#45. On the money

IS MONETARY ACTIVISM THE NEW OPIATE-OF-CHOICE?

Revised 10th February 2015

For quite some time it’s been my intention to investigate the nature of contemporary money. The results of that investigation are set out here, and I hope readers find it interesting despite its unusual (but necessary) length. As ever, your comments will be much appreciated.

This investigation has led me to some very disturbing conclusions. The contemporary monetary system has become progressively more detached from the underlying “real” economy of labour, resources, goods and services. Just as the pre-2008 credit bubble detached debt from any real prospect of repayment at value, subsequent monetary activism has tended to undermine the concept of money as a “store of value”.

To explain this a little further, we need to look at the years prior to the 2008 financial crisis as an era of progressively more reckless “debt activism”.  This occurred both narrowly (in the increasingly reckless proliferation of dangerous forms of debt) and more broadly, as economies used debt to create “growth”. The latter tendency was evident across the board, with America, China, Britain, Spain, Ireland, Greece and Iceland being conspicuous examples of basing supposed economic “expansion” on the recycling, through consumption, of escalating amounts of debt.

Since 2008, and although debt levels have continued to rise – indeed, the global debt mountain has grown by a further US$ 57 trillion since then – much of the global economy has resorted to another gimmick – monetary activism, which seems to have replaced reckless borrowing as the new drug-of-choice for a global economy.

Basically, the post-2008 systemic problems have been (a) a lack of growth, and (b) a severe overhang of debt. The immediate problem with excessive debt is the cost of servicing it, and this virtually forced central banks into policies designed to squeeze interest rates downwards.

This has been applied both to policy rates (through ZIRP, or ‘zero interest rate policies’) and to market rates (through yield-depressing strategies based around using monetary policy to inflate capital markets). Though central banks might have hoped (if so, mistakenly) that this mix of monetary activism might also restore growth, the real aim has been to enable the system to co-exist with excessive debt.

In doing this, the authorities seem to have replaced (or supplemented) a debt bubble with a money bubble. If this is so, it suggests that we face another, potentially even nastier crunch. In other words, we may have compounded reckless distortion of debt with equally reckless distortion of money itself.

Small wonder that a letter-writer told the Financial Times that, whilst he now understood the concept of QE (quantitative easing), he no longer understood the concept of money.

This poses two obvious questions. First, is money losing its traditional role as “a store of value” by becoming a tool of manipulation instead? Second, has reducing the price of money (interest rates) involved undermining its value as well?

This, however, is to anticipate. First, we need to look at various interpretations of what money is and how it works.

The basics

Most people probably assume that money is a pretty simple topic, further assuming that it is supplied by the government. Neither assumption is correct. Money is an extremely complex issue, so much so that it forms a distinct and increasingly important sub-discipline within economics. Money is not created by government alone, though the state obviously has an extremely important part to play.

Let’s start by noting that, today, almost all of the world’s financial systems run on fiat money. That is, money does not have intrinsic value, and neither is it convertible on demand into a commodity with intrinsic value, such as gold. Ultimately, fiat (meaning “command”) money has value simply because the government says it has. Its acceptability rests on the “full faith and credit” of the state.

This means that we accept and use money because we trust the government and, more broadly, the financial system. This is a comparatively new situation – Britain may have abandoned the “gold standard” in 1931, but convertibility continued, on a global basis until Richard Nixon “slammed the gold window” in 1971.

Critics, of course, would argue that a monetary system based entirely on trust has put the entire financial system at risk because such trust has proved to be misplaced.

The purpose of money

Traditionally, money is said to have three characteristics. It is “a means of exchange”, “a unit of account” and “a store of value”. The latter point is debatable, to say the least – in terms of purchasing power, the pound sterling lost 94% of its value between 1964 and 2014, and the purchasing value of the American dollar declined by 87% over the same period.

According to the central banks’ own explanations, the vast majority of the money in a modern economy is “loaned into existence” by the commercial banks. Today, central bankers tell us, the banks do not “leverage up” from reserves (“fractional reserve banking”), and neither do they need to take in deposits before they can lend. If a bank lends someone £1,000, that action “creates” the money. (Likewise, money is “destroyed” when a debt is repaid). This occurs as matched transactions – when a bank lends someone money and puts it into his account, it creates a “liability” (the customer’s account) and a matching “asset” (the customer’s debt to the bank). For the customer, the terminology is reversed, his account being an “asset” and the debt his “liability”.

The amount of money that banks “lend into existence” is not infinite, but is determined by market forces and regulatory oversight. By setting interest rates, the central bank influences how much money the banks can afford to create whilst remaining profitable. In recent times, the fall in interest rates to virtually zero has negated the rate-setting tool, and it is this which has prompted central banks to “create” money in the form of “quantitative easing” (QE).

Divisions of opinion

Opinions are starkly divided about the current system. At one end of the spectrum are those who lament the passing of the gold standard, and who point at cumulative loss of value through inflation in making a case for “sound money”. At the other end lies “modern monetary theory” (MMT), sometimes called “neo-chartalism”, which views the money-creating process in a very different way, and which, as we shall see, goes on to make some assertions which can seem, according to taste, either enlightening, counter-intuitive or plain bonkers.

My own view is that money has value only in terms of what it can buy. My work distinguishes between two economies, the “real” economy of goods, services, labour and resources, and the “financial” economy of money and debt. In this interpretation, money is a “claim” on the products of the real economy, and so is debt, since debt is ‘a claim on future money’. If the creation of these monetary “claims” exceeds what the real economy can deliver, the value of money must fall, because the stock of money and debt contains “excess claims”, meaning claims which the real economy is unable to honour. If and when this happens, the “excess claims” have to be destroyed, in one way or another, typically through inflation (“soft default”) but sometimes through outright repudiation (“hard default”).

Money today – an official view

What, then, is money? As the Bank of England (BoE) explained it in a recent paper, there are really two kinds of money. The first of these is “base money”, which comprises currency (notes and coins), plus the central bank reserves of the commercial banks. “Broad money”, on the other hand, is the total amount which individuals and companies (which collectively can be called “consumers”) are able to spend. This “broad money” consists of currency and commercial bank deposits, with the latter accounting for the overwhelming majority (in Britain, 97%) of the money circulating in the economy.

To understand this in slightly more detail, we need to appreciate that the monetary system consists of equal amounts of assets and liabilities. In order to lend £1,000 to customer A, a commercial bank does not (as you might suppose) need first to take in a deposit of £1,000 from customer B. The bank can lend £1,000 to A just by deciding to do so, and by this decision the bank creates the £1,000 simply by crediting it to A’s account.

Clearly, commercial bank deposits are the dominating component of broad money. This money is not, as you might suppose, supplied by the government. Rather, the BoE explains, it is simply lent into existence by the commercial banks themselves.

To put some figures on this, “broad money”, known to the BoE as “M4EX“, totalled £1,715bn at the end of 2013, comprising currency of £67bn and commercial bank deposits of £1,648bn. “Base money”, meanwhile, totalled £365bn at the same date, consisting of commercial bank deposits and currency. For context, British economic output (GDP) in 2013 was £1,713bn.

Rational, or reckless?

At first glance – and especially to a general public which nowadays views banks with profound mistrust – the idea of most of the country’s circulating money being lent into existence by bankers sounds a bit like letting a schoolboy loose in a chocolate factory. In practice, according to the BoE, this does not give the banks an open-ended ability to create as much money as they like.

