditure is only part of the flow of funds, another part consists of expenditure with, to use Keynes his phrase, a ‘zero elasticity of production’ as it does not lead to the production of new goods and services.
In the case of the pension fund, the pension fund will however invest this money in something, be it in real investments with a positive elasticity of production (which i.e. leads to higher aggregate demand) or in financial investments, like German Bunds (which i.e. does not lead to higher aggregate demand, or only veryvery indirectly).
Loanable funds is out, endogenous money is in.
And quadruple entry accounting is in, too.
And real, ‘final demand’ investments are not the same thing as financial, ‘zero elasticity of production’ investments. Building a road is not the same thing as buying 2013 Vatican stamps. Or Bunds.
But maybe I misread Tyler Cown. I mean, he wrote: ‘that money need not disappear’ (emphasis added). Maybe he was just writing about pension funds and other non-MFI financial institutions.
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Loanable funds are not out Merijn. I know non-bank lenders who are lending millions of dollars in existing money. In fact all bank depositors are lending existing money created as some borrower’s debt. 75% of all money in the USA is twice-lent in normal times and went up to 81% at the Crash. Given that the evidence corroborates my theory of causation, you’d think economists would be interested, because it totally explains the growth imperative and THE CRASH.
http://paulgrignon.netfirms.com/MoneyasDebt/MAD2014/problem5.htm
First the money is created as a borrower’s debt to a bank, endogenous money. It is spent, and then lent to a bank as a deposit. If it stays deposited (loanable funds) how will the original borrower pay off his debt? Only with the Principal of another loan. Now we have more than one loan dependent on the same Principal.
Any reduction in new borrowing from banks will cause some mortgage payer to lose their house strictly by the DESIGN OF THE MONEY SYSTEM. I do wish someone would try to refute this argument, instead of ignoring it, you especially, given that it was you who invited me to publish my analysis at the WEA.
http://peemconference2013.worldeconomicsassociation.org/?paper=proposed-new-metric-the-perpetual-debt-level
In fact all bank depositors are lending existing money created as some borrower’s debt. Paul Grignon
No. Existing money equals reserve deposits at the Fed, vault cash, and coins and Federal Reserve Notes in circulation. Otoh, all deposits are CLAIMS on a bank’s reserve deposits and vault cash regardless of whether a depositor got a bank loan or deposited fiat. Loans do create deposits but those deposits (all deposits) are CLAIMS to fiat.
What I mean by “existing money” is what you and I have in our bank accounts. It was created by someone borrowing it into existence. Now we have lent it to our banks. It is the same Principal owed simultaneously to two lenders.
“Banks can create as much money as we can borrow” is the line from my first movie. (2006)
The creation of money is limited only by the Basel Accord Capital Adequacy Requirements. The requirements are 8% general, 4% secured by real estate, 0 for national government debt, the zero requirement being the one that makes the movie statement true.
Central banks create the aggregate reserves as needed.
“In other words, at all times, when banks ask for reserves, the central bank obliges. Reserves therefore impose no constraint. The deposit multiplier is simply, in the words of
Kydland and Prescott (1990), a myth. And because of this, private banks are almost fully in control of the money creation process.”
IMF Working Paper, The Chicago Plan Revisited,
Jaromir Benes and Michael Kumhof
pg. 11 http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf
What I mean by “existing money” is what you and I have in our bank accounts. PG
Yes, I gathered that yet the distintion between fiat and bank credit is an important one since we shall always have government. But banks? I sincerely hope not! At least not to any significant extent.
It was created by someone borrowing it into existence. PG
The monetary sovereign spends fiat into existence and that fiat ends up in bank reserves accounts at the Fed (or as physical cash) without any necessary borrowing.
Bottom line: Monetary financial institutions can participate in the central bank’s fractional reserve lending in support of a fiat currency, while other institutions cannot. I think I got it.
See the reply to F. Beard.
