Category Archives: Full Reserve Banking

Endogenous money, MMT, Positive Money, & financial reform

Posted on by under Circuitism / MCT / Keen / Bank Reform / Credit Money, Full Reserve Banking, Modern Monetary Theory (MMT)

Among the Post-Keynesian groups concerned with understanding and fixing problems that lead to the 2007/8 Global Financial Crisis (GFC) and other ongoing economic problems there are different areas of focus by circuit theorists, Modern Monetary Theory (MMT), Steve Keen’s approach to private debt, and other Post-Keynesians. (MMT, while often with a focus on other aspects of the economy [as L. Randall Wray writes, leading from neo-Chartalist and functional finance insights to fiscal policy] is nevertheless firmly grounded in endogenous money theory). Despite these various approaches having important disagreements and areas of interest all are grounded in reality & therefore their discussions on policy options are coherent and useful, unlike orthodox policy discussions.

There is another perhaps small but dedicated and often visible group of reformers that focus on the monetary system. Broadly these are the various groups that want to change the monetary system such as The American Monetary Institute (AMI), Positive Money (PM), economists associated with the New Chicago Plan and others. Their relation with the Post-Keynesian groups mentioned above is somewhat complicated, and the key reason involves endogenous money. Before continuing, it helps to divide these diverse money reforming groups into two broad categories:

I. A significant number of monetary reformers focus on a money multiplier (and often on fractional reserves). They are still stuck in a loanable funds world, probably because orthodox economics has been so successful in teaching their delusion that we live in a loanable funds world, so these reformers, despite being heterodox in their goals, learn their economics from orthodox sources. Of course, we are not in a loanable funds world, so there is no money multiplier (and here). This means this significant section of monetary reformers is (rightfully) dismissed by those who understand how banking works. 

II. There is another group of monetary reformers that do understand that we are in an endogenous money – not a loanable funds – world. Their proposals do not focus on a (non-existent) money multiplier. Their proposals are aimed at actually making the current endogenous money system into a true loanable funds system. This would be a “no reserves” system. (Positive Money and related proposals are examples of this group).

For the second group above, this leads to a somewhat difficult intellectual position. Post-Keynesian economists have been trying to get orthodox economists to understand the way the economy actually works (with endogenous money) in the real world for decades, and have looked on in dismay as orthodox economists have spent whole careers writing about a non-existent loanable funds system and in turn giving terrible, indeed dangerous, policy advice. Thus it is natural to view holders of the loanable funds view as enemies who do real harm to the economy and the public. But it is different to be frighteningly delusional about reality (as orthodox economists are about loanable funds) than to understand that the current system is an endogenous money system and want to make it a loanable funds system (as PM-type proposals do. There are other main reasons many Post-Keynesians reject PM-type proposals. At times, though, it seems mere association with the muddled orthodox view of banking does influence how/whether some Post-Keynesians really weigh the details of PM-type proposals).

I think several points follow from making the above distinctions into two groups. Primarily they concern the possibility for PM type money reformers to strongly support some key MMT proposals for financial reform, and in turn good reasons for Post-Keynesians to be in dialogue with both types of monetary reformers, rather than seeing them as some misguided offshoot of the loanable funds mainstream.

On the AMI, PM, monetary reform side –

  1. Realize the danger of being thought “not to get” endogenous money (or of actually not getting it for those in group I above). Educate those who still talk about “full/fractional reserves” and a money multiplier that these are just not the issue. Irrelevant terms such as full/100%/fractional reserves immediately suggest that the banking system is simply not understood. The loanable funds system PM and others propose is a “no reserves” system, not a full reserve system. PM type proposals are about changing the endogenous money banking system to a (no reserves) loanable funds system.
  2. Strongly support MMT proposals that get part of the way to your goals, even if you ultimately want further changes. Warren Mosler’s proposals go a significant way towards reducing negative aspects of the current endogenous money system and are in accordance with PM type views; two in particular:

“Banks should only be allowed to lend directly to borrowers and then service and keep those loans on their own balance sheets.”

“Banks should not be allowed to accept financial assets as collateral for loans.” (Mosler)

Both of these would significantly alter and restrict the current endogenous money system in ways that move the system towards PM and similar plans’ goals. Indeed, PM itself lays out what their ultimate goals (brief version here) are and separately shorter-term goals that in part are similar to what many MMT and similar proposals for bank reform want.

Also – some MMT (and other Post-Keynesian) proponents are in favor of nationalizing banks, and/or of creating an additional system of narrow banking for those who want it. PM recognizes this as an important step towards their ultimate goals. Creating postal banks or any other narrow banking system as at least an option for the public is a logical and do-able goal that many sides could unite behind.

In other words, if PM type proposals want to move from “A” (today’s system) eventually to “D” (a loanable funds system), and Mosler-type proposals move the system to “B” (significant restrictions on the way endogenous money is currently created; the existence of a parallel narrow banking system for those who want it) then PM should be very much on board.

For Post-Keyenesians:

  1. Try (even) harder to teach monetary reformers that are erroneously still worried about a money multiplier (group I) that there simply is not one in the current system (I know – it seems they just won’t listen to good advice). If they understood endogenous money and that loans create deposits they would see that reforming a “money multiplier” is a waste of time. This might then lead them to see the logic of and support reform proposals such as Warren Mosler’s. Another possibility is that they would become part of group II above and at least understand the issues more clearly. This would make coherent discussions possible, and take one more group out of the spell of orthodox nonsense.
  2. Regarding group “II” above – Post-Keynesians should recognize that group II monetary reformers are different from orthodox economists in a crucial way – they get endogenous money – they just don’t believe it serves the public purpose. They truly believe that a real loanable funds model is possible to create and serves the public purpose better than the existing system. Recognize that real dialogue is possible with them unlike with the vast majority of orthodox economists. If a loanable funds model would not work or would be worse for the public, clearer statements of why could be made. I know there are essays by Post-Keynesians about some of these proposals; I think they could be better (more on this below). For example, usually one of the more conscientious writers of the MMT economists, Bill Mitchell, compares some of these proposals to the gold standard (although he seems to be considering some of the Austrian type proposals in part of the essay). Mitchell writes “There would be the equivalent of a gold standard imposed on private banking which could invoke harsh deflationary forces.” While under a true loanable funds system such as PM proposes endogenous private credit-money would not be created, it is obviously still a fiat system, and neo-Chartalist and functional finance insights hold: limitless (except by inflation) money could be pumped into the economy as needed through fiscal policy, tax decreases, and citizens dividends. The gold standard comparison simply does not make sense.* Ditto concerns about PM proposals being deflationary (not in the long run for the reasons mentioned, nor in the short run since the changeover would be portfolio neutral – I think the New Chicago Plan has a good explanation of this, page 49 ).

Although PM and similar proposals are not necessarily among the largest or most influential groups (compared to orthodox economists and their policy groups) they do have some visibility and any additional organized, visible support for much needed reforms, and any addition to coherent discussions of our endogenous money system should be welcome.

Rather than arguing among themselves, Post-Keynesians and PM-type groups should focus on the important overlaps of their bank/finance reform proposals. If those are achieved, then the further changes that PM type groups want can be discussed. And despite seeming to have radically different end goals (a fair, stable endogenous system versus a true loanable funds system) the most pressing immediate bank reforms are agreed on by most sides.

Both MMT and PM-type proposals are to use state money for public purpose. The real contention between MMT and PM lies in whether or not endogenous private credit-money creation also serves the public purpose.

The key issues:

Many of the concerns with the PM proposal I have seen brought up are actually discussed in some detail in the PM literature (and/or related points usefully discussed in the new Chicago Plan) and it often seems that critics of the plan simply do not closely read PM explanations of the details of the plan. However, of course there are serious concerns, perhaps the most consistent being:

Would the new system of exclusively state money be able to create a fair system for large business loans? How would that system differ from the current system?

Concerns with the current endogenous money system:

Does the fact that endogenously created private credit-money dwarfs state money restrict the ability of the government to act in the public purpose in the way MMT believes? (possibly through the inflation limitation – can the government really contain inflation while using state money for public purpose when such huge amounts of private credit-money are created?)  Does this render MMT ideas on the role of the state in the economy unworkable? (An example of these worries is Cullen Roche’s criticism of MMT here). 