There are two main caps on banks’ ability to create money. The first of these is market forces. In order to create an excessive amount of money, a bank would have to undertake equally excessive lending, and market forces imply that this would involve attracting borrowers by offering interest rates so low that profitability would be undermined, whilst macro-prudential considerations further suggest that issues both of liquidity and of solvency would come into play.

The second limit on money creation is the base rate operated by the central bank. If this rate is lowered, commercial banks can create a larger amount of money whilst remaining profitable. At the same time, reducing the cost of debt should increase customer demand for credit. Conversely, raising base rate cramps the banks’ ability to lend new money into existence whilst remaining profitable.

Strong safeguards?

Thus described, central bank control seems extremely arms-length, and as such raises two red flags and a lot more questions. The first red flag is the assumption that banks are run rationally, and this seems a somewhat naïve assumption, because there certainly seem to have been instances of banks being managed by – let me put it this way – people of somewhat limited competence.

Second, the assumption (famously made by Alan Greenspan) that banks always put shareholder interests first seems doubtful. Recent events might suggest instead that banks prioritise senior remuneration over both dividends and risk management.

Even where banks are managed by competent people who put shareholder interests first, things can go wrong. For a start, bank assets (in other words, loans to customers) tend to be long-term, whilst deposits (the liability flip-side of these assets, for the banks collectively) are shorter-term. As well as seeking to profit from the margin between lender and depositor rates, banks are in the business of arbitraging long-dated assets and shorter-dated liabilities. One can easily see how even the most astute banker could get this arbitrage wrong.

The regulatory approach

The way in which central banks describe the creation of money might give the impression that the system is virtually ‘hands-off’, which could indeed be worrying given the failings of the banking system in recent years. Fortunately, there is a complementary “second string” to central banks’ oversight of the financial system.

This “second string” is the regulatory framework, which consists of two elements – the “microprudential”, which addresses risk at the level of the individual bank, and the “macroprudential”, where the focus is on systemic risk.

Both individually and collectively, banks are exposed to two distinct types of risk. The first is “solvency” risk, where losses on a bank’s assets (its loans to customers) could result in these assets becoming worth less than its liabilities (its obligations to depositors). The second is “liquidity” risk, where a bank, though solvent, is insufficiently liquid to satisfy demands that depositors may make upon it.

To guard against these risks, the regulatory authorities impose both capital and liquidity requirements. Capital requirements dictate the amount of risk-absorbing capital that banks must hold, whereas liquidity rules focus on the ratio of liquidity to overall liabilities.
In both cases, regulators have accepted a need to make qualitative as well as quantitative judgements. For example, two otherwise-identical banks might have differing asset or liability profiles. High-risk assets might require a higher capital ratio, whilst reliance on short-term funding has implications for liquidity risk.

To this end, regulators have developed a reliance on the “risk-weighting” of assets. Though logical, this process involves the subjective application of risk to different asset classes, and these judgments are capable of error. This weakness was typified by the under-weighting of mortgage risk in the pre-crash years.

Quantitative easing

Of course, when policy rates reach a “lower bound” – in layman’s terms, when they have already been reduced as near to zero as makes no difference – the central bank’s key rate-varying tool becomes ineffective. This is where central banks resort to a policy known as “quantitative easing” (QE) or “asset purchasing”. As its advocates explain it, QE involves the central bank using newly-created money to purchase assets (almost invariably bonds, which are tradable debt paper), principally from investment institutions.

By creating additional demand for bonds, this raises their price. As the interest rate (“yield”) of a bond is its (fixed) annual payment (“coupon”) expressed as a percentage of its price, increasing bond prices pushes market interest rates downwards, carrying out by proxy a lowering of rates that, in more normal circumstances, would be undertaken simply by reducing the central bank’s policy rate. Proponents of QE deny that it involves “printing money”, and claim (through the principle of matched assets and liabilities) that it is no more than “a balance sheet operation”.

Critics are entitled to claim that, even if QE does not amount to “printing money”, it has at least two potential drawbacks. First, it can inculcate complacency about money, undermining its role as a “store of value”. Second, it seems almost undeniable that QE has contributed to the widening of inequalities within the economy.

Money off the leash?

Opinions about the current monetary system range from “sound money” conservatism at one end of the spectrum to the radicalism of MMT at the other. The conservative view is a pretty straightforward belief that money’s primary characteristic should be retention of value, and that anything which puts the emphasis elsewhere plays fast and loose with this fundamental role.

The radical view, as exemplified by MMT, looks at money in a quite different way. The basis of MMT is that fiat money, wholly controlled by the state, cannot be viewed in the same way as traditional forms of money. For one thing, a government cannot go bankrupt in a currency that it creates and controls itself.

This idea can be traced back to a 1924 work by Georg Friedrich Knapp, whose thesis (known as “chartalism”) advocated replacing the then-prevalent gold standard with paper money. The central argument here is that government does not need to tie the value of money to gold, or to concern itself overmuch with the quantity of money, because it can create money, or tax it away, through the fiscal system. If the government wishes to stimulate the economy, it spends more than it takes in through taxation, an interpretation more generally associated with Keynes. Indeed, there seems little doubt that Knapp and chartalism helped influence Keynes’ work.

From the view that taxation is a lever for stimulating or restraining an economy, it is not too much of a stretch to contend that this is the main purpose of taxation – in other words, that tax is used as a tool of monetary policy, and not principally as a way of funding government expenditures. If this is so, it can be argued that governments should almost always run deficits, and standard GDP equations can seem to demonstrate that the private sector can only run a surplus if the state maintains a deficit.

What MMT describes, then, is a government which: can engineer policy through its control of money; cannot go bankrupt in its own currency; and is not reliant on taxation to fund its expenditure. Presumably, then, neither fiscal deficits nor public debt are particularly important, and governments need not worry, either, about the cost of future welfare commitments.

If I have summarised MMT correctly, it is certainly at stark variance with standard practice, where governments attribute huge importance to deficits and debt. This said, some critics of current policy worry that central banks may be moving towards a more MMT-based stance, at least in the sense that money’s role as a “store of value” is being undermined by its use as a policy tool.

Let’s be clear on one point here. Acceptance of the mathematics of MMT means accepting that MMT is an accurate description of the contemporary monetary system. It does not, however, mean that we must endorse the efficacy of the system thus described. In short, MMT may provide an excellent guide to a deeply flawed system

Monetary activism

Those of us who worry about monetary activism note how central banks, having lost the ability to apply further stimulus through rate-lowering, have resorted instead to QE, the effect of which has been to inflate bond markets and thereby lower market interest rates. Those who have enjoyed the bond market surge of recent times may be failing to question the value of the money in which they may ultimately be repaid. Meanwhile, buying government bonds (debt), from institutions which then go straight out and buy newly-issued government bonds, can be depicted as paying off debt with newly-created money, however hotly central banks deny this accusation of “debt monetisation”.

From this, it follows that a “race-to-the-bottom” currency war might be one logical consequence of the current fashion in monetary activism.

It is at least arguable that the bond market has become detached from the underlying fundamentals, which should be rooted in the NPV (net present value) of future income streams, appropriately discounted to capture the time value of money in the future. If one buys bonds solely on the basis of how much further their price may be pushed upwards by central bank policy, the implication is that one is speculating, not investing. Whilst speculation (rather than investment) can be a perfectly appropriate way for an investor to behave, it does seem a bizzarre way to conduct monetary policy.