“The deposit multiplier is simply, in the words of
Kydland and Prescott (1990), a myth”
There is no difference between bank lending, pension fund lending, lending chits that represent money in a vault, lending gold coins, or your dad pulling some money out of his mattress and lending it to someone. Lending is lending.
It does not create money but velocity. Velocity is one of the factors of the M x V = Q x P.
M x V is the imaginary side of the equation and Q x P is reality. Care must be taken when modeling reality with an imaginary system.
Lending simply moves money that would otherwise be parked somewhere.
The money does not cease to exist when payed back, it just stops moving and goes home.
Fractional reserve is not a magic way to create money. It is simply a way to co-ordinate lending between multiple banks so that ones excess does not reflect on the other banks.
I am not talking about Central Bank lending where they fake book keeping entries and lend the imaginary money it to their cohorts.
That is another matter.
In the case of MFI’s – it does cease to exist. MFI-banks do not lend out their reserves. They create new money when they lend. When the money is payed back it ceases to exist.
They do not lend their reserves but they do lend against them, and must pay reserves out to settle claims created by the loans they make if the loan money is not deposited back in their bank.
In this type of lending the financial institution is acting as the agent for the depositor in making loans. They are doing nothing that any individual lender can not do for themselves and that is to loan the money to keep it moving creating velocity. Lenders earn interest by creating velocity.
The creation of money at the central bank by fiddling the books should not be confused with the act of loaning it after creation.
In practice it doesn’t matter if money is extinguished or velocity is extinguished as long as the difference is
understood.
There is no difference between bank lending, pension fund lending, lending chits that represent money in a vault, lending gold coins, or your dad pulling some money out of his mattress and lending it to someone. rddulin
Baloney! Individual lenders do not have a default monopoly on the risk-free storage of and transactions with fiat and claims on fiat. They also do not have a lender of last resort to counter bank runs.
So banks CAN in effect create purchasing power from nothing by government-enabled embezzling of deposits – something an individual cannot do.
Thanks for your comment.
What I am saying is that we are talking about two different things, both of them practiced with the intent of defrauding people of their money and property.
BOTH of them can create purchasing power. One by creating “M” and one by creating “V”.
One of these is lending and that can be done by many different entities on a corporate or personal level.
Lending done by any entity creates “V”.
It has evolved that the Central bank of most modern economies can create money as a book keeping entry. It then has to be lent into the economy to create purchasing power M x V.
All banks use to be able to create money by issuing
banknotes. No one knew what was in their vault. Being local in nature they cashed their own checks and could steal the locals blind. Many times this trick was abused and an individual bank would crash possibly harming other banks but always damaging the reputation of banks in general.
Banks formed cartels allowing only the central bank to actually create money in exchange for the uniform regulation of member banks and the insurance that the central bank would bail them out if they got in trouble.
The problem is that purchasing power “M x V” can create inflation that destroys profits from charging interest.
Banks do not like this and will consent to some regulation to prevent this from happening,
The process of regulating each others creation of purchasing power, yields the appearance of a sound money supply, fooling most people into thinking that lending is a fair and efficient way of managing a “Unit of Exchange”
You are absolutely right. All banks can create purchasing power acting as agents of others money, but so can any other lender, lending their own or others money.
The central bank can create purchasing power out of thin air.
That is why lending is practiced, to create purchasing power “M x V”. The problem is not “Banking” but “Lending”.
IT IS ACTUALLY THE BORROWERS WHO CREATE MONEY BY PROMISING TO PAY IT BACK TO A BANK. Please let that idea sink in. It is the reality that economists studiously IGNORE!!! Bank lending IS different than all those other forms of lending.
And… to deposit a check in a bank is to lend A SECOND TIME what has already been lent once in order to have been created.
As long as we have money deposited in savings, we have a Perpetual Debt that cannot be escaped without a mathematically inevitable default and a growth imperative that cannot be escaped without periodic Crashes like 2008
P of “money” < 2P of debt of that money
http://paulgrignon.netfirms.com/MoneyasDebt/MAD2014/problem5.htm
Reblogged this on Arijit Banik.