Does the inherent instability and procyclical nature of endogenous money have too many social costs?

Does the endogenous money system stealthily but inexorably lead to regulatory capture? Relatedly – Does the endogenous money system have a systemic tendency to funnel wealth upwards & into the FIRE sector? Lead to unsustainable levels of private debt? To highly inequitable wealth distributions? [related post]

On these latter questions, Steve Keen’s work seems especially relevant, suggestive of the way in which in the current system of private credit-money seems to ratchet up private debt and credit-money and create crises and inflate the FIRE sector. (e.g., “Are We It Yet?“, “Deleveraging with a Twist” and others; also see important work towards reconciling MMT & Keen’s work).

There are plenty of critiques of MMT – most of which are completely misguided and due to fundamental misunderstandings of the economy due to orthodox economic blinders. I see the most important debate concerning the balance of state and private credit money in a state theory of money and what follows from a state theory of money. These are a few more discussions that touch on that area:

A debate on Endogenous Money and Effective Demand: Keen, Fiebiger, Lavoie and Palley

Modern Money Theory and New Currency Theory  (book length version: Modern Money and Sovereign Currency) (the historical discussion of why MMT and PM-type proposals differ on banking is very enlightening; I disagree with Huber on important aspects of the second part of the paper, especially where he still falls into the household analogy trap, and his unfortunate and confusing use of the term “fractional reserve system” when that is just not the issue. He clearly knows the difference between a no reserves system and “full reserves” although I think there are simpler ways of explaining it).

The Credit Money, State Money, And Endogenous Money Approaches: A Survey And Attempted Integration L. Randall Wray

__________________________________________

[Postscript – A few bits I cut from above for readability]

*On Mitchell’s comparison of creating a loanable funds model to a gold standard – Ralph Musgrave makes similar points concerning Warren Mosler’s light dismissal of Martin Wolf’s article on banking reform. (But please Ralph – quit talking about “Full/Fractional reserve! : ) The PM loanable funds model will be a “no reserves” system!)

PM-type proposals & MMT are in essential agreement that the state can and should just spend state money for public purpose, with inflation the limiting factor. This is sometimes unclear because of the operational peculiarities of various countries, not least of the US. Whether this is just through continued deficit spending, or a 60 trillion dollar coin or similar, circulating treasury notes (the same thing really), or whatever, ultimately makes little difference. PM-type proposals have long used the US Greenback – circulating (mostly digital) treasury notes, as a key example, and MMT economists have the same view.

A final note – sometimes in comments here and elsewhere a criticism is made that “there are more technical papers that do deal with ____, since you don’t have them here you don’t know what you are talking about!” and/or “this post only relies on other blog posts and simple sources, it is not useful/serious/informed! etc.” I do try to read more “official” and/or technical papers when relevant. Two points though – 1) If bits and pieces of answers to some of these points are buried in technical papers somewhere, that doesn’t help anyone too much – cite them specifically (& better yet – summarize them and why precisely they matter) and 2) I think when good economists like Keen, Wray, Fullwiler and Mitchell with technical work write their views in plain English those writings reflect – and quite often best reflect – what their technical work tells them is right.

 

Why lately I write more on sane economics (MMT, MCT) than good urbanism & the social sciences

Posted on by under Circuitism / MCT / Keen / Bank Reform / Credit Money, Full Reserve Banking, Modern Monetary Theory (MMT), The social & human sciences, Urbanism

I have mainly focused in recent months on MMT (Modern Monetary Theory) & MCT (Monetary Circuit Theory, also see here, esp. credit-money & stability), not the other things mentioned in this blog’s tagline.

The reason is fairly simple: It is where I see the most good can come about now.

In this blog I am most interested in addressing what I see as three main problems in the social sciences and their use for the real world:

(1) The highly destructive impact on society brought about by high-modernist architecture/planning on our cities (later aided & abetted by postmodernism; Kunstler is good on this point)

(2) The undermining of the social sciences by postmodernism (Sokal & Bricmont is still a classic on this) diverting attention from real problems. This has served to turn many away from the social sciences, which is particularly destructive in the political realm, when those responsible for funding looked at the results and content of (often postmodern dominated) social science, and understandably rejected it.

(3) Neoclassical “economics”. Economics is the most expensive discipline by far. That is, its undercurrents of thought influence the trillion dollar decisions, actions and policies of governments probably more than any other social science. Whole societies and generations end up essentially as lab rats for the theories of an earlier generation’s “academic scribblers” as Keynes so rightly stated. Incidentally – I see the refuge of neoclassical economics in meaningless equilibrium formulas as the same response as postmodern babble in other social sciences: giving up on understanding in the face of the incredible complexity of the social realm.

 Of these three, I think at the moment it is economics that is most important. Fortunately the tide has changed significantly with the first two. “New urbanism”, which is nothing more than a return to common sense and the normal urbanism of the last 11,000+ years, has pushed the absurd notions of high-modernism (and its subsequent nihilistic, postmodern apologists) more and more out of the picture. It will take generations to undo the damage done by the imbecilic building methods of modernism, but we are on the right path.

More or less the same can be said of postmodernism in academia, although mercifully with a much quicker time-frame for how quickly the puerile, self-serving prattle of the postmodernists and their ilk is being left to gather the dust it deserves: contentless, unreadable, and unread.

THE CASE WITH ECONOMICS is different for several reasons. The Great Financial Crisis (GFC) continues, so the time for change is as urgent as ever, and the political possibility greater. The bad economics of recent decades remains as entrenched as ever, dismayingly illustrated by the policies of most Western governments in response to the GFC.

Additionally, it is not as if the answers aren’t there. This is not an attack on something with nothing constructive to replace it with. There are true descriptions of the economy (e.g., MMT, MCT, Post-Keynesianism in general, The Other Canon), and with them, functional policies that empower the citizenry to optimize its well-being.

So it seems that of the three scourges on intelligent discussion of society mentioned, that somewhat or completely arose from academia – high-modernism in planning and building, postmodernism in the social sciences and humanities, and neoclassical economics – that it is most timely to attack the latter, and strive towards supplanting it with the sane, functional economics of MMT and other heterodox approaches.

TOWARDS A PURE STATE THEORY OF MONEY

Posted on by under Full Reserve Banking, Modern Monetary Theory (MMT)

Knapp State Theory of Money cover, 1905[Prologue to this post]

MODERN MONETARY THEORY (MMT) notes correctly that money is a creature of the state, and that important macroeconomic and policy conclusions follow from this understanding, e.g., sovereign states are not revenue constrained and spending is primarily limited by inflation. Taxes give value to state money and maintain its value (i.e., inflation can be controlled through taxes).

One (among many) key policy insight is that a job guarantee is possible. A job guarantee not only achieves what many think should for myriad social reasons be a primary goal of macroeconomics but also further creates a buffer stock (the most useful one of any imaginable given the social reasons just mentioned) that achieves an additional primary macroeconomic policy goal – stability.

However, there is no state that operates under a pure state system of money. Most of what serves as money in most banking systems in the world is privately created credit money.

We can compare the current most common banking system with a pure state system of money:

PURE STATE SYSTEM OF MONEY

 

CURRENT SYSTEM

Money is a creature of law.

Money is a creature of law.

Money is valued because it can be used to extinguish debt to its issuer.

Money is valued because it can be used to extinguish debt to its issuer.

The issuer is the state.

The issuers are the state and private banks.

Taxes move resources into the public sector

Taxes move resources into the public sector.      Loan repayments move resources into the private (often finance) sector

This raises important questions. If the state is not a monopoly issuer of money, do other neo-chartalist/functional finance/MMT insights hold?

A sovereign currency issuer is still not revenue constrained. And it can still spend towards full employment and other public purposes.

One major worry, however, is whether, because the state does not have a monopoly on money creation, it can set prices in the ways MMT argues. Especially, trying to do so while not having a monopoly on money creation may be inflationary even with otherwise appropriate taxation.

So what are the possibilities? Let’s imagine a system where the state truly has a monopoly on money creation. The state creates money and a payment system. There can still be loans and borrowing, but borrowing will be from someone else giving up use of their money, just as if you loaned a friend a tenner from your pocket. The risks and rewards of this can be pooled for large capital projects.