Points of reference

Our understanding of money seems to be in a state of flux, with the debate polarised between those who emphasise the fundamental “store of value” role of money, and those who, instead, see fiat money as a malleable component of monetary policy. If you agree with the latter school of thought, you can take a relaxed view of the future, in which debt, deficits and austerity are outmoded considerations. If you are of the former persuasion, however, you might worry that central banks are positioning us for a disaster in which money loses all credibility as a store of value.

My response is to fall back on three, I hope well-founded, observations.

First, it is perfectly possible for the value of money to be destroyed, in ways that the official line about balanced assets and liabilities apparently fails to take into account. If a bank decides to lend money to Mr A, and creates money for this purpose, assets and liabilities do indeed match – Mr A has an asset (say, £200,000 in his bank account) matched by a liability (his £200,000 debt to the bank). But what if he spends this money buying a property which then falls in value to, say, £150,000? It seems pretty clear that £50,000 has been “lost” or “destroyed” somewhere. Unless you believe that Greece (for instance) really can repay all of its debts at full value, the same logic can be applied to macro-scale debt as well.

My second observation, linked to this, is that money has no intrinsic value. This is certainly true of fiat money, which you cannot eat or put into your fuel tank, but is true, too, even of commodity money like gold, which you cannot eat either, and whose value also rests fundamentally on your ability to exchange it for items having utility. By this standard, then, real wealth lies in physical items (like land, machinery, resources, food and labour), though this definition of value clearly extends, also, to “quasi-physical” assets like intellectual property, human capital and brands.

This leads me to my third observation, which is that the ultimate role of money is as a proxy for the “real” economy. Specifically, money has value to the extent that it can be exchanged for what I call “things with utility“. Whatever happens to money, a farm has value in producing food, a mine has value in supplying minerals, and a house has value in providing somewhere to live.

Conclusions – dangerous territory

I conclude, then, that we are in very dangerous territory. Current monetary policy is dominated by the imperative of manipulating interest rates downwards, accomplished in part by inflating capital markets. As well as creating a gigantic bubble, this policy risks undermining the role of money as a store of value. Conservatives are probably right to say that this courts disaster, because the value of a currency depends fundamentally on the relationship between money on the one hand and, on the other, “things with utility”.

I further believe that monetary activism can all too often be a futile attempt to create wealth and growth where they do not actually exist.

In short, a system which reduces the price of money (interest rates) close to zero may be doing exactly the same thing to the value of money.

We may simply have replaced the folly which created the crash with a new folly which compounds its consequences.

72 thoughts on “#45. On the money

  1. Choo-Choo! Hark do you hear the sound of the hyperinflationary express? It’s not a light at the end of that tunnel…

  2. Thank you so much for this. I have no background in economics but this helps enormously. The explanations of QE I’ve read only ever refer to what happens to the bonds and not what a government does with the money – do they really think they can keep this going for any length of time?

  3. “My own view is that money has value only in terms of what it can buy”

    “But … but … CPI inflation is falling towards zero !”

    We’re in a situation where
    a) the industrialisation of the low-wage, high-intelligence Far East and
    b) mass immigration and consequent real wage decline for most
    have reduced the cost of both manufactured goods AND services
    (en passant, this nonsense about deflation delaying purchases – who in the real world puts off buying a flat screen TV or a computer on the grounds that it’ll be cheaper next year, as it has been for 25 years now?)

    while “things with (wealth-producing) utility” are getting very pricey – agricultural land and property being prime UK examples.

    • Hello

      I couldn’t, here, go into inflation and deflation. Falling inflation reflects really sluggish economic activity, low interest rates, downwards pressure on real wages, and continuing weakness in consumer demand, combined with consumer caution.

      As for deflation, you are quite right – computers and tech have coped fine with falling prices, and the US economy thrived during decades of deflation in the nineteenth century. The real problem with deflation, in today’s high-debt economy, is that deflation makes real debt levels grow whereas inflation helps devalue them.

  4. Tim,

    An offshoot of MMT called “monetary realism” founded by a guy called Cullen Roche has some interesting insights, they’ve got a pretty good paper on the operational realities of the modern monetary system here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1905625

    They’re an interesting lot, in that they advocate a more hands-on engineering type approach to understanding money and economics.

    To add to the discussion about MMT, my impression is that they don’t think public debt/deficits are a major issue, but that’s not to say they’re unimportant. They still need to be well managed by competent people, because obviously paying off all a countrys bond holders at the stroke of a key would likely create mayhem.

    Another way MMT might be hamstrung (if it does indeed represent the most accurate model of how the monetary system/economy works) is that many people seemingly don’t know of or understand it’s conclusions and implications. Therefore there are limits imposed by political/perceptional constraints.

    I think my big worry in all this comes from the fact that very few people in the MMT scene (from what I’m aware) have thought through various edge case scenarios. Such a situation would be represented by something like peak oil, or peak net energy, which we might well be near. Then again, I doubt that there’s a single monetary or economic system on the planet which this wouldn’t destabilise.

    • Thanks. I think the fundamental issue here is what you rightly call an “engineering” approach to money. Granted this could be done well, or done badly – but should we be engineering money at all? Wouldn’t it be better left as a ‘neutral’ store of value, something everyone can rely on?

      If we start engineering money (“monetary activism”), it seems to me that we are “tinkering with the foundations” because we think we can improve the house that way.

      My approach (albeit a dark one) is to combine this tinkering with today’s report on global debt (a further USD 57 trillion added since the crash), and it looks to me that the authorities are playing smoke and mirrors.

      I’m sure you’re right about the edge case scenarios. Also, MMT could put a dangerous temptation into the hands of politicians and others who don’t really understand it?

    • Tim,

      When I said “engineering type approach”, I really meant more to the understanding of the operational realities of how the thing works. as opposed to “monetary engineering”. An analogy might be to consider how a physicist and an engineer would look at a plane. To a physicist it’s things like the interaction of gravity with fluids, defined by the navier stokes equations and so on. To an engineer these both play a part, but there’s also a much dirtier understanding of the various operations of things like engines and what have you, and how these interact and function to form a working system.

      I think that the point they’re trying to make is that you’d take your plane to an engineer to have it fixed, and in this instance many of the economists who are looking at the state of the economy are more akin to physicists, and don’t have a clue about the dirtier internal workings of the monetary system, and as such some of their proposed fixes won’t work because they don’t really understand some of the key parts of how it functions under the hood.

      As an example, the mmt crowd would NEVER have proposed a system like the euro, because they’d argue it couldn’t possibly work in it’s present format. However since lots of other government economists fundamentally misunderstood how monetary systems function, they went ahead with it.

  5. Sam:

    Understood. With the euro, I think anyone (whether engineer or theorist) should have known that it wouldn’t work – fiscal and monetary policy need to work together, so one currency with umpteen budgets was always a recipe for failure.

  6. Thanks TIm – I have struggled with money and fractional reserve banking for a long time and finally I have found an explanation.

    The concept that a bank doesn’t need a deposit in order to lend is quite amazing. But banks do borrow, British banks were borrowing heavily on the wholesale markets whent they froze in 2008., Is this borrowing purely for liquidity purposes as deposits ebb and flow i.e. why does a bank need to borrow at all if it can magic money into existence ?