All banks can create purchasing power acting as agents of others money, but so can any other lender, lending their own or others money.
Only banks and credit unions have access to government deposit insurance and to the lender of last resort so the problem IS government privileges for banks. The monetary sovereign ITSELF is the only proper provider of a risk-free storage and transaction service for its fiat. Government deposit insurance is an abomination as is a fiat lender of last or any resort. Banks should be 100% private with 100% voluntary depositors. Anything else is fascism (government for special interests including the rich).
And banks are NOT needed for endogenous money creation anyway since shares in Equity (common stock) is an ethical from of private money that requires no government privileges, no deposit insurance, no borrowing, much less usury, and no fractional reserves. But why justly share when one can legally steal instead?
F. Beard “And banks are NOT needed for endogenous money creation anyway since shares in Equity (common stock) is an ethical from of private money that requires no government privileges, no deposit insurance, no borrowing, much less usury, and no fractional reserves’.
I’m with you on that idea.
My proposal is that money be time-limited claims on short-term production, backed by a claim on equity. If the Issuer of the claim redeems the claim with product the claim is extinguished. If the Issuer fails, the claim is a secured first lien on the Issuer’s equity.
Money as Debt III is a 2 1/2 hour animated movie illustrating the kind of economy we could create with this concept of money.
http://paulgrignon.netfirms.com/MoneyasDebt/MAD3movies.html
One economist has actually looked into it. Here’s his review.
http://paulgrignon.netfirms.com/MoneyasDebt/MAD2014/solution3.htm
If the Issuer of the claim redeems the claim with product the claim is extinguished. PG
Yes, that is the idea but it’s not really a claim anymore than the dollar in my wallet is a claim to what Kroger sells. Otoh, accepting the common stock of a company for the goods and services that company produces is an excellent way to:
1) Avoid the need for fiat except for taxes.
2) Add tangible, immediate value to the common stock that is independent of the fluctuations in the supply of fiat and bank credit.
I add that there is no real need to reinvent the wheel. Common stock has ALWAYS been a perfectly valid private money form. The problem is the exisitence of the government-backed credit cartels that enable those with equity to steal rather than justly share.
We do not share our definition of fascism. But I agree with your first two sentences: considering the present situation (the creation of what boils down to government money is de facto outsourced to private banks) the ECB should have bailed out the Cypriot depositors. With cash. Even the Russians.
the ECB should have bailed out the Cypriot depositors. With cash. Even the Russians.
Yes. And the US Treasury should distribute new fiat to the entire US population until all deposits are 100% backed by reserves less borrowed reserves less the reserves used to buy MBS (which should be crammed back on the banks).
Yes. And the US Treasury should distribute new fiat to the entire US population until all deposits are 100% backed by reserves less borrowed reserves less the reserves used to buy MBS (which should be crammed back on the banks). F.Beard
I agree. Per capita direct distribution to each citizen of legal age is the only equitable way to create money in a society. Probably once a month as needed.
Of course a 200% tax has to be put on any interest payments received to stop parasitic lending.
This distinction between bank lending and non-bank lending is a dangerous one. It’s based on an extremely outdated picture of how the financial sector operates, if indeed it was ever applicable. This should be clear to anyone who has looked at the role of shadow banking in facilitating credit growth in the run up to the crisis.
To construct an argument that lending by banks is special, people who style themselves as post-Keynesian find themselves having to resort to explanations based on the idea that aggregate demand is driven by the quantity of money in circulation. This completely misses the point that “loans create deposits” is most usefully understood as a just a form of “investment creates saving”, rather than as observation on double entry bookkeeping. It also is completely inappropriate in a world where the financial sector routinely transforms assets into deposit substitutes outside of the traditional banking.
To construct an argument that lending by banks is special, … Nick Edmonds
It is special because:
1) Government deposit insurance.