Let’s ignore the sometimes heard first criticism of this: “deflation!”. Imagine moving to this system in a portfolio neutral way, so that essentially all M’s (M2 and beyond) are, through bookkeeping entries, changed to M1 in a one-off system change. (There are also worries that this “creation” of M1 would be inflationary by others; they seem not to understand what “portfolio neutral” means.)

The obvious advantage is that bank runs will be a thing of the past – assuming a few other obvious regulatory moves (on securities and such) and all bad loans will be losses to individual investors, never systemic (this incidentally puts the incentives for loan quality and underwriting in the right places, raising the quality of loans in the first place). If Joe doesn’t pay you back his tenner, you are the only loser and there is no amplification of this loss. Cascading liquidity crises simply are not possible under this system.

THERE ARE THEN TWO RELATED objections – first, that without continued private credit money creation, this new system would still be deflationary. The related objection is that the “dynamic” private credit money system is behind much innovation and growth, and this would be lost.

On the first – this is interesting as it highlights a major question on the purpose and effectiveness of government. If money is a creature of the state, and a sovereign government cannot be insolvent, then it cannot be that a pure state money system will be deflationary because there is not enough money. The state can create as much money as it needs to re-inflate an economy.

The worry, then, must be that somehow the state will not be able to get the money it can endlessly create into the right hands, while somehow the private credit money system does. This highlights the fact that the worries about abolishing private bank credit money creation cannot truly be about the quantity of money or credit but about how and by whom the money and credit needed to keep the economy from deflation is created and spent into the economy.

This gets to much of what is the core concern of a pure state money system by both advocates and detractors alike, although often they are not nearly as clear as they could be about it.

What serves the public purpose more- having only the state create and spend money and credit into the economy, or allowing the private sector to control part of this public utility?

We already saw that one concern is that private credit money may force a tradeoff between public spending and inflation. What are some other potential costs? What is the real value and real cost of funding borrowers’ needs by allowing credit money to be created privately?

Costs

– We already mentioned policy space – the current system of substantially privatizing a public utility seems to move many resources into the private finance sphere, arguably reducing the policy space for public purpose (job guarantee, education, health care, etc.).

– A major tenet of MMT/Functional Finance is that it is how we utilize real resources now that matters, not deficits, and that we cannot borrow from the future. Money creation through credit likewise does not magically transport future resources to the present, it can only redistribute existing resources. Ceteris paribus (on taxes, policies, and who is utilizing the money) there is X amount of money that can be spent into an economy without inflation. Credit money creation can only redistribute this X amount of money and the real resources it affords (or cause inflation), and it is not clear that the private system does this in an equitable, nor necessarily the most efficient, manner.

– Where private money creation is combined with maturity transformation, as in the shadow banking system, money market and many bond funds, there is a distorted yield curve on interest rates. Some, especially Austrians, view this as leading to market inefficiencies in the long run, in addition to being severely unstable. This system allows narrow private benefits at the expense of widespread socialized costs and chronic instability (Maurice Allais’s non-Austrian work on this seldom receives the attention it merits, especially in the English speaking world.)

– Instability – allowing credit money has time and again led to intense and highly damaging episodes of instability. Diamond & Dybvig formalized the multiple equilibrium nature of banks runs; there is no stable equilibrium of credit-money creating banks without a lender of last resort. The true costs of instability are seldom weighed as a whole, nor presented in a way the general public can understand. What is the true and total cost to the public of the crises of 1907, 1929, 2008, the many smaller crises such as S & L, the Japanese asset price bubble, LCTM, banking crises in Finland, Sweden, Asia, Russia, Mexico, Argentina, Ecuador, Uruguay, and throughout Europe, the dot.com and housing bubbles, the bailouts of AIG, Northern Rock etc.? Is it truly, with proper accounting, worth the growth that some defend the current private system as promoting? On balance, a stable economy without socialized losses may be more dynamic and productive and allocate the real resources of the economy more efficiently than the current system, if judged with proper accounting standards.

– This leads to another point: Reality. The government already funds the banking system, both with occasional trillion dollar bailouts and on a daily basis. “Private” systems have shown time and again to be backstopped by governments (e.g., the U.S.and U.K.bailouts). The US government has proven to de facto guarantee the entire U.S. financial system (and the UK government the British system and so on), and lenders know it, much to their advantage (and distortion of the real economy). As someone else has written* “When A guarantees B’s liabilities, B needs to be on A’s balance sheet. This is accounting 101, folks.”

– MMT very correctly insists that an economic theory, to be worth considering at all, must at a minimum match real bookkeeping. To meet basic standards of accounting we would have to “[c]onsolidate the entire financial system onto USG’s balance sheet. While we’re at it, merge the Fed, Treasury, Social Security and Medicare into one financial entity. Clean up the whole mess of interlocking quasi-corporations. The US government is one operation. It should have one balance sheet.”* Again,  this is Accounting 101.

 IF IT IS INDEED THOUGHT that the benefits of credit money creation are worth the instability and other costs this system incurs on society, this raises another question:

Can a government duplicate credit money creation while distributing the gains and losses more equitably (i.e., socialized gains as well as socialized losses, instead of the current system that is mostly private gain and socialized loss)?

As we noted, in the current system, in addition to the money that people and businesses already have, they often want more money for productive and socially useful purposes. We further noted that there are two ways to get this money:

1. through other people loaning money that they already have or

2. through private credit money creation.

The first is not problematic, while the second is.

Would it be possible for the state to maintain something like the current system operationally, just making the parts of it that already are backstopped by the state actually state? This raises questions: Could this system be kept apolitical? (this potential political downside has to be weighed against the already existing downside: our private system has already experienced extensive regulatory capture). Could it be kept as competitive as it is now? Would it be as unstable as now with a truly “risk-neutral non-liquidity-constrained economic agent” (that is, the government) behind it?

This system could be thought of in this way:  Individuals and businesses that desire more money for productive purposes than they can get from other money holders are granted the privilege of additional state money created just for them; alongside this special privilege they voluntarily accept an additional tax burden to maintain the value of the money system. Let’s add that (in bold) into the comparison we made above between a pure state theory of money and the current state/private hybrid system:

PURE STATE SYSTEM OF MONEY

 

CURRENT SYSTEM

Money is a creature of law.

Money is a creature of law.

Money is valued because it can be used to extinguish debt to its issuer.

Money is valued because it can be used to extinguish debt to its issuer.

The issuer is the state.

The issuers are the state and private banks.

Taxes move resources into the public sector

Taxes move resources into the public sector.       Loan repayments move resources into the private finance sector

Some businesses or individuals want to borrow money. There are two ways to do so. One is for others to loan their existing money. This may be too restrictive and keep growth at suboptimal levels. The other is for new money to be created. 

 

Some businesses or individuals want to borrow money. There are two ways to do so. One is for others to loan their existing money. This may be too restrictive and keep growth at suboptimal levels. The other is for new money to be created.

The government creates this new money. The individual or business pays an additional tax for this privilege.

  Private banks create this new money. The individual or business pays the bank interest for this privilege.

The “lender of last resort” is the lender of first resort. There are both private and social gains and corresponding private and social losses.

 

Privately created money is inherently unstable without a lender of last resort. The government is the lender of last resort. There are private gains and socialized losses
 As a monopolist over its currency, the state has the power to set prices, including both the interest rate and how the currency exchanges for other goods and services. As a monopolist, the state can fund a job guarantee and other public goods without causing inflation.  In a system with “redundant currencies” (Innes 1914) the state may not be able to achieve macro policy goals and prevent inflation simultaneously
 The system is inherently stable. Stability leads to optimal investment, insurance, and allocation decisions and optimal long-term growth and welfare. Redistribution of private and social gains and losses is minimized.  The system is inherently unstable and uncertain. Chronic instability and uncertainty leads to suboptimal investment, insurance, and allocation decisions and suboptimal long-term growth. The system continuously transfers unearned wealth into the private (often finance) sector, furthering suboptimal economic performance and incentivizing rent-seeking and regulatory capture.