    Is it fair to say that regulator capital/leverage/liquidity ratios are also major constraints on the limits to a bank expanding a balance sheet. Post 2008 these ratios were tightened which led to banks being forced to shrink balance sheets and hence lending. Hence not surprisingly banks reduced lending and have been heavily criicised since.

    I did expect inflation to take off as a result of the massive QE and I am surprised it hasn’t. The normal punishment for a country that debases its currency is a downward adjustment in its currency. For a country running massive external deficits this would risk triggering an inflationary spiral that would ultimately end in inflationary default.

    But this hasn’t happened – simply because it can’t. If a big debtor defaulted in our fragile global economy then the dominoes would fall, a complete breakdown of the world financial system and with it global trade – 2008 gave people a glimpse of the apocalypse.

    The big creditors and debtors have a gun to their heads – they have to continue to accept currency debasement of the central banks else its game over for everybody. For the moment the central banks rule.

    My feeling is this fragile stand-off can continue longer than logic might suggest – it will only stop when it hits a real world constraint What will happen when those debased currecies are being used to compete for diminishing oil supplies – thats the question.

    • Thanks Dave. I had two reasons for writing this article. First, I felt readers would welcome a reasonably clear explanation. Second, though I felt reasonably comfortable with the subject, I felt I needed to discpline my thinking by putting a structure on it, so I learned a lot myself doing this. The results aren’t exactly reassuring, are they?

      The interpretation of banks “lending money into existence” is the official explanation. To read the official view is to learn (?) that reserve ratios don’t seem to matter, which to me is nonsense.

      So my guess is that there are two official positions here. The monetary policy one emphasises how banks create money, restrained by interest rate policy. But there is also – I hope! – a regulatory process that looks at reserves ratios and liquidity/solvency issues. If this is so, then where these two meet is “commercial bank reserves”, i.e. money belonging to the banks but lodged with the central bank. Interestingly, the big change in the numbers since QE came in is in the expansion of these “commercial bank reserves”. So has QE, as well as boosting markets and thus depressing yields, also buttressed banks “at-call” reserves? To explain, if Mr A pays Mr B, the central bank is informed, and transfers money from A’s bank’s commercial bank reserves to B’s bank. So in that sense the reserves held at the central bank are the “spine” of the system and a clearing house for transactions (I hope this makes sense?).

      If all this is right, then the central bank (a) uses these reserves to protect stability, and (b) used QE to increase them.

      I think your explanation about the big creditors having a gun to their heads is right, and this would indeed require treating big debtors the same way – hence the hard line taken towards Greece?

      Clearly all this is complex – I doubt if 1 in 1000 of the public have the faintest idea how it works – but we have a real need to know (hence my article). It all looks to me like a fragile house of cards.

    • My reading of the below paragraph is that there is no constraint on lending. Banks are expected to manage their risks by holding enough liquid reserves – and in 2008/2009 my limited understanding was that much of their liquidity is borrowed from each other to meet short term requirements. When lending to each other stops – just phone the GovernBank and wail for a tax payer bail out.

      From: http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf

      “Managing the risks associated with making loans Banks also need to manage the risks associated with making new loans. One way in which they do this is by making sure that they attract relatively stable deposits to match their new loans, that is, deposits that are unlikely or unable to be withdrawn in large amounts. This can act as an additional limit to how much banks can lend. For example, if all of the deposits that a bank held were in the form of instant access
      accounts, such as current accounts, then the bank might run the risk of lots of these deposits being withdrawn in a short period of time. Because banks tend to lend for periods of many months or years, the bank may not be able to repay all of those deposits — it would face a great deal of liquidity risk.
      In order to reduce liquidity risk, banks try to make sure that some of their deposits are fixed for a certain period of time, or term.(2) Consumers are likely to require compensation for the inconvenience of holding longer-term deposits, however, so these are likely to be more costly for banks, limiting the amount of lending banks wish to do. And as discussed earlier, if banks guard against liquidity risk by issuing long-term liabilities, this may destroy money directly when companies pay for them using deposits.”

    • Thank you, I think this clears up a great deal. What we are looking at, then, is a blend of monetary policy (what my article is mostly about) and macro-prudential regulation. What we really need from here, it seems to me, is an article putting both together?

  7. What we really need is a system where the unit of exchange provides a clear signal to its’ users about the health of their environment, that responds automatically to conditions, and does not need any Soviet Central Planning Committee to manipulate and control. But that is just my 2C

  8. Thanks Dr Morgan for setting this out with such clarity.

    Having a Science/Engineering background my ‘gut feeling’ is you are correct to be sceptical about MMT. However much the MMT advocates think they can do the economic equivalent of walking on water..well they darn well can’t.
    Scientists know instinctively that you cannot create something from nothing..which is what MMT seems to do. Similarly real wealth or economic success cannot be created from nothing…but the day of reckoning when decades of living beyond our means can be delayed so that it becomes ‘somebody else’s problem…

    Your recognition of the importance of energy in the economy has helped me focus my view which i’m trying to sketch out here ….applying classical thermodynamics to economics would perhaps look something like this….

    Useful work (goods or services that people value ) = Energy (human and mechanical) X efficiency of energy conversion.

    So a country with efficient working practices,that add high value, with reasonable energy costs will produce large amounts of useful work and be more prosperous than one that doesn’t have these advantages. It’s real GDP would be high.

    It is this real GDP that ultimately underpins the value of money. The money and market manipulators are playing with fire if they think they can ignore these fundamentals by driving down bond yields etc.

    A country can only become more prosperous by exploiting more energy and/or harnessing it more efficiently.

    Unfortunatley much of what now contributes to GDP is a sort of ponzi scheme where borrowed money is channeled into consumption. Or other activities that to borrow Dr Morgan’s terminology can usefully described as ‘taking in each others washing’.

    The economy, i suspect isn’t anything like as big as we are led to believe and that the recent growth , is just an illusion.I suspect that the UK’s real GDP has been in steady decline – I’d really like to see how big a proportion of the Uk’s economy could be described as having real intrinsic value ?

    It seems that both money and the means by which we measure key economic indicators is being distorted to a dangerous degree.

    .

    • Kenneth

      Thank you. First of all, I should say that my problem with MMT isn’t the theory but the practice. As Yogi Berra put it:

      “In theory, practice and theory are the same. In practice, they aren’t”

      So we find ourselves considering (i) that MMT argues that governments needn’t worry about deficits or how much they spend, but (ii) common sense and experience disagree.

      This suggests to me that these arguments have a missing or misunderstood “not-common denominator” somewhere, and that is surely money – in other words, might “money” mean one thing to the MMTers but something else to what I might call “pragmatists”?

      We then come to something you mention, which is validity of measurement. There are huge holes in our measurement of GDP. Imagine that the state employs 10,000 people to dig holes, and another 10,000 to fill them in. No value is added – but both the digging and the filling in add to GDP.

      Just suppose, for a moment, that MMT is right – BUT that the data available is very poor. That would make MMT a good description of bad data…..

    • Dr Morgan thanks again,

      I was recently debating with an advocate of MMT who was arguing that deficits don’t really matter per say and we should be far more relaxed about the size of our national debt. I put the argument to him that we should pay gangs to go around smashing windows so as to provide jobs for council sponsored glaziers and hence stimulate the economy and provide jobs.
      He said that it would probably do some good!.

      To me this kind of thinking is crazy as it ignores the waste of human potential. There must be a cost in educating, housing and NHS treatment for each individual which is a debt owed to the state.