2) Lack of a Postal Savings Service for the risk-free storage of and transactions with fiat leaving the banks with a default monopoly.
3) A legal creator/lender for the benefit of the banks when ONLY the monetary sovereign should create fiat and for the GENERAL WELFARE only.
This completely misses the point that “loans create deposits” is most usefully understood as a just a form of “investment creates saving”, Nick Edmonds
It is investment with stolen purchasing power and is particularly stupid since ever increasing debt is needed to prevent contraction. Purchasing power should SPENT, not lent into existence so that deflation is not built-in.
Dear Nick,
The point I make is that paying back a debt to an MFI does lead to annihilation of the money used to do this. Which is not the case when I pay back this money to a non-MFI financial institution. And this does matter in times of balance sheet recessions. And we really have to unlearn just to talk about banks, all the time. The financial system is by definition as much about households and non-financial companies. Can these routinely transform their already mortgaged under water houses into deposit substitutes outside of the traditional banking system? And I did not state that aggregate demand is driven by the quantity of money in circulation – if anything, I wrote about the flow of money. This flow is also defined by the velocity of money (which I do not define as Y/M as aggregate demand is only part of the flow of money).
I don’t have any problem with the idea that loan repayment to an MFI reduces the money supply (where the money supply is defined as debt claims on MFIs) and loan repayment to non-MFIs does not. The issue I was raising was whether that distinction matters much.
The important question for post-Keynesians should be whether the debt repayment (which is equivalent to saving) somehow causes some investment (or other form of expenditure) to take place. You talk in your post about the factors which might determine whether banks are making new loans and about how the way pension funds invest their money might affect whether actual expenditure on goods and services takes place. This is all good stuff. The talk about money doesn’t add anything.
The issue I was raising was whether that distinction matters much. Nick Edmonds
It does matter because:
1) Banks can create an unlimited amount of new credit so long as they can find so-called “credit worthy” borrowers; conversely a huge amount of existing credit would normally be destroyed if those credit worthy borrowers can no longer be found. Otoh, your Dad, for example, can only lend as much fiat or bank credit as he owns.
2) The repayment of fiat or bank credit (but not to the originating bank) does not destroy that fiat or bank credit and thus no further lending is required to replace it to prevent contraction in the money supply.
The distinction is thus huge when banks cannot find enough credit worthy borrowers to keep the boom going.
F. Beard
That is a very good point. There is an asymmetric relationship between MFIs and other financial corporations (OFCs) which means that OFC lending is limited by MFI lending in a way that doesn’t apply in reverse.
However, OFC lending can still vary significantly even in the absence of variation in MFI lending. This volatility is more than sufficient to account for the credit contraction we get in crises, such as the recent one (see for example Gallin J., (2003) Shadow Banking and the Funding of the Nonfinancial Sector). This is why I say it is a dangerous distinction to make.
This is why I say it is a dangerous distinction to make. Nick Edmonds
Well OFC’s, by themselves, cannot drive people into debt since the more they lend the more they must legitimately borrow (as opposed to credit creation) and thus the lending is self-limited by a finite amount of “loanable funds.”
My point here, all along, has been the fallacy of loanable funds does not depend on the role of bank liabilities as “money”.
Yes, an OFC can leverage a bit even by itself but it would be VERY risky without a government-backed credit cartel to backstop it. Imagine the profits to be made by sniffing out overleveraged OFCs, buying their liabilities and then presenting them for redemption?
It all goes back to the government-backed banks which are an abomination on their face in our so-called “free-market economy.”
OK Nick, tell me where I am wrong…
I want to borrow $400,000 to buy a house. The bank creates it for me.
The seller spends $ $300,000 of it and saves $100,000 indefinitely by lending it out as a term deposit. The remaining $300,000 is circulated for the first ten years while I am paying mostly interest, and in the process $100,000 passes into the hands of a number of private lenders who permanently add it to their lending capital. Another $100,000 ends up in the indefinite savings (Ie. lent to a bank) of an indefinite number of savers, leaving only $100,000 potentially circulating with only the original debt attached.