 

Currently, many of the most important neo-chartalist/MMT functional finance insights are not applied in the US, UK, and other countries, and they are clearly desperately needed. However, even if they were applied, the private credit money system would still interfere, possibly greatly, and would still lead to the same type of instability it always and everywhere has. The ongoing “crash” of 2008 seems to be fundamentally and deeply related to issues of private credit money creation, not the equally important issues of state money that MMT has so usefully brought to light. A true state theory of money must address the fundamental instability and inequitable nature of what Innes (1914) called a situation of “redundant currencies”, a system of both state and private money creation, and to be fully consistent, integrate it into its framework completely. It is not enough to “agree with the MCT folks” (or vice versa). The two must be a seamless whole.

~~~

* This wording is by an arch-Austrian good with pithy wording; I am not “Austrian” but on this issue, at least, he has interesting observations.

(Previous post: TOWARDS A PURE STATE THEORY OF MONEY, PROLOGUE: A NOTE ON KNAPP & INNES )

TOWARDS A PURE STATE THEORY OF MONEY, PROLOGUE: A NOTE ON KNAPP & INNES

Posted on by under Full Reserve Banking, Modern Monetary Theory (MMT)

Neo-chartalists rightly look to Georg Friedrich Knapp and Alfred Mitchell-Innes as brilliant forefathers of a state and credit theory of money. However, Knapp and Innes* of course wrote in a different time and had their hands full with explaining the fallacies of metallism and explaining why money is credit.

Now, however, the problems of metallism and the idea of money as credit, and in turn the functional finance implications, are well understood. Besides the contributions of Knapp and Innes to these areas, what did they think about private credit money creation? There is, given their focus on metallism and other issues of the time, relatively little on private money creation in their work. The past century, as mentioned, has seen the development of more or less a full understanding of the implications of the ideas of Knapp and Innes. However, there have been numerous relatively small crises in the past century (just since the 1980s: Savings & Loan in the US, the Japanese asset price bubble, LCTM, banking crises in Finland, Sweden, Asia, Russia, Argentina, Ecuador, Uruguay, and throughout Europe) and two massive economic crises (1929, 2008) that have had much or most of their basis in the private credit money creation realm of the economy. In other words, although a great deal of the suboptimal performance (sustained unemployment, lack of investment in infrastructure, education, and healthcare) has been due to a failure to understand and apply readily implementable state money & functional finance insights, there has also been another major source of economic suffering, resulting from the non-state-money side of the economy. The worldwide private credit money system has caused untold suffering and misery for millions. This side of the equation must be integrated into any functional finance insights that arose from Knapp, Innes, and others (the subject of my next post).

Although the answers to questions about state and private credit money stand or fall on their own merit, it is perhaps useful to note what Knapp and Innes thought about the private credit money side of the financial system.

Knapp does not focus on this area, perhaps in part why subsequent neo-chartalist developments did not either. The most interesting passage in Knapp on the subject may be the following:

  “It is a great favour to the banking world that the State permits the issue of [bank] notes. As is well known, other business men may not issue notes, or private till-warrants. Certainly the State also controls the business by law, for it rightly counts it of public utility. But it is nevertheless remarkable that the profits which are increased by this means, of a magnitude only explainable by the note issue, should flow exclusively to the owners of the capital. The State is giving to the holders of bank shares a means of increasing their profits which it absolutely denies to other businesses.” (Knapp 1924 [1905], 136-137)

It seems somewhat surprising that many (by no means all) of the others who built on Knapp’s work did not focus more on integrating this “remarkable” “great favour” of the state to “the owners of capital” and the social and systemic implications for a state theory of money (again, some have; I think not enough).

ON INNES

Innes, of course, wrote from within the Anglo-American financial milieu, and, it is important to remember, immediately after the creation of the Federal Reserve and under the gold standard.

In his two influential papers (1913, 1914) in The Banking Law Journal he develops the credit theory of money which Wray (Wray, working paper**) and others show is consistent with and reinforces Knapp’s state theory of money. Innes only turns his attention to private credit money at the end of the second paper (1914).

Innes, before considering private credit money, discusses a mechanism for inflation of state money under the gold standard. He then goes on to argue that the system where government money is leveraged by private credit money creation amplifies this inflation significantly, and that this is “by far the most important factor” in inflation. (Innes uses the common yet mistaken “fractional reserve” argument for how this leveraging occurs. Considering how common this mistake is, and that he was writing only 1 year after the creation of the Fed, this is understandable in his case).

In my opinion it is difficult to tell where Innes is laying the blame here (and he warns that he does not fully understand this area of money). He uses the term “redundant currencies” several times (all quotes from Innes are from Innes 1914, p. 166-167), which implies he thinks that this mixed system is somehow flawed. It seems, however, that in one case the “redundant currency” is private money, and in another use, it is state money.

Innes makes clear, (in his notes and several other places) that he views private money creation as a natural state of affairs, although he also seems to see the modern mixing of the two systems as possibly problematic (“in old days…it was easy to draw a sharp distinction between government money and bank money”). He also, however, implies that it is merely the way the system is being used (“ignorance of the principles of sound money”) that may be the problem.

As mentioned, Innes cites “this redundant currency” in a way that it seems he is referring to private credit money in the first use. But in the second use of “redundant currency” he seems to be referring to HPM (state money) – a “redundant currency operates to inflate bank loans in two ways, firstly, by serving as a ‘basis’ of loans” (Innes is assuming a loanable funds system).

At any rate, I do not want to make a claim that Innes was against either state (in favor of some kind of free banking) or private money (in favor of some kind of narrow banking system that would soon be in vogue – e.g., by Soddy, The Chicago Plan, Fisher etc.).

But it is clear that Innes saw the state/private hybrid system, as it was in his time, as deeply problematic and the root of inflation.

“Just as the inflation of government money leads to inflation of bank money, so, no doubt, the inflation of bank money leads to excessive indebtedness of private dealers, as between each other. The stream of debt widens more and more as it flows.

That such a situation must bring about a general decline in the value of money, few will be found to deny. But if we are asked to explain exactly how a general excess of debts and credits produces this result, we must admit that we cannot explain. ” (Innes 1914, 166)

I do not want to misrepresent Innes, so I include the entire passage below, with what I see as some of the more relevant parts in bold. I do want to make clear that I am not making, nor do I think Innes actually meant to make, an anti-Fractional Reserve argument, but rather, had he understood that loans create deposits and reserves are not of much importance, Innes would simply have stated his concerns as being about the relation of private to state money.

“Again in old days the financial straits of the governments were well known to the bankers and merchants, who knew too that every issue of tokens would before long be followed by an arbitrary reduction of their value. Under these circumstances no banker in his senses would take them at their full nominal value, and it was easy to draw a sharp distinction between government money and bank money. To-day, however, we are not aware that there is anything wrong with our currency. On the contrary, we have full confidence in it, and believe our system to be the only sound and perfect one, and there is thus no ground for discriminating against government issues. We are not aware that government money is government debt, and so far from our legislators realizing that the issue of additional money is an increase of an already inflated floating debt, Congress, by the new Federal Reserve Act, proposes to issue a large quantity of fresh obligations, in the belief that so long as they are redeemable in gold coin, there is nothing to fear.

But by far the most important factor in the situation is the law which provides that banks shall keep 15 or 20 or 25 per cent, (as the case may be) of their liabilities in government currency. The effect of this law has been to spread the idea that the banks can properly go on lending to any amount, provided that they keep this legal reserve, and thus the more the currency is inflated, the greater become the obligations of the banks. The, importance of this consideration cannot be too earnestly impressed on the public attention. The law which was presumably intended as a limitation of the lending power of the banks has, through ignorance of the principles of sound money, actually become the main cause of over-lending, the prime factor in the rise of prices. Each new inflation of the government debt induces an excess of banking loans four or five times as great as the government debt created. Millions of dollars worth of this redundant currency are daily used in the payment of bank balances; indeed millions of it are used for no other purpose. They lie in the vaults of the New York Clearing House, and the right to them is transferred by certificates. These certificates “font la navette” as the French say. They go to and fro, backwards and forwards from bank to bank, weaving the air.

The payment of clearing house balances in this way could not occur unless the currency were redundant: It is not really payment at all, it is a purely fictitious operation, the substitution of a debt due by the government for a debt due by a bank. Payment involves complete cancellation of two debts and two credits, and this cancellation is the only legitimate way of paying clearing house debts.

The existence, therefore, of a redundant currency operates to inflate bank loans in two ways, firstly, by serving as a “basis” of loans and secondly by serving as a means of paying clearing house balances. Over ten million dollars have been paid in one day by one bank by a transfer of government money in payment of an adverse clearing house balance inNew York.

Just as the inflation of government money leads to inflation of bank money, so, no doubt, the inflation of bank money leads to excessive indebtedness of private dealers, as between each other. The stream of debt widens more and more as it flows.

That such a situation must bring about a general decline in the value of money, few will be found to deny. But if we are asked to explain exactly how a general excess of debts and credits produces this result, we must admit that we cannot explain. (Innes, 1914, 166-167)

Again, I am not sure on how precisely to interpret Innes’ argument or intentions here. He clearly felt something was wrong with the system but, as he says, he is not entirely sure what. Had Innes lived to see the demise of the gold standard and other developments in the financial sector, one can’t help but wonder what he might have thought about state money, private bank credit money, inflation, and financial instability.