      If that persons potential is diverted to worthless activities, that debt must never be repaid in a real sense?. How can that debt be repaid… unless the real value of money is distorted to such a degree that the money used to repay that debt is as worthless as the work done to repay it ?

      It seems to me it is MMT’s flaw that it doesn’t fully recognise the hazard of wasted human and other forms of energy’s potential.
      It just lumps them all together.
      If my local council provides a range of non jobs with a subsidised cars they are wasting both the employees time, roadspace, the people they come into contacts time and the petrol and diesel they are using etc.

      Useful Energy output =Energy X Efficiency of conversion

      Perhaps if activities that are equivalent to digging holes and filling them in again were given a negative efficiency coefficient and conversely an engineer introducing a succefull new process a positive coefficient then perhaps we could start to unpick the real value of the economy?.

    • Kenneth

      I think you’re maybe a bit mistaken about some aspects of what MMT proposes. MMT essentially just views money as a tool which can be used to facilitate exchange, nothing more. Generally mmt people view the availability of real resources as the main binding constraint, not the the availability of something like money, which ultimately is a fiction anyway. Combined with the insights about the fact that a government which is soverign creator of it’s own currenty can NEVER default, unless it chooses to, this leads to some unique insights.

      For example, government deficits generally aren’t as big a problem as they’re made out when they’re in that government controlled currency. There are good and bad times to run government deficits, and a time such as the last 5 years, when households have been over-leveraged with too much debt on their balance sheets, generally represents a good time to run deficits.

      However they don;t just think that infinte debt is a get out of jail free card. There’s the recognition that using debt to speculate on housing, instead of investing in productive assets, is a bad idea, for example. And there’s certainly the recognition that things like peak oil or whatever pose a serious threat.

      If you’re itnersted in a thermodynamic approach to economics then Tim Garrett at Utah is your man:

      http://onlinelibrary.wiley.com/doi/10.1002/2013EF000171/abstract

    • Thanks Sam,
      I certainly don’t pretend to understand everything about MMT or how the economy works – I suspect it’s too complicated for almost anyone to understand fully and perhaps that’s part of the problem. I am most critical of the culture of MMT that has led to a detachment from real world realities. Dr Morgan suggests that the fault line could be a collapse in the value of money?.
      I suspect there is a link between the modern trend towards self worship and the need for instant gratification which fits in with the relaxed spend today money tokenism of MMT.

      I recognise mine is a minority view that MMT and Keynesianism has deep and fatal flaws. We had Gordon Brown re labelling all spending as ‘investment’ or ‘stimulus’ which ended very badly. The coalition have followed the same path of ‘extend and pretend’.

      Despite Mr Osborne’s and Mr Cameron’s rhetoric about ‘mending the roof while the sun shines’ the deficit still remains stubbornly high and the national debt eye wateringly big. (But it’s no bid deal okay because the MMT people say so).
      Perhaps a few more sceptical voices are needed.

    • Well you are certainly muddled in your ideas about MMT. Fancy saying it’s detached from real world realities! Where did you see that? Why don’t you go back to the sources. There you’ll find MMT is a “NUTS&BOLTS” description of how modern money works. No space there for waffle. It’s clinical. You might be referring to opinions about theories that have been associated with MMT. but MMT in spite of its name is NOT a theory. It’s bit misleading in accepting that name. The Reserve Bank of Chicago describes it more accurately as Modern Money Mechanics.
      To hopefully set the record straight, Watch this video as one example of what it’s all about:

    • Kenneth,

      I kind of see where you’re coming from, but to be honest MMT very very little acceptance or influence within the mainstream and is still very much considered heterodox economics in most places, so any problems which anyone might have with the current economic system (I share Tim’s view that the gap between real wealth and the claims on that real wealth represented by money is growing quite ridiculously large) really shouldn’t be directed towards it as a school.

      At it’s heart, as John has mentioned, MMT tries to be a “bottom up” description of the money system. That is, it tries to start with how the modern monetary system actually operates on a nuts and bolts level (looking at how bank balance sheets work, the concepts of central bank reserves, et cetera) and works its way up from there. It ends up in contrast with some of the older schools of economic though, which are attached to an older model of how money works. Under an MMT understanding things like the “money multiplier” are essentially shown to be nonexistant.

      There’s a very interesting, and somewhat enlightening, article on MMT and how it relates to austerity available here, which might help you better understand where it comes from as a school of thought:

      http://www.renewal.org.uk/articles/modern-money-and-the-escape-from-austerity

  9. Tim, I have had a longish look at your thesis here. I think the dangers you point out are real enough, but I have some comments on detail. In random order, as I remember them;
    Re MMT, you say it says is totally controlled by the state. That is not at all true. Only the creation of currency is controlled by the state and of the tiers of government only the monetary sovereign Commonwealth or Federal section of government can do that. Most of the money, like 97% is created by banks. Central banks have no control of the money supply. All they can do is try to regulate it through interest rates. and monetary policy of taxation [regulated by the government].
    There are many definitions of money as you point out. There is vertical money, which is what the government creates and affects net financial assets. There is horizontal money, bank credit money, which has no effect on net financial assets, as that balances to zero. Normal accounting.
    The central bank has no money and no need of money. It just creates it when it needs to pay a creditor. Which requires that all banks have accounts at the reserve, their money.
    I have issues with your third observation about money. You haven’t specifically picked up on wagers [aka derivatives etc] For me this is all shadow banking because the money is not shown in the national accounts, although IMO it has a big effect on widening the gap between the wealthy extreme and the rest of us. Only wealthy investors can play. I imagine your comment about things with real utility don’t include such “play” money. It has real consequences because it contributes to our unsustainable consumption of real resources, but in the day to day running of an economy it isn’t noticed. This part is utility free.
    In your First observation about rises and falls in value, it is just another example of gambling. losses are worn by the loser, and vice versa. The money comes from nothing and is destroyed/created. I don’t see why it has to be taken into account except when the account is settled. Mortgages are gambles – but they have legal protection. Even wagers relating to insurance are protected now! The first casualty of that was Enron.
    Returning to MMT, I really don’t see how you can criticise the nuts and bolts part of it, but you are.
    It just describes what happens in the economy today. It’s not a theory per se, although people are now doing that to some extent, with job guarantees, etc .
    My conclusion is a bit different from yours. The unregulated creation of money through unregulated banking is credit creation in excess. A lot of it is not real assets, but gambling money. Just the same we are creating credit with little regard to creating real assets. I think there is a fundamental “elephant in the room ” here. WE DO NOT HAVE SUFFICIENT REAL RESOURCES any more to supply real assets. We only have human resourcefulness left.
    We are well into deflation now and the growth we so crave and on which credit systems rely is barely possible and will soon be impossible. Our civilization is in decline and began back in 1971.
    Nothing to do with oil peaking, but with overexploitation of the planet. But Tim you well understand all that!

    • John

      Thanks. I have no problem with your comments until we get to wagers, loss of value and so on. What MMT and the central banks’ official explanation have in common is the concept of matching assets and liabilities, but I believe that value can be destroyed all the time. Greece is an example – it is surely inconceivable that Greece can ever repay its debts. As I replied to Kenneth, I don’t have much of a problem with MMT as a theory, but I question some of the policy prescriptions, and I doubt the quality of data.

      I like very much your point about gambling money – I think this gets to the gist of this. But, unless I’m missing something here, how does this money differ from the money that Mr and Mrs average spend on groceries?