I now pay off my $400,000 Principal Debt and extinguish $400,000 of money.
Please do a mathematical summation of this situation for me and see if it differs from mine.
The way I see it, at this moment Money = ZERO
Remaining debt of that money = $300,000 or 75% of the money originally created.
Please note the similarity to reality.
http://paulgrignon.netfirms.com/MoneyasDebt/MAD2014/problem5.htm
Unless new bank-debt money is created in sufficient volume and ON TIME, those debts will default.
Economists are still struggling with the concept of endogenous money. Those who get it imagine it to be like a balloon that can expand and shrink with the demand for credit. They have not yet conceived of it as a Yo-yo, spun out into circulation as credit on a schedule and needing to return, except it can’t because it has been grabbed by a more powerful kid called “savers”.
Hi Paul,
Can I recommend Godley and Lavoie’s Monetary Economics as an excellent source for illustrating the interaction of flows and balances within a monetary economy. I think you would find it very helpful.
except it can’t because it has been grabbed by a more powerful kid called “savers”. Paul Grignon
So create some more but if the banks aren’t lending enough then the monetary sovereign must deficit spend to make up the difference and/or the country must net export (if which case the central banks creates the needed domestic fiat in exchange for foreign fiat?).
And then that money ends up in the possession of the rich and you have to do it again and again forever.
Not necessarily – if the banking cartel is abolished* and shares in Equity encouraged as a private money form.
*This would include a universal bailout until all deposits were 100% backed by reserves less borrowed reserves less reserves used to buy MBS (which should be crammed back on the banks.)
That’s the nice thing about the flow-of-funds data. They don’t care where it came from – debt is debt , period.
Dear Marko,
that’s the point. Debt’s are nor created equal. For one thing, there is the Hudson/Bezemer point that debt can be created by people or companies who want to invest in in new ‘capital’, like new houses, machinery or new products (many of these new products will fail – but that does not matter. Some won’t). Or they can be created by people and companies who want to invest in second hand stuff, like land, stocks, bonds or existing houses – which does add to their micro stock of capital but which does not add to the macro stock of capital.
For another think – it does matter if you borrow from an MFI-bank or from another financial institution. Borrowing from MFI-banks will increase the amount of money – something which enabled the run up of house prices after the middle of the eighties (thanks to the Ponzi-feed back loop between houses as collateral and houses as financial investment). If you look carefully at the flow of funds data, you will spot these differences.
And there is a reason why people like Milton Friedman never did look at (or at least did not write too much) about these flows but just at his sort of singly entry accounting variables M-2 or M-3. Comparable statistics based upon quadruple entry accounting would have shown that the increase of the amount of money in the USA in the thirties after 1933 was not due to private sector actions but to the government borrowing directly from money creating banks (according to Koo, at least, I did not check this).
By mentioning the flow-of-funds data I was simply trying to highlight a way to avoid being misled by relying on commercial bank data. Of almost $60 trillion in outstanding , all-sector U.S. debt , less than 1/4 appears on the balance sheets of U.S. commercial banks.
And though it may matter if you borrow from an MFI , it often doesn’t matter for long. Many of us who borrowed for our homes from a bank ended up with our mortgages being held by a pension fund in Austria.
I share your concerns , however. We’re living in a very prolonged ‘Minsky Moment’ – in the U.S. and globally – and we’ve yet to come to terms with that.
Are you suggesting that if regulatory measures had been impose to cut MFIs out of this process and we had relied even more extensively on shadow banking for credit supply, that it would all have been fine?