 ~~~

* Although it seems his correct name was Aflred Mitchell-Innes, references to him as both Mitchell-Innes and Mitchell Innes can be found. Innes’ original Banking Law Journal articles did not use a hyphen, and in them, Innes allows himself to be addressed in a letter as “Mr. Innes”, so I will use the shorter of the two.

** L. Randall Wray.  “The Credit money, state money, and endogenous money approaches: A survey and attempted integration.”

Knapp, Georg Friedrich. (1924 [1905]. The State Theory of Money. Clifton: Augustus M. Kelley.

Mitchell-Innes, Alfred (1914), ‘The credit theory of money’,  Banking Law Journal, (Dec/Jan.), 151-68.


(Next post – TOWARDS A PURE STATE THEORY OF MONEY)

 

Some pre- Great Depression roots of The Chicago Plan (& Minsky’s Financial Instability Hypothesis)

Posted on by under Full Reserve Banking, Modern Monetary Theory (MMT)

 

[This post is primarily focused on a sometimes underappreciated, though by no means unrecognized, pre- Great Depression direct influence on the architects of The Chicago Plan, with brief mention of related influence on Minsky & Milton Friedman. There is a tiny nod to MMT as well]

It seems to often be assumed that The Chicago Plan developed in direct reaction to the Great Depression (perhaps in part because Irving Fisher’s slightly later bank reform proposals are indeed thought to be). For example, Phillips 1992 outlines the early stages of the Great Depression and writes “It is within this historical context that economists at the University of Chicago presented their proposal for reform of the banking system.” (1992, 6).

Economists and historians are of course well aware of the long history of bank reform proposals before this period. But two strands that are sometimes neglected are worth remembering, especially as they relate directly to current renewed interest in The Chicago Plan and indirectly to the work of Minsky which is also appropriately receiving increased attention (they also relate through the same line to Milton Friedman and aspects of his work that tie in closely to bank reform and Minsky).

The direct link is from radiochemist Frederick Soddy (in the social sciences, best known for his 1926 Wealth, Virtual Wealth and Debt) who has often been criticized as a “crank” writing outside of his field and dismissed – perhaps incorrectly, as we will see – as un-influential (Soddy is usually associated with Full Reserve Banking – he was against the gold standard and for floating exchange rates – and/or known for arguments related to ecological economics). The degree, directness, and timing of Soddy’s impact may have been underestimated.
[To be clear: this is not an attempt to revive Soddy’s views, ahead of but still a product of his times, especially the ones on the tangent of energy, although these have some relevance to economics and environmental concerns , but merely to point out a somewhat surprisingly direct influence from his work].

Phillips (1992) does not mention Soddy at all. Another prominent and detailed work on The Chicago Plan, Allen (1993), writes that:

“In March  1933,  a  group  of  economists  at the  University  of  Chicago, evidently  with little if any  influence from Soddy,  gave  very  limited circulation to  a six-page statement..”(Allen 1993, 705).

Yet it seems both Phillips and Allen overlook a key piece of evidence that shows that the hugely influential Frank Knight, one of the original architects of the confidential 1933 memorandum on banking reform (and teacher of Milton Friedman, George Stigler, James M. Buchanan and senior collaborator with the young Hyman Minsky) was directly influenced by Soddy’s work. Perhaps more remarkably, Knight was influenced well before the Great Depression.

In 1927 Knight penned a short but in retrospect historically important review of Frederick Soddy’s 1926 Wealth, Virtual Wealth and Debt in The Saturday Review of Literature. Knight is highly critical of parts of the book, especially the mistakes Soddy as a non-economist makes and his neglect in realizing the extent to which economists had long struggled with banking and monetary issues. However, Knight also writes “These problems cannot be gone into here, but we can say with assurance that if this book leads economists to go into them as they deserve it will render the world a service of inestimable value.” Knight then concludes “The concepts of wealth, virtual wealth (money), and debt emphasize important and neglected distinctions, and in general it is a brilliantly written and brilliantly suggestive and stimulating book.” (Knight, 1927).

This is preceded by a still more remarkable passage, especially if we remember it was written in 1927 by a future primary author of The Chicago Plan and future teacher of Milton Friedman and especially developer of the Financial Instability Hypothesis, Hyman Minsky:

 “The practical thesis of the book is distinctly unorthodox, but is in our opinion both highly significant and theoretically correct. In the abstract, it is absurd and monstrous for society to pay the commercial banking system “interest” for multiplying several fold the quantity of medium of exchange when (a) a public agency could do it at negligible cost, (b) there is no sense in having it done at all, since the effect is simply to raise the price level, and (c) important evils result, notably the frightful instability of the whole economic system and its periodical collapse in crises, which are in large measure bound up with the variability and uncertainty of the credit structure if not directly the effect of it.” (Knight 1927, 732).

PS  The Peel Act, Soddy, Simons, Knight and Minsky

Henry Simons was of course a close colleague of Frank Knight (the second draft of The Chicago Plan was written by Henry Simons in close collaboration with Knight and other Chicago economists; they also edited an economics journal together I believe) and an even greater influence on Minsky than Knight (Wray writes that Minsky’s “biggest influences were…Henry Simons, but he also worked with Oscar Lange, Paul Douglas, and Frank Knight”; .Simons is thought to have been especially influential on Minsky through his 1936 article “Rules versus Authorities in Monetary Policy”, Moe 2012).

Simons seems to have been considering banking reform well before the Great Depression. He writes in a letter to Irving Fisher in 1933 that he had been interested from apparently as early as1923 in “trying to figure out the possibilities of applying the principle of the English Act of 1844 to the deposits as well as to the notes of private banks.” (Letter from Simons to Fisher, March 24, 1933, in Allen 1993, 706).

Much less known and rarely mentioned, Soddy had two earlier publications (and gave lectures) that discuss aspects of economics, his 1920 Aberdeen Lectures and 1921 Cartesian Economics: The Bearing of Physical Science upon State Stewardship.

Given that Soddy won a (real) Nobel Prize in 1921 I thought his other writings or economic lectures might have been noticed, and thought I would check if they seemed to have been of any influence on Simons, who, as we saw, said that he was interested in bank reform as early as 1923. However, as far as I can tell, neither of these works mentions the Peel Act nor much else that would probably have interested Simons in 1923. (Soddy cites as influences Silvio Gesell, who seems to have influenced Keynes as well, and Arthur Kitson – this is if nothing else a visually fascinating look at Kitson by the way)

At any rate, in the pre-Great Depression intellectual milieu surrounding Frank Knight and Henry Simons there seems to have been significant attention to ideas related to credit creation and financial stability, as expressed in Simons’ interest, apparently as early as 1923, in the Peel Bank Charter Act of 1844 and in Frederick Soddy’s documented influence on Knight in 1927, where he writes about bank credit-money creation leading to “frightful instability of the whole economic system and its periodical collapse in crises, which are in large measure bound up with the variability and uncertainty of the credit structure if not directly the effect of it.”

It is fascinating to see threads of connection running from modern work such Minsky, Steve Keen, or Benes & Kumhoff to the Bank Charter Act of 1844 (via Simons) and Frederick Soddy (via Knight), especially as Soddy was often dismissed as a crank writing outside of his field.