      On your broader point, I think we agree 100% that credit creation is far in excess of “real” value in the economy – indeed, this was one of the two central arguments in “Life After Growth”, of course.

    • This is a reply to Tim.
      RE debts they are spending brought forward. Remember the old lay-by system? It has been superceded well and truly. Most now wouldn’t know what it was. Instant gratification versus paying for it first. That’s symptom of our problems.
      There is no solution now IMO. not in the sense of paying it back, although loan contracts for mortgages are likely still working OK.
      These need protecting and are subject to laws. However the $trillions in derivatives shouldn’t have legal protection [ but insurance based ones do]
      Frankly these debts will eventually be written off, a debt jubilee.
      That money is the same as any money except it is not much of a contributor to GDP. A lot of GDP data is silly and anti beneficial, like including all the prison system, but we are stuck with it at the moment.
      I can recommend accessing this blog about Monetary Sovereignty.
      http://mythfighter.com/2015/01/07/sneak-attacks-cut-social-security-increase-the-gas-tas-widen-the-gap-between-the-rich-and-the-rest/
      Rodger Malcolm Mitchell likes MMT but also has issues with its application. He uses plain english.
      If you want serious discussion about MMT by an insider economist then consult billyblog Bill Mitchell, an Australian academic
      http://bilbo.economicoutlook.net/blog/?p=1623
      He has a lot of data and can parse the most complex questions.
      Having an issue with MMT however because it says debts don’t matter is a misreading of the data. Debts do matter but only if they cause excess spending over what the latent worth of the economy is. MMT doesn’t advise such an action. It advises to spend up to this point, and chosen by the parliament.

    • John:

      Conventionally, debts are consumption brought forward but saving is consumption deferred. So if A borrows, he consumes now, but if he is borrowing from B, then B is deferring his consumption – so B is handing consumption today to A, in return A will make up that consumption later, plus interest. Instant gratification is indeed a big part of the problem (and is treated as such in my book, with no holds barred).

      As I plan to show in a future article, the UK is an example of this. UK growth looks quite good – but have you seen what’s happened to the net international investment position (NIIP)? This is debts owed to us by foreigners, plus overseas assets, less debts we owe to foreigners and their assets here. In three years this has slumped from -£70bn to -£450bn. So we have gone a net £380bn into hock over three years – and we talk about “growth”?

      I still fail to see how debts can be written off (as indeed they must be) without creditors losing out – and if this happens on a big scale, who on earth is ever going to lend after that? Current interest rates are already giving the clearest possible signal – “don’t save”. I see a big bond market correction coming.

      Thanks for these links, very interesting and I shall follow up.

    • Yes, Tim, we agree. I have not heard of NIIP, but I have seen charts that show Brits owe an enormous sum for every person, much worse than for the USA.
      I first came across the debt jubilee idea in a youtube presentation by Bix Weir. He painted a pretty scary position with all the banking shenanagins, saying that the DTCC [Depository Trust Clearing Corporation] is hopelessly behind in doing that because of the high speed trading.They miss 300 million trades per day he said. It is supposed to hold all documents in storage under the name Cede and Co at 55 Water St, NYC, which got flooded by Sandy. The banks have ceded their ownership of securities to Cede and Co. I don’t know for sure, but it makes it seem the banks don’t actually own their mortgage backed securities [?]
      This is the video ;http://www.youtube.com/watch?v=-zzSAoD2mzU
      Anyway a debt jubilee will have winners and losers. It’s likely the winners will be debtors with mortgages, because the banks will not be able to foreclose on them[!]
      Also its mentioned in David Graeber’s book “Debt-the first 5000 years” In his final paragraph as his answer to the problem. He points out the “flagrant lie” We don’t ALL have to pay our debts – only some of us do. He calls Debt “the perversion of a promise” corrupted by both maths and violence.
      Like your graph in Perfect Storm [fig.5.12] we are on the cusp of an energy cliff.
      To me it seems we are on the cusp of a debt cliff also?
      Funny how no one can forecast which of these pressures will burst first or for how much longer we can keep on keeping on. But we all agree it’s ordained by mathematics bounded by our finite world.

    • John,
      The purpose of this comments section, which seems to have escaped your attention in your reply , is to comment upon the views expressed by Dr Tim Morgan (who’s views I greatly respect by the way)
      .I don’t feel particularly isolated in my view that MMT ignores a number of real world realities. So forgive me If i carry on with my ‘muddled’ thinking.

      The economist Paul Krugman argues that ‘MMT goes too far in its support for government budget deficits and ignores the inflationary implications of maintaining budget deficits when the economy is growing’.

      MMT is a theory it isn’t newton’s laws of motion – the clue is in the name.
      It is an influential theory that has gained traction amongst spendthrift governments for it offers them a degree of (misplaced?) comfort.

      MMT has only received attention recently due to it being a “policy polemic for depressed times”. Marc Lavoie (another economist) argues that whilst the neochartalist argument is “essentially correct”, many of its counter-intuitive claims depend on a “confusing” and “fictitious” consolidation of government and central banking operations.

      Dr Morgan describes some of MMT’s assertions being in a range between ‘enlightening to plain bonkers’. depending on your point of view. Hardly a description of a ‘Nuts and Bolts’ description of ‘how modern money work’s.

      Whether MMT is shaping monetary policy or simply describing it I do not know but It must have some influence.

      Dr Morgan says ‘Some critics of current policy worry that central banks may be moving towards a more MMT-based stance, at least in the sense that money’s role as a “store of value” is being undermined by its use as a policy tool.

      ‘What MMT describes, then, is a government which: can engineer policy through its control of money; cannot go bankrupt in its own currency; and is not reliant on taxation to fund its expenditure’. A recipe for disaster perhaps?.

      In Dr Morgans words we are in ‘dangerous territory’.

    • We are certainly in “Dangerous Territory” and it’s possible all this argy bargy about money is just rearranging deck chairs on a sinking civilization.
      Just the same you still misunderstand MMT or, as I prefer to call it Modern Monetary Mechanics. This is what the Reserve Bank of Chicago uses to describe it.
      You obviously decided not to watch the video talk I sent. It was supposed to help you.
      But your mind is made up.

    • Kenneth, John, Adam

      Thanks for all of your contributions here – I have read the Yanis article, and have watched the video. I find the interchange of views extremely helpful, and I certainly don’t expect everyone to agree with me, or with each other!

      I’m going to update the article to reflect some of this. But let me just say two things. First, I don’t doubt that MMT is an accurate description of how the current monetary system works. Second, though, the view I’m coming to is that I don’t like the system that it accurately describes – ever since 1971 (when the global link to gold via the USD ended), the system has been cut adrift from any real anchor to value. Maybe this is my (small c) conservatism.

      Yanis presents a very good analysis of how things have gone wrong. Though he sounds critical of America, I can cite American writers who take a very similar view. I think I was a rarity, in the City anyway, in expressing grave doubts about globalisation, and about excessive de-regulation.

      It seems clear to me that the monetary system is out of kilter with the ‘real’ economy – as you know, I see the real economy as ultimately an energy equation, remembering that “energy” includes labour, food and broader resources.

      What I’m aiming to confront is this – ‘having created global imbalances, and a debt bubble, are we now creating a money bubble as well?’ My feeling is that we are.

  10. Dear all:

    I’m planning to update this article to include some of the issues raised here, and also bring in the regulatory point that I left out of the first version.