I’m suggesting no such thing, I state matters of fact. As Minsky stated:
“Modern capitalist economies are intensely financial. Money in these economies is endogenously determined as activity and asset holdings are financed and commitments of prior contracts are fulfilled. In truth, every economic unit can create money – this property is not restricted to banks. The main problem a ‘money creator’ faces is getting his money accepted”
Look here (and if you read this post you might realize that we have a little in common): https://rwer.wordpress.com/2012/10/21/the-endogenous-definition-of-money-business-accounting-view/
The point: the government takes care that the money created by MFI’s is accepted. The government solves the problem of the MFI money createors. By accepting it as a means to pay tax and by enacting laws which stipulate that, next to coins and paper money, MFI credits have to be accepted as the means of payment for monetary contractual obligations. That’s not the same thing as shadow bankig credit:
“While they are not necessarily used directly in transactions, these claims have the short-term safety and liquidity needed to function as stores of value, and thus can serve as imperfect substitutes for money. A key question is how Fnancial innovation impacts this kind of liquidity provision by Fnancial intermediaries”
Click to access money_20131221_e9123de9-351b-43bc-bd83-5f5053b45e3a.pdf
I.e. – you, your bank and the government can reject them when they are used to pay your salary or when you want to pay taxes ot to pay down a debt.
This is a crucial difference between MFI credit and shadow banking credit, it’s not the *legal* means of payment.
Shadow banks of course also use an intricate system of lending, borrowing and haircuts to lend, the Iceland banks being a particular weird case in point (I lend a billion krona to you, you lend a billin krona to me, we REPO the corresponding assets (asset backed commercial paper) on the international financial markets (who trust us because the Icelandic national bank issued our banking licence) and use the Dollars or Euros obtained in that way to lend to others…).
However – even the niftiest shadow bank can not *create* Euros or Dollars, i.e. money with the government ‘brand’ and government guarantees. But I do agree – when they are part of a larger MFI which does this job for them it sure can look that way. But I still can’t pay my taxes (or mortgage) with their asset backed coimmercial paper, at least not without a haricut. And it’s still the MFI which, ultimately, issues the Euros or Dollars.
By the way – the whole phrase ‘shadow banking’ is daft.
The point: the government takes care that the money created by MFI’s is accepted. The government solves the problem of the MFI money createors. By accepting it as a means to pay tax and by enacting laws which stipulate that, next to coins and paper money, MFI credits have to be accepted as the means of payment for monetary contractual obligations. merijnknib
And that’s entire bogus. Government should only accept checks drawn on its own fiat storage and transaction service (Postal Savings Service) where no hanky-panky with funds is ever allowed. And there should be no legal tender laws for private debt.
So then what would the banks do to get their “money” accepted? Who cares? But in general they would have to be a lot more willing to share the profits of purchasing power creation by paying interest rates and/or by issuing and accepting their own common stock as private money.
First off, I think we do agree on some important things, because as I said the stuff in your post that relates to elasticity of production is spot on in my opinion.
It is true that certain claims on banks do have the special feature that they can be “transferred” in payment, a feature not generally applicable to claims on OFCs. We can call these “special claims”. However most claims on banks do not have this feature, and therefore can be very similar to claims on OFCs.
The supply of total claims on MFIs is relatively inelastic, because it is largely determined by the asset side of the balance sheet, i.e. the amount of lending going on. This is one of the things we mean by saying that “loans create deposits”. The supply of special claims, however, is highly elastic. MFIs will supply the quantity of special claims demanded, by which I mean that they let the customer decide the split between special claims and other claims. It is me that decides how much of my savings I keep in my transaction account and how much in my savings account – not the bank. They may, of course, adjust rates if the balances change too much.
So the quantity of special claims in the economy is not determined primarily by the quantity of bank lending, but by the decisions of deposit-holders. The quantity of total claims on banks is determined primarily by bank lending, but most of these are no more liquid than comparable claims on OFCs.
The point of this is that the impact of variations in bank lending is to vary the quantity of a class of assets that is very similar to that created by OFC lending; it is not to vary the quantity of payments money.
(Just to clarify, by supply of a particular asset, I mean the taking of a debtor position, so demand would be taking a creditor position.)
You keep separating MFI’s and OFC’s as if the latter can’t borrow from the former but they can do so.