The MMT Bit:

I ran across these in Soddy 1921:

“Wealth is a flow, not a store…I can conceive no nation so barbaric as to regard gold as a store of value. Demonetise it and where is its value? Not a gold mine would be at work on the morrow.” (Soddy 1921)

money “ought to bear precisely the same relation to the revenue of wealth as a food ticket bears to the food supply or a theatre ticket to a theatrical performance.” (Soddy 1921)

A hint of MMT here – stocks & flows, state theory of money, and money as a token or a ticket. All within a few paragraphs.

Works Cited:

Allen William R. 1993, “Irving Fisher and the 100 Percent Reserve Proposal”, Journal of Law and Economics, 36: 2, 703-717.

Knight, F. (1927), “Review of Frederick Soddy’s ’Wealth, Virtual Wealth, and Debt’”, The Saturday Review of Literature Vol. 3 no. 38 (April 16), p. 732. Full text here

Knight, F. (1933), “Memorandum on Banking Reform”, March, Franklin D. Roosevelt Presidential Library, President’s Personal File 431.

Moe, Thorvald Grung 2012 Control of Finance as a Prerequisite for Successful Monetary Policy: A Reinterpretation of Henry Simons’s “Rules versus Authorities in Monetary Policy” Levy Economics Institute,Working Paper No. 713

Phillips Ronnie J., 1992, “The ‘ChicagoPlan’ and New Deal Banking Reform” Levy Economics Institute, Working Paper No. 76

Soddy,Frederick, 1920, Science and Life -AberdeenAddresses [1915-1919] (hard to find – ISBN = 0548629781 and 978-0548629789)

Soddy,Frederick, 1921, Cartesian Economics: The Bearing of Physical Science upon State Stewardship.

Soddy,Frederick, 1926,  Wealth, Virtual Wealth and Debt. The solution of the economic paradox. George Allen & Unwin.

Wray, 2012, Why Minsky Matters (Part One)  March 27, 2012 http://www.multiplier-effect.org/?p=4172

Note: This is by no mean an attempt at a resurrection of Soddy’s work, although Soddy 1926 certainly has some important points in it and in retrospect is clearly more than just the work of a “crank”. The main point here is simply to show that there is documented evidence that Soddy influenced Knight well before the great depression. Given Simons’ direct influence on both Friedman and Minsky, it is also interesting the evidence that Simons was, like Knight, interested in credit-money reform well before the Great Depression. Soddy should also be recognized for his influence on concerns about economic growth and the environment, remarkable for his time [although perhaps not surprising for someone educated in physics and chemistry].

April 1 2019 Update: The new book is finished and available! Live on Amazon here –

1000 Castaways: Fundamentals of Economics

More of Soddy’s economic writings:

Books

Soddy, Frederick, 1931, Money versus Man. London: Elkin Mathews & Marrot

___________ 1934, The Role of Money,London: George Routledge & Sons.

 

Other

“Economic ‘Science’ from the Standpoint of Science”, The Guildsman, No. 43, July 1920.

‘Money’, A lecture delivered to the Oxford City Labour Party in Ruskin College, 21st January 1923.

“What I think of Socialism”, Socialist Review, August 1928, pp. 28-30.

“Unemployment and Hope,” Nature, 1930.

Poverty Old and New, lecture to the New Europe Group,London, published by The Search Publishing Co. Ltd., 1932

“A Physical Theory of Money”, paper to the Liverpool Engineering Society, Transactions of the Liverpool Engineering Society, 56, 1934

“The Role of Money”, The Oxford Magazine, June 7. 1934

“TheNew BritainMovement”, Supplement to New Britain, June 20, 1934

‘Money as Nothing for Something’, Garvin’s Gazette, March 1935.

(A later volume – Garvin’s Gazette)

‘The Gold Standard Snare’, Garvin’s Gazette, July 1935.

The “Pound for Pound” System of Scientific National Monetary Reform in Montgomery Butchart (editor) To-morrow’s Money, Stanley Nott. 1936

‘Money and the Constitution: report of the Prosperity Campaign Conference’, DigswellPark, August 1936

Credit, Usury, Capital, Christianity, and Chameleons, The Economic Reform Club. 1937

The Budget, synopsis in one hundred verses of the author’s ‘Reformed Scientific National Monetary System’, Knapp, Enstone, Oxon. 1938

Money and the Constitution, Knapp, Enstone, Oxon. 1938

Social Relations of Science, Nature, 141, 784-5., 1938

Abolish Private Money, or Drown in Debt: Two Amended Addresses to our Bosses by Walter Crick and Frederick Soddy, 1939

“Finance and War”, Address to members of the Parliamentary Labour Party at the House of Commons , Nature, 147, 449, 1940

‘The Arch-Enemy of Economic Freedom: what banking is, what first it was, and again should be’, A reply to the Rt. Hon. R. McKenna’s ‘What is Banking ?’, Knapp, Enstone, Oxon, 1943.

Demand For Monetary Reform inEngland, a letter sent to the Archbishop of Canterburyand nine other clerical authorities, signed by thirty-two monetary reformers, Authored by Soddy and Norman A. Thompson 1943

‘Present Outlook: A Warning-debasement of the currency, deflation, and unemployment’, For Local Administration Authorities, September 1944.

(the more obscure works are from http://booksinternationale.info/pipermail/freshink/2009-July/002319.html )

Off topic but – While looking for Saturday Review of Literature Covers I ran across a number of interesting ones-

http://ecx.images-amazon.com/images/I/51h3%2BP52nQL._SL500_AA300_.jpg

Saturday Review of Literature August 8, 1942 Sergei Eisenstein Cover

Small c chartalism, sovereign money, & public policy space v. private profit space

Posted on by under Full Reserve Banking, Modern Monetary Theory (MMT), Uncategorized

There is a high degree of disagreement, even within heterodox economics,  on the meaning and relations between monetary terms such as exogenous, endogenous, vertical, horizontal, chartal, monetarism, state, fiat, inside, outside, what money things are, is money debt, whether state money can be considered exogenous and on and on.

Part of the problem is that some try to define concepts through identifying historical examples, others through defining “ideal types” of the concepts and then relaxing or mixing these pure definitions to match real world systems, while still others define concepts based on the use of the words by past writers.

The degree of disagreement is so great as to pose a seemingly insuperable barrier to discussion between anything larger than the smallest of in-groups.

Not only is there immense disagreement on definitions of terms between schools of thought (understandable) but significant divergence of definitions and usage within heterodox and Post-Keynesianism (circuitiste, horizontalists, structuralists, Basil Moore, etc etc) and even within the various branches of these.

Just one example from comments on the last post: Ralph Musgrave writes

“First, I’m bothered about your use of the words fiat (as is Tom Hickey)…My Oxford Dictionary of Economics starts its definition of ‘fiat’ as follows. ‘Money which has no intrinsic value, but has exchange value because it is generally accepted.’ On that definition, central bank created and commercial bank created money is fiat. Thus your claim that ‘we do not have a true fiat currency’ is not correct: our existing system is 100% fiat.”

Yet Wray clearly distinguishes between fiat and bank credit-money, the latter of which

“can be thought as a type of ‘leveraging’ of fiat money” (Wray 1998, 111)

(Later Wray doesn’t even see modern money as fiat at all apparently;  he writes that

“The state’s money is not ‘fiat,’ but rather is ‘driven’ by the sovereign ability to impose tax liabilities…”

{Wray 2007; note, however, that the state imposes taxes by fiat}).

 The Way Forward

I think the only way to even begin discussing these issues is to agree on stipulative definitions that are based on ideal types rather than hagiographic discussions of past works. The latter is a prescription for factionalization; the former is a path to consensus and clarity. In such a complex and contested realm,  stipulative rather than descriptive and etymological definitions are needed. Define pure examples of a concept (even if they never existed) and when discussing mixed systems, just say so.

Example

A pure idea of a state theory of money would be to define it as a system where there is only intrinsically worthless currency decreed to be of value by the state, backed by its power to tax.

Alternatively, there can be commodity money.

Either commodity money or state money can be leveraged by private entities.