    Tim

  11. Yes, Tim. The system MMT describes is what’s happening and I agree its a bad one. I often say the debts are so enormous we will just clear the slate, but they have made our consumption of resources terminal for our civilization. It seems we only survive because of credit growth. An economy must continually outgrow its debt, an endless treadmill! This will cease, and by extension so will our civilization.

    • My pleasure, Tim
      On another note, I am a fan of your document “Perfect Storm” from 2012.
      Have you revisited it since and can point to any updates?
      It’s quite a remarkable document!

    • Thanks. My book “Life After Growth”, published in late 2013, is an expanded “Perfect Storm”.

      Also, if you go to my blog article on 9th January 2014, you will find “A brief guide” to surplus energy economics, which can be downloaded.

  12. THIS ARTICLE HAS NOW BEEN REVISED, incorporating (a) a description of the regulatory system, and (b) points arising in this discussion. As a temporary guide, the revisions are underlined, though I plan to remove this underlining shortly.

  13. Tim,

    I think you have it bang on when you say that you don’t like what MMT describes, though it is accurate. Something that one mmt writer once said went something along the lines of “no matter how much debt we have, out children will still be able to consume what they produce”, and I think that to an extent this is true, especially when one looks at it from an energy/resources real-world based perspective. However the system that mmt describes still operates firmly in the “perpetual growth” paradigm, and believes that our children will undoubtedly produce and consume more than us, and that there are no biophysical limits, and therefore is fundamentally flawed.

  14. I take issue with those that suggest MMT is just a description or analytical tool for the economy that is universally correct.
    It is a doctrine, largely a restatement of elementary Keynesian economics. I’m surprised to see Dr Morgan backtracking somewhat in his view – he was correct in his original article to link the doctrine of MMT to the destruction of the intrinsic value of money. Why are the proponents of MMT so thin skinned?.

    Paul Krugman – ‘ MMT goes too far in its support for government budget deficits and ignores the inflationary implications of maintaining budget deficits when the economy is growing’.

    Why would a senior economist have an issue with MMT if it is just a theory to describe events with no influence?.

    MMT is arguably a prescription for the economy not simply a description as some would seem to believe. It takes the heat out of concerns about deficits and trade imbalances which can’t be a good thing.

    It offers a prescription of (more debt and phoney money) that Mr Osborne et al seem only too willing to take as it is the easy option.
    I note that the Coalition’s ‘long term economic plan’ is to channel more borrowed money into consumption, keep immigration high to support growth in GDP and interest rates low while making token cuts in public spending. Perhaps some fresh thinking is needed. ?

    • Seriously Mr Moore your attitude to MMT is just ridiculous! Taking issue with MMT as you describe it is like complaining about the alphabet because you don’t like someone’s language.
      You seriously refuse to learn which you have demonstrated, so you should desist until you do learn. You are not contributing except rubbish.

    • I don’t think I’m backtracking. What I’m saying is that MMT may well describe the system, but IF it does then it’s a dreadful system.

      Agree with you about the UK plan – the UK economy (though it’s not the only one) looks like a pyramid scheme!

  15. Thank you,

    I appreciate your replies although not the arrogant patronising tone . The fact that you are making spiteful remarks instead of engaging with the points I am making reflects badly upon the value of your contribution. Perhaps you need to learn better manners when dealing with others whose opinions you disagree with ?.

    Ref:Article: The Emperor Still has no Clothes
    http://www.thomaspalley.com/docs/articles/macro_theory/mmt_response_to_wray.pdf

    Perhaps you would like to tell the author of this article he is also talking ‘rubbish’ and that he needs to ‘learn’ not to offend the religion of MMT?.

    Was it Mr Blair that told reporters to sit down and ‘stop being bad’ when they asked awkward questions..I know how they must have felt now to be so chastised.

    • I’ve heard about Talley being critical of MMT, It’s mentioned in Wikipedia. However in reality he is just muddying the waters probably being paid to stir up trouble[?]. His entire argument is based on one essay [“T&W”] about MMT. He’d be better served to take on Bill Mitchell, who has a much deeper understanding of ordinary economics then you or I do. Talley says he is an “independent analyst” which could be me too, although in my case it’s just a hobby, far removed from my own profession but important enough to be worth studying.
      The reason I took issue with you is that you have taken a polemical line with obviously flawed reasoning which showed you are ignorant of MMT. The support you quote is likely suspect [particularly in this age of spin and lies ]. I suggest you take the time to watch the video talk I listed. Then have a rethink. It’s pretty straight forward! and basically simple . It’s certainly not radical in the sense Talley writes, but it is an antidote to the rubbish spouted by politicians and journalists. As to having no clothes, Talley trashes the value of his argument with one phrase. He’s just out to make trouble.

  16. I think we need to be quite robust about criticism of our ideas – personally, I can take a lot of criticism about my views (and believe me, I have had to!) but it should never be personal.

    • I totally agree.
      I remember around 2004 discussing the economic situation with a friend saying that it was all too good to be true etc. The merry go round of rising house prices, pay and public spending making us all feel more comfortably off without corresponding increase in effort. Manufacturing was going downhll, the public sector getting progressively more bloated…It was a miracle……
      Ofcourse plenty of people were fooled and dutifully voted Labour….There is no shortage of stupid people out there.
      Brown’s boast that there would be no more ‘boom and bust’ seemed hollow to me. I was aghast when the Conservatives matched Labour’s reckless spending plans.
      No doubt plenty of clever and talented economists in the treasury and beyond thought everything would be okay apart from a few lonely outsiders. Perhaps there were theorists about then that saw the dangers but they seemed to have guarded their opinions. The group-think position was that Gordeon Brown was a ‘prudent’ and ‘competent’ chancellor.

      So perhaps being critical and not too deferential towards so called ‘experts’ is a good thing and real world experience and intuition counts for something.

    • Kenneth

      Like you, I felt an increasing sense of unreality about things from about 2003, as it became clear that the economy was driven by (a) consumption financed by borrowing, and (b) massive increases in public spending.

      My view now is that the economy is still built on borrowing, and Britain’s net international investment position, and serious current account deficit, are not getting enough attention.

    • Thanks Dr Morgan – my earlier comments were not in any way directed at you by the way -i appreciate you were one of those that recognised the danger signs.

      The difficulty seems to be the poor standard of political debate and what passes as being newsworthy. A financial storm brewing doesn’t become newsworthy until it hits us. I can’t imagine the BBC leading on the issues you mention anytime soon.
      I think work likes yours is chipping away at the complacency and lazy assumptions of our leaders – when we have a prime minister that doesn’t seem to understand the difference between debt and deficit I just despair.

      His latest wheeze is to claim he has now halved the deficit by changing the definition from cash to GDP terms.
      We seem to have a world in which the increasing unreality of money is matched by an unreal world conjured up by the rhetoric of our politicians.
      All the Conservative Mp’s coached by the whips to mention the ‘Long term economic plan’ 10,000 times every day and hope nobody notices the economy is being run like a pyramid scheme…..