A quick perusal of Godley and Lavoie’s Monetary Economics chapter titles indicates no mention of money being created as one debt and deposited as another. Rather than directing me to read a long dense book, how about refuting my argument as presented in this animation?
http://paulgrignon.netfirms.com/MoneyasDebt/MAD2014/twicelentanimated.html
There’s no real distinction between deposits that are created and deposits that are deposited; they are BOTH equal claims to fiat.
Agreed. So what? You missed the point entirely!
Apologies. I took your comment to mean you wanted some help understanding the monetary circuit so I recommended what, in my opinion, is the definitive post-Keynesian text on the topic.
I’m afraid I don’t follow your example. Ultimately, I like to be able to break things down into the actual debits and credits that the bank would make, but I don’t think there’s enough information there to be able to do this.
Thank you for the book recommendation.
You said you couldn’t “follow” my illustrated argument.
I’m happy to discuss it with you.
Perhaps if we start with this 4 minute cartoon?
How to Create the Impossible Debt that is Swallowing the World
http://paulgrignon.netfirms.com/MoneyasDebt/MAD2014/How_to_Create_Impossible_Debt.mov?v=241uEv-m4Qw
I don’t really do cartoons, but I had a look through some of the other stuff on your site and I think some of the material on your “The banking system, itself, is the ROOT CAUSE of Money System Instability” page sheds a bit more light on it.
I would make a few observations.
Obviously, if some entity has positive net financial assets, then there must be at least one other entity with negative net financial assets (technically this is not quite true as gold bullion is classed as a financial asset, but we can ignore that as the relative amount is very small). So if somebody has net savings, someone else must have net debt. Who has the net debt may change from time to time, but as long as someone is a net creditor, someone else must be a net debtor. This needs to include the state and overseas entities as well, of course.
So the only way we can ever get rid of all the liabilities is to also get rid of all the assets. Of course, we would never want to do this, because there will always be people wanting to save and always be people wanting to borrow.
If people reduce their spending because of increased hoarding, then income will also be lower. In general, this makes it harder for debtors to repay their debts. The relationship between the spending and the nation’s gross asset/liability position is a complex one, but it’s an empirical matter, rather than being an accounting identity.
These points seem to me to be quite key to what you’re saying, and I think they are all fairly uncontroversial.
Nick Edmonds wrote:
“If people reduce their spending because of increased hoarding, then income will also be lower. In general, this makes it harder for debtors to repay their debts. The relationship between the spending and the nation’s gross asset/liability position is a complex one, but it’s an empirical matter, rather than being an accounting identity.
These points seem to me to be quite key to what you’re saying, and I think they are all fairly uncontroversial.”
If they are so “uncontroversial” why didn’t economists predict the Crash?
According to my analysis, this chart shows it was coming as plain as day.
http://paulgrignon.netfirms.com/MoneyasDebt/MAD2014/problem5.htm
Oliver didn’t get “twice-lent money” over at:
He broke down all the asset liability pairs and asked me to show him where the problem arises. If you like that kind of analysis rather than cartoons, you can follow the exact same logic there.
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It is certainly clearer the way Oliver sets it out.
In your reply to him, you describe a position where there only two financial assets (together, obviously, with the corresponding liabilities): a loan from lender 1 to borrower 2 and a loan from lender 2 to borrower 1.
Obviously, it is not possible for anyone to increase their financial net worth, without someone else decreasing their net financial worth. So neither borrower can reduce their debt without at least one of the others changing their position. This is really no different from noting that if one person wants to buy apples, they can’t do so unless at least one other person is prepared to sell apples.
In the real world, there are vast numbers of people increasing and decreasing their net worth every day, so the question is not whether anyone will do so, but rather by how much people are doing so. The question of what brings increases in financial net worth into equality with decreases is a very important one, but it is also a very complex one because ultimately it depends on people’s behaviour.