Separate names could be given to each type of mixed system (leveraged commodity money, leveraged state money).
If you want to call the latter mix “Chartalism” instead of reserving that term for a pure state theory of money, fine.

But then there should be some name for a system where the only money that circulates is state money.

A Pure State Theory of Money

Wray writes

“Modern money is state money…There is a pyramid of these liabilities, with nonsovereign money liabilities leveraging the sovereign’s currency.”    http://www.levyinstitute.org/pubs/Wray_Understanding_Modern.pdf

In this context Wray is calling private credit-money “nonsovereign money”.  Now Wray on sovereign government currency:

“In the US, the dollar is our state money of account and high powered money (HPM or coins, green paper money, and bank reserves) is our state monopolized currency. I prefer to expand the conventional definition of currency…[to] include HPM plus Treasuries as the government currency monopoly.” (Ibid.)

So “sovereign currency” is HPM plus Treasuries.

If you want to reserve the word “Chartalism” for a hybrid system of sovereign and nonsovereign money (sort of confusing to have a “State Theory of Money” that includes a massive amount of “nonsovereign money”, but whatever) then a system of “state money only” can be called a sovereign money system.

~~~

On private leveraging: In a commodity money system this may be useful.

However, there is no operational reason why state money needs to be leveraged.

A pure state money system is feasible.

MMT and Bank Credit-Money

I think part of the lack of emphasis in MMT on the (negative) role of private bank credit-money in our leveraged state money system stems from earlier bouts with non chartalists, especially metallists, who wanted to prove that money arose privately, and not from the state. As a result, chartalists have a natural tendency to downplay the role of private money in general, including privately created credit-money. Chartalist literature frequently (and often gratuitously, almost a tic)  turns to discussions of metallism. Simultaneously, in highlighting a state theory of money, chartalists needlessly minimize the utterly dominant role of private banks and private credit-money creation for many centuries, leveraging for private gain both commodity and state money in different places and times  (A pernicious dominance that I think vestigial in the current system, and should be excised). With stipulative rather than historical,descriptive definitions of a state money theory, one can recognize the role of private money both now and historically, without weakening a State Theory of Money in the least.

Note – A similar dynamic is evident in Bill Mitchell’s rejection of Full Reserve Banking, where he associates FullRB with the gold standard and Austrians (and says it would be deflationary, a peculiar thing to think considering a sovereign government can always issue currency, and would simply replace existing credit-money with state money with keyboard strokes), when there are plenty of arguments for stopping private credit-money creation that have nothing whatsoever to do with the gold standard or Austrian beliefs.

Sovereign money and public policy space versus private profit space 

There are good reasons to want to remove vestigial private-money creation from state money that have nothing to do with past state money v. private money discussions, debates on metallism etc.

It is hard to understand why a state system of money with private leveraging (a “leveraged state money system”) is somehow more desirable than a system of state money only, a true monopoly by sovereign money. MMT never tires of (correctly) saying that a currency issuer is always solvent. So why is there a need for private leveraging, when the state can always fulfill the money-creating role directly rather than expansion by private leveraging? (the investment and credit purposes of banks are easily carried out with no new credit-money creation).

Éric Tymoigne, in “Chartalism, Stage of Banking, and Liquidity Preference,” writes

“The demand for money-things…ultimately rests, because money-things are debts, on the capacity of their issuers to make them scarce. For the private sector money-things, this means the capacity of the issuers of money-things to make profit…” (Tymoigne 2005, 12).

What purpose is served by letting private entities profit from the public good that is sovereign money? The sovereign cedes policy space for public purpose to private space for private gain. Needlessly and inequitably.

___________________________________________________________

Tymoigne, Éric, 2005 “Chartalism, Stage of Banking, and Liquidity Preference”

Wray, L. Randall, 1998, Understanding Modern Money

Wray, L. Randall 2007 “Endogenous Money: Structuralist and Horizontalist” Levy Institute Working Paper No. 512

~~~

[This post is written partly in response to comments on https://clintballinger.edublogs.org/2013/01/03/mmt-can-address-operational-realities-or-analyze-a-chartalist-system-but-it-cannot-do-both/]

 

MMT can address operational realities or analyze a Chartalist system. But it cannot do both.

Posted on by under Full Reserve Banking, Modern Monetary Theory (MMT)

Yuan Dynasty Chao 鈔 – oldest known fiat currency

[First, to be clear, I think neoclassical economics is a non-starter, with the only real discussion of the economy being amongst various mainly post-Keynesian approaches.]

Summary: Both proper stock/flow accounting and chartalism must form a large part of any correct understanding of the economy, and MMT has been/is/will be central to this development. There are, however, some problems related to issues of productivity, foreign trade, and endogenous money. This post is on the latter.

The operational reality is we (the U.S., but really most any country) have a tiny state-money system dominated by a much much larger bank credit-money system.* MMT is usefully focused on the operational realities of this system (god knows the neoclassicals aren’t).

However, there are good reasons to believe that a true chartalist system would be a fairer, more stable, and more productive system (as well as more amenable to MMT analysis).

However, when it is suggested that changes should be made to the existing system to change it to true chartalism, a common response is that MMT is focused on operational realities, the system as it is, and anything else is just wishful thinking.

But this is disingenuous. As (especially) Scott Fullwiler never tires of mentioning, MMT is and has long been full of proposals for change – either changes in how the current system is utilized or changes to the system itself.

Although there is a pragmatic core focus on operational realities (an extremely good thing), MMT does indeed speculate and prescribe (also a good thing). The question, then, is why does MMT seem open to some changes and not others?

An obvious answer is that some changes are more important than others either because of value judgments, or because they seem to follow naturally from the logic of MMT, or both.

For example, the job guarantee seems to be both. Most people of any persuasion would agree that unemployment is not desirable. Additionally, the logic of MMT (and some other views) suggests we have to choose some buffer stock, and a full employment buffer stock is the best option if your goal is full employment and price stability with an overall goal of public purpose (I agree with the MMT JG).

But once the option for change is on the table, why not consider other MMT-friendly options, especially if they are at least as politically viable as the job guarantee? And what could be more neo-chartalist friendly than (true) chartalism?

MMT can either address operational realities, or analyze a chartalist system. But it cannot do both, because the operational reality is that we do not have a true fiat currency and are not operating in a true chartalist environment.

There may be moves away from this operational reality that lead to full employment, a  more just economic system, and greater price stability.  There is good evidence that a highly useful move would be to change to a true fiat currency system.

MMT would be a natural choice to lead this change.

___________________________________________

PS  This comment by Tom Hickey 1. demonstrates the standard first reaction when change is discussed to highlight that MMT has an important descriptive element (this is true, and useful, but besides the point in this case; MMT also has prescriptive elements, and therefore MMTers are choosing their prescriptions just like anybody else), 2. expresses the common view that MMT is not interested in Full Reserve Banking, which as I have pointed out,  is really a movement to implement a true fiat currency (whether Full Reservers realize it or not) and 3. lists proposals by Warren Mosler that come very close to creating a true fiat currency. Which makes me wonder why instead of the relatively complicated steps Mosler and other MMT plans call for, the relatively simple and neo-chartalist friendly step of just creating a true chartalist system is not on the table with MMTers.

* You can say “but the government could make this a true fiat system, they are just parceling out the public power of fiat to the private banks because we want to”. Fine, but still the operational reality is that we do not have a fiat system of money. (It may even be that we have reached/are reaching a point where politically the “operational reality” is that it is not realistic to believe a true fiat system could be enacted even if or when we decide we want one. The reality will be a permanent private credit-money dominated system in a plutocracy.) Oh, and don’t try to hand wave and say credit-money is not state HPM and so doesn’t count, or that it nets to zero and doesn’t count. Credit-money clearly functions as just “money” in the current system in ways that matter, accumulates in an inequitable and unstable way that additionally nourishes the problematic FIRE sector, and clearly causes problems.