  17. Hi Tim,
    Since we both agree the current system is pretty crappy, I am making my reply a call for a superior system, something we can expand on in the future.
    My idea was sparked by a comment made by Richard Werner on a video I saw. I assume you have read some of his material?
    He said we need intervention in the banking system to limit credit allocation to productive purposes. This requires incentivation from the government. The banks only interest is their ability to grow and prosper. There is no social or environmental question asked about their lending practices.
    The banks should be discouraged from lending for purposes of consumption or for speculation. Speculation is non productive asset price inflation [the housing market]
    The ability banks have to create money is a privilege. The government can regulate that privilege so banks will fall into line.
    An alternative, and not at all a new one, is to create a government owned bank which is sovereign and can create money without interest. Not that it’s big problem. The government can create the interest payments as well, free.
    The main thing is that it can create money without debt.

    • I did not say anything to contradict that. Debt precedes money. every dollar has interest attached. If bank lending were restricted then the dollars themselves would go down.

  18. Why can’t we just call MMT for what it actually is? ‘Fraud’

    As an example; I am an individual. I have no capital because i’m capitally impaired. I want to own a house so I loan myself £200,000 which i create out of thin air using my future labour as insurance for the loan. After a year i lose my job. I default on the debt. As issuer of the debt I seize the asset. I now own a house for one year’s worth of labour. Freedom!

    Remember, deficits don’t matter!

    Debt = principal + interest

    But remember, only the principal was issued so how do you pay back the interest?

    Can you say, ‘default’?

    Sorry if i sound flippant. I can’t believe they’ve gotten away with this for so long. I’ll cut them a deal. They can work 40 hours a week for minimum wage and i’ll issue the currency.

    • I don’t think you are being flippant – your points are more than reasonable.

      On MMT, I think it is two things – a way of describing the situation, and a set of policy prescriptions.

      Now, there is a lot of truth in how MMT describes the system – in fact that helps us critics of the system, by helping us to see quite how illogical the monetary system has become.

      My point in this article (beyond trying to explain the system) is that the monetary system has been debased – money is now a tool for policy manipulation, and is no longer a store of value. That’s scary – one could say that the system is run by knaves or fools, or that these people are trying to forestall a crash, having no way of “pressing reset” and reintroducing sound money. Money is losing value even though consumer price inflation is low – just look at the prices of “real” assets.

      Another way to look at this is to imagine that someone lent the UK and US governments £100 and $100 in 1964 – they would have got back £6 and $13 respectively in 2014.

      Imagine, also, that you are paid weekly, in cash. One week of every year you are robbed of your wage on the way home – you wouldn’t like it, but that’s LOW inflation. Then you are robbed of your wage on two other weeks – that’s the cost of using the banking system. Then you are robbed of another week’s pay – that’s “fiscal drag”.

      In other words, the user of the currency is to some extent a victim. I fear that nearly all of us will be victims of the debasement of the monetary system. That said, if MMT helps us to understand how bad the system is, it is helpful – but I wouldn’t follow their policy ideas!

    • Hi Tim,

      Thanks for the response. I see that you’re using MMT to describe the theory, and you are right to do so, I was using it as the practice which is where I caused confusion. I think we’re both in agreement as to the consequences of practicing such madness.

      I posted this on another site which I think adds a little clarity as to what we mean by an economy and the crucial part money plays (some of my learning is taken from your posts so this may seem familiar)

      To address the problem of money I’ve recently found it helpful to understand what an economy actually is. I call an economy the ‘transition of energy’. It has three stages;

      1) Growth/Extraction
      2) Refining
      3) Transportation

      1) Growth/Extraction – Goods are either grown or extracted. Examples of grown goods are corn, wheat, cattle, trees. Examples of extracted goods are iron, copper, oil, gold

      2) Refining – Most of the goods listed above are refined to produce more complex goods; wheat is ground to flour, cattle slaughtered for steak, iron refined into tools and so on.

      3) Transportation – These goods are then transported to markets to be traded; either directly for another good or for money which is used to purchase future goods.

      All 3 stages require energy, hence why I call an economy the ‘transition of energy’. Remove energy from any of the three stages and your economy collapses. Surplus energy allows the economy to grow, a deficiency means the economy will shrink.

      Where the central banks, private banks (and any other counterfeiter you care to mention) step in is at the end of stage 3 when goods come to market for trade. Now counterfeiters don’t produce anything of value, rather they force you to accept their promises as lawful mediums of exchange (usually through deceit or through threats of violence or incarceration). Digitising this medium doesn’t resolve the issue – what we really want is a promise that if we don’t wish to exchange the product of our labour in return for goods right away we can do so at some point in the future. The commodity we actually want is trust. Trust requires transparency. Transparency requires audits – the ability to show people you have what you say you have. Traditionally this was done with sea-shells, precious stones, silver and gold.

      All the best,
      Luke

  19. So, money divorced itself first from gold, then cash, now from all sense and soon from any value?

    • Yes.

      To see why we’d need to look into many things, such as poor leadership and the quest for immediate gratification, plus a system that is predicated on growth so is breaking down now that sufficient growth has become hard/impossible to deliver.

    • So, how do you look on the current position reshuffling of core global players, US, EU, China, Russia, India, Gulfies, .. in terms of the debt system, FX etc. Are they at some point going to force a coherent “new” system, or is the upcomming “shrinkage” going to be overall disorderly process in your view? Thanks

    • I think these groups are likelier to pull apart than pull together. The US has the strongest economy on current performance, but is very heavily indebted, and growth ex-energy hasn’t been that spectacular. The EU has a huge problem in that the EUR is dysfunctional (something I might write about soon). China worries me in two ways – debt, and the difficulty of transition to greater emphasis on internal consumption. Russia is an irrelevance in economic terms. India has huge potential, and the Gulf states will prosper once the current excess of oil production capacity has been squeezed out of the system. So they all have very divergent aims, and very divergent attitudes.

      The reality that I come back to is a faltering “real” economy behind the increasingly-bloated and manipulated “financial” economy. I see no reason whatever to doubt that the real economy has gone ex-growth, and the need to satisfy public opinion is why pseudo-growth is being manufactured by currency manipulation. This manipulation necessarily widens income and wealth gaps, feeding into a growing political theme. On this basis, the US is in the strongest position because of the global prestige of the USD. Economic power will return to the Gulf states within 2-3 years.

      Meanwhile, we are approaching a race-to-the-bottom in FX markets. How this is handed will be, err, “interesting” in a context of ZIRP.

      As well as looking at the EUR situation, I’m contemplating writing a “wrap” on the current situation as I think a snapshot or summary at this point could give us all plenty of room for thought and comment.

  20. It seems to me that all it will take is for the Gulf to insist on gold for oil and it’s pretty much game over.

    • Indeed.

      There is a theory that Saddam provoked the 2003 invasion by planning to price oil in euros or other currencies instead of dollars. The petro-prop is vital to the US’s ability to issue currency and debt, because anyone buying oil has to buy dollars first.

  21. HI Tim
    Enjoying the articles.
    As a very simple summary of your work, it seems to me we can view everything in terms of leverage and diminishing returns. ie
    – (A) Oil has allowed us to leverage growth/value in the real economy
    – (B) Debt has allowed us to leverage value in the financial economy
    Because of diminishing returns in A, in association with natural resource limits/walls in general we are increasingly reliant on B which is now improving impossible to increase. Problem.
    The only real solution is deleverage which takes time and a lowering of discretionary income / standard of living / consumption … These are things no one gives away easily so the system will eventually have to enforce it.

    Regarding MMT (or our current settings), it appears to me the obvious flaw is in the theoretical infinite capability of the future …

    • Yes, very neatly put. Depending on how you look at it, either the real and financial economies are pulling apart, or the financial construct is heading for collision with economic reality.

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