Perhaps it might also help you to note that, provided someone is in fact prepared to reduce their financial net worth, the lack of “money” is not necessarily a problem. For example, lender 1 could buy borrower2’s real asset and borrower 2 could repay the loan. Both submit payment instructions to the bank. The bank processes the payments on the same day, leaving no net movement on either party’s account.
Nick Edmonds wrote: “For example, lender 1 could buy borrower2′s real asset and borrower 2 could repay the loan.”
Well for one thing lenders only lend.
And for another if the lender buys the asset so what?
Borrower 2 just lost their real asset due to the shortage of Principal I just proved.
Borrower 2 could just as well have let the lender foreclose as in my scenario.
I have written a critique of this post here (of course doesn’t mean I agree with Cowen)
http://www.concertedaction.com/2014/02/13/effects-of-interest-payments-on-debt-with-addendum/
has tyler cowan ever been right on anything? he’s anti government libertarian market anarchist, on the dole at GMu via the government, knows exactly zero mathematics, and u can look at his wikipidia picture and it looks like koch bros and mercatus center—-you can tell he eats all the junk food that money can buy—like all of GMU staff.
I don’t agree. Just like Kenneth Rogoff he is actively searching for long term real life patterns (hmmm… any pattern there?). On the background there is some kind of neoclassical general equilibrium thinking – but when it comes to these long term patterns only to a very limited extent. To quote Keynes about the ideal economist:
“The study of economics does not seem to require any specialized gifts of an unusually high order. Is it not, intellectually regarded, a very easy subject compared with the higher branches of philosophy and pure science? Yet good, or even competent, economists are the rarest of birds. An easy subject, at which very few excel! The p aradox finds its explanation, perhaps, in that the master-economist must possess a rare combination of gifts. He must reach a high standard in several different directions and must combine talents not often found together.
He must be mathematician, historian, statesman, philosopher – in some degree.
He must understand symbols and speak in words.
He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought.
He must study the present in the light of the past for the purposes of the future.
No part of man’s nature or his institutions must lie currently outside his regard.
He must be purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician.”
Tyler combines an unusual amount of these requirements and I learn a lot from him. Now, if he only also mastered accounting…
F. Beard wrote: “The monetary sovereign spends fiat into existence and that fiat ends up in bank reserves accounts at the Fed (or as physical cash) without any necessary borrowing.”
Is this your desire or what you think happens now?
You are contradicting the Fed’s own description of what happens.
Fiat money is created when the nation’s Central Bank buys debt (normally only the national taxpayer’s) with new fiat money, either physical cash or reserve credit at the Central Bank.
Fiat money is actually a debt-of-itself, just like bank credit.
Click to access Where_does_Money_Come_From.pdf
From Modern Money Mechanics page 6:
“Let us assume that expansion in the money stock is
desired by the Federal Reserve to achieve its policy objec-
tives. One way the central bank can initiate such an expan-
sion is through purchases of securities in the open market
Payment for the securities adds to bank reserves. Such
purchases (and sales) are called “open market operations.”
How do open market purchases add to bank reserves
and deposits? Suppose the Federal Reserve System,
through its trading desk at the Federal Reserve Bank of
New York, buys $10,000 of Treasury bills from a dealer in
U.S. government securities
In today’s world of computer-
ized financial transactions, the Federal Reserve Bank
pays for the securities with an “electronic” check drawn
on itself! Via its “Fedwire” transfer network, the Federal
Reserve notifies the dealer’s designated bank (Bank A)
that payment for the securities should be credited to (de-
posited in) the dealer’s account at Bank A.
At the same time, Bank A’s reserve account at the Federal Reserve
is credited for the amount of the securities purchase.
The Federal Reserve System has added $10,000 of securi-
ties to its assets, which it has paid for, in effect, by creating
a liability on itself in the form of bank reserve balances.
These reserves on Bank A’s books are matched by
$10,000 of the dealer’s deposits that did not exist before.
The spending comes first and the borrowing afterwards and the borrowing is not needed and should be dispensed with since it is welfare for the rich and banks.