 

Modern Monetary Theory & Full Reserve Banking: Connected by Fiat

Posted on by under Full Reserve Banking, Modern Monetary Theory (MMT)

[The fourth of a series of posts on MMT, ‘The Chicago Plan Revisited’, and related issues; see also part 1, part 2, & part 3]

Summary: MMT understands the monetary system in depth, particularly a fiat monetary system. “Full Reservers”, because they have not always fully grasped the significance of the fact there is no money multiplier and that the loanable funds model is wrong, often have a misplaced emphasis on the reserve ratio and sight deposits. Nevertheless, they can be understood ultimately to be worried about endogenous money, and in effect are arguing for a pure fiat money system. Steve Keen shows the magnitude of the negative effects of endogenous money on the economy. If Keen is properly understood, and what are in effect the anti-endogenous money policies of Full Reserve plans implemented, the end point is a pure fiat money system. And the starting point of a true chartalist system, the natural home for neo-chartalism.

There are actually two concerns most advocates of Full Reserves have

1. Solvency – there are few solvency issues with full reserves; not surprisingly a major concern in the 1930s for Simons, Fisher, The Chicago Plan etc.

2. (Endogenous) money creation

The second is much the more important, but the two are often confusingly conflated.
Partly this is because the significance of the fact that the loanable funds model is wrong and there is no money multiplier is not always fully appreciated by Full Reservers.

Banks do not make loans based on reserves or loanable funds but based on demand, perceived profitability, and the capital they hold. The government covers reserve requirements later. Raising reserve requirements can raise costs but does not stop money creation. Even the focus on sight deposits (i.e., PositiveMoney) misses the point – not only do reserve requirements not stop money creation, neither does stopping lending based on sight deposits. Banks loans pull money from the central bank, with the limit being the ratio of capital to risk-weighted assets.

So, unless Full Reservers are only worried about bank solvency, which is doubtful, they are really addressing concerns that have their root in endogenous money.

Anti endogenous  money, pro- true chartalism proposals

The main benefits of plans such as AMI, PositiveMoney, Kotlikoff, the Chicago Plan, Werner etc are, or would be with any needed tweaking, that:

Issuing fiat would be rightfully reserved for the issuer of the fiat decree: the government. A monopoly on money (but not on banks; entities that invest people’s money and distribute the gains would exist much the same as now). As L. Randall Wray notes, “money is a social creation. The private credit system leverages state money, which in turn is supported by the state’s ability to impose social obligations mostly in the form of taxes.” (Wray, 35)*. As the system stands, a public good is leveraged for narrow private gain, in a process that entails public costs through intrinsic systemic instability.

Implementing restrictions on the type of lending that leads to endogenous money creation would be “no big deal” according to Warren Mosler. (The details of how this would work, and why credit, investment in capital, and instruments for earning interest would still exist are in the various plans; Mosler suggests they would only be allowed to invest their equity capital. Some details are here).

The effect of this, however, would be a very big deal indeed. It would be the creation of a true fiat system of money, instead of the mixed state-credit financial system (as Steve Keen calls it) we have now. All money would be outside, exogenous, vertical, HPM.

Endogenous money creation is a vestige left over from older systems, where either banks were powerful enough to challenge sovereigns, or rich enough to buy off lawmakers, or where commodities actually were leveraged with bank notes. And before digital accounts, weakening banking regulation and related developments completely untethered credit-money creation from reality.

Whatever the past utility of endogenous money, in the modern economy it serves no socially useful purpose that could not be retained under a true chartalist,  pure fiat money system. Worse, endogenous money is increasingly understood to be extremely socially costly (especially in the work of Steve Keen).

Pro Full Reserve advocates, if the goals of their proposals and root of their worries are reviewed carefully and in light of the fact that loanable fund and money multiplier models are incorrect, are most concerned with the same problems Keen has also so clearly shown, that endogenous money is destabilizing and harmful.

It is evident that (neo)chartalist policies would work better under (true) chartalism than under the mixed state-credit financial system we operate under now.

That is why I say that Modern Monetary Theory & Full Reserve Banking are Connected by Fiat.

_______________
*L. Randall Wray “The Credit Money, State Money, and Endogenous Money Approaches: A Survey and Attempted Integration” Link

Although the simplifying assumptions are not perfect, Endogenous Supply of Fiat Money highlights some incentive problems with bank credit-money creation.

P.S. This post was partly inspired by a perceived lack of interest on the part of MMTers in full reserves, and vice versa (and downright hostility to MMT from the AMI Full Reservers). Good discussion here.

I see MMT, the aims of Full Reservers, and followers of the enlightening work of Steve Keen as natural allies.

Bob Mitchell (MMT), and Ralph Musgrave (pro-Full Reserve), both explicitly disagree, stating that MMT and Full Reserve have little in common. I will consider Bill Mitchell’s objections  in another post. In a nutshell though, Mitchell’s proposals (besides his analysis needlessly wading into the bogs that are Austrian thought) for banking are all very good, needed under any system, and I very much agree with him. However, they are to a large extent trying to undo the damage caused by an inherently flawed pseudo-chartalist system that has all the incentives wrong, a system that creates bank-credit-money bubbles that are the fundamental enablers of much bad activity in the financial sector. You might say that endogenous money adds fuel to the “FIRE” that Mitchell wants to extinguish. Excising endogenous money creation from our fiat money is needed to truly effect the changes Mitchell wants.

Can Full Reserve Banking actually even stop credit-money creation? The Chicago Plan v. Positive Money

Posted on by under Full Reserve Banking

[This is a comment from a previous post on Post Keynesianism, MMT, & 100% Reserves Project, Post No. 2. It is in answer to the question “Do Full Reserves actually even stop credit-money creation?” Scott Fullwiler at one point said full reserves could not, as well as some other commenters.]

Andrew Jackson, December 25th, 2012

“Does full reserve stop banks being able to create money out of thin air.

Quick disclaimer, I work for Positive Money.

It’s interesting that you mentioned us alongside the Chicago plan in the first post. The Positive Money (PM) proposals do indeed have the same goal as the Chicago plan/full reserve/100% reserve proposals, that is to stop banks creating money in the process of making loans (or buying assets),. However, the method is different. In the case of Chicago plan they do it by forcing banks to hold reserves against their deposits. As some people have pointed out, this doesn’t necessarily stop banks creating money – that is it is quite possible for there to be money creation by the banking sector with 100% reserves (incidentally for exactly for the same reasons a 10% reserve ratio doesn’t constrain deposit creation, although it does require the central bank to play along).

The PM proposal, on the other hand, does not suffer from this problem. Instead of backing deposits with reserves, we give people access to the state created means of payment itself. Thus, unlike in the current system where two types of money circulate separately – central bank created reserves which are only used by the banking sector, and commercial bank created deposit money which is used by everyone else – in the PM system there is no longer a split circulation of money, just one integrated quantity of money circulating among banks and non-banks alike.

This is achieved by removing the sight [on call] deposits from banks balance sheets and placing them onto the central bank’s balance sheet (which will be called transaction accounts). The private banks then obtain a new liability of the same size to the central bank, and correspondingly the central bank an asset from the banks. This banks’ liability to the Central Bank is to be repaid as their assets mature, with the money repaid in this way to be recycled back into the economy by the central bank granting money to government to be spent into circulation.

In effect, the central bank has ‘extinguished’ the banks’ demand liabilities to their customers by creating new state-issued electronic currency and transferring ownership of that currency to the customers in question. In a sense everyone starts baking at the central bank (although we would hire the banks to administer our accounts for us).

Lending occurs in this system when people move their money from their transaction account (held at the central bank) to an ‘investment account’. This will be broadly similar to a time deposit today – there will be minimum notice periods, however, unlike today they will also carry some risk (i.e. if the underlying assets go bad they may lose some of their money). The money transferred to the banks will then be transferred to a borrower. So in this system lending by banks merely transfers money around the system, no new money or purchasing power is created when loans are made. Because in this system because all money is held on the central bank’s balance sheet any bank can be allowed to fail, without any effect on the money supply.

So with the PM system it is possible to achieve the aims of the Chicago plan, whilst retaining double entry bookkeeping. The question is then not if it is possible, but if it is desirable. Obviously you have covered the boom bust cycle, financial crisis etc. and the unemployment and high house prices that go along with it. However there are also other issues, such as higher taxes, the effects on individual debt levels, inequality (interest transfers money upwards), subsidies and the too big to fail problem etc.”

[Andrew Jackson works for PositiveMoney, their homepage is here]

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