The Ponzi Arithmetic of Profit

June 20th, 2012
in Op Ed

Written by Derryl Hermanutz

Michael Pettis has written a most illuminating perspective on the long term Ponzi w-captionSMALLcycles of the macro economy in his great analysis “Globalization and Minsky”!

Pettis observes:

“Indeed, with the exception of the globalization period of the early 1900s, which ended with the advent of World War I, each of these eras of international integration concluded with sharp monetary contractions that led to a banking system collapse or retrenchment, declining asset values, and a sharp reduction in both investor risk appetite and international lending.”

That should immediately lead one to wonder how it could be that money could grow and contract in such a fashion.  Where does the money come from that savers have in their deposit accounts?  Where does “liquidity” come from?  And where does it go when the system suffers from “illiquidity”?

Follow up:

"Debt Money" vs. "Sound Money"

Contrary to classical/neoclassical theory in which banks are irrelevant because, in that conceptual universe, money just somehow metaphysically “exists”, so that banks are merely intermediaries who allocate their depositors’ savings to borrowers.  Steve Keen is among those who have pointed out that in the real world banks actually “create” the deposits as “loans”.  It is commercial banks creating loans and collecting repayments to extinguish loans who expand and contract the money supply, not central banks printing currency and creating reserves as Austrian “sound money” devotees accuse.

At least 96% of the total money supply is directly created as bank deposits by commercial banks.

And contrary to the fuzzy intimations of true fantasists, money does not just metaphysically exist without some person creating it.  At least 96% of the total money supply is directly created as bank deposits by commercial banks.  Imagining otherwise does not change this straightforward fact about “who” creates the money in modern money systems.  Nor does imagination ameliorate the consequences of creating virtually all of our money supply as debt to the banks who issued the deposit-money.

The Barter Assumption

The dominant schools of economics (neoclassical and Austrian) describe a barter economy in which participants exchange “value”, where “value” is usually (but not necessarily) denominated in standardized units of exchange called “money”.  Relative supply and demand for all the goods and services (including labor) being traded “in the marketplace” determines the relative exchange values of those goods and services.  The goods and services themselves are the things that are being exchanged in this marketplace, quid pro quo, value for value, so as long as there are valuable goods and services being offered for exchange in the marketplace it is impossible that there not be enough “money” to enable the exchanges.  The dominant schools see money as merely a representation of the real economic value that resides in the goods and services themselves.

The dominant schools are describing an economy that doesn’t exist, and they are utterly failing to engage and address the real world money economy that actually does exist.

In fact we do not live in an economy where goods values are exchanged in a marketplace.  We live in a world where stuff is produced by the real economy and where everything is bought and sold FOR MONEY.  We do not “trade”.  We “buy and sell stuff”, for money.  Money does not merely ‘represent’ the real values that are being exchanged.  Money is the entire demand side of every transaction.  No money, no sale, no “exchange”.  We don’t live in a barter economy.  We live in a money economy.

The Money Economy

The dominant schools are describing an economy that doesn’t exist, and they are utterly failing to engage and address the real world money economy that actually does exist.  Money is numbers, and money numbers are created as bank deposits and loan balances on banking system computers.  A money economy is described in accounting equations that obey the rules of arithmetic.

In a money economy, the “macro equation” IS “the economy”.  GDP is a number with a $ sign on it.  The $ sign does not alter the arithmetic of the equation.  It merely indicates that you are referring to money numbers.  You get GDP by adding up all the money that was spent into your economy in a year.  Adding up numbers to find a sum is called an “arithmetic equation”.  The total economy is called the “macro” economy.  The money is originally and fundamentally added into the macro equation as bank loans, all of which must be paid back to the bank that issued the loan money.

When our banking system adds a number (makes a loan) then later subtracts that same number (repayment extinguishes a loan) the net sum = 0.  An equation that is designed to systematically sum to 0 is called a “zero sum equation”.  Our money system is a zero sum equation.

Remember, the money was created as a “bank deposit”, which exists as a number in a banking system computer.  Money is a positive number, but money in your deposit account is exactly offset by debt in your loan account (you have to repay the loan of the bank deposit money) which is a negative number.

I suppose we could call this the quantum theory of money, where money is both real and unreal at the same time.

When you repay your bank loan the bank doesn’t add your money to a big pile of money in their vault.  A bank loan creates a positive number, your new bank deposit balance, and repayment of the loan extinguishes that number, reducing both the positive number deposit balance and the negative number loan balance to $0.  When bank loans are repaid, the “money” ceases to exist.  The dominant schools believe the money gets added to the big pile in bankers’ vaults, because they just can’t get their head around the fact that money is just numbers and bankers create and “uncreate” those numbers.

The Quantum Theory of Money

So on the one hand the dominant schools want to see money as merely an abstract “representation” of real economic values.  And on the other hand they want to see money as something that is physically added to and removed from bankers’ vaults.  I suppose we could call this the quantum theory of money, where money is both real and unreal at the same time.  But in our actual world money is numbers created by bankers, so let’s ignore dominant school monetary confusion and leave quantum theories to the physicists, okay?

. . . an increase in bank lending is actually an increase in the money supply . . .

It is true that “investment banks” actually take in deposits and lend or invest them to try to earn money for their depositors.  But investment banks are (or used to be, before the 2008 bank bailout where suddenly everybody became a “commercial bank”) not allowed to create deposits (notional values of derivatives notwithstanding).  Only “commercial banks” which are licensed as “depository institutions” are allowed to create deposits.  Deposit creation, which is money creation, is the business of commercial banking.  If commercial banks created no deposits there would be no money for people to invest in investment banks.  The money “originates” as a ‘loan’ of bank deposit money by a commercial bank.

Money Expansion Comes from Banks

So an increase in bank lending is actually an increase in the money supply, and because people who borrow money from banks immediately spend or invest that money (banks always want to know what you plan to “use” your loan money for, and they don’t advance the funds until you’re ready to spend the money), this form of money creation also accelerates the velocity of money.  An accelerating increase in both M and V (in Irving Fisher’s famous MV = PQ equation that was revived and popularized by Milton Friedman) creates an equal accelerating increase in PQ, Prices times Quantity of sales at those prices.

PQ is the definition of GDP.  All of these numbers reside and have their existence in accounting equations.  The equations are true by definition, just like $X - $X = 0 is true by definition.  A money economy is described by these accounting equations, not by supply and demand curves as generations of mainstream economists have been taught.

MV is the money that is available to buy stuff, and the velocity at which receivers of the spending turn around and spend it again.  MV is the demand side of the macro equation.  PQ is the supply side of the macro equation, the stuff that is for sale at prices.  Money cannot be “spent” unless somebody “sells” something, so logic, arithmetic and definition all declare in unison that MV MUST = PQ.

This is called an “accounting identity”, which is true by definition, and not open to ‘interpretation’ according to the competing definitions that reside in our favorite theories of political economy.

The Main Stream Ignores the Source of Bubbles

The problem with the accelerating monetary expansions described by Pettis is that they invariably inflate the P of some favored asset class to bubble proportions in the final “Ponzi” phase (in Minsky’s formulation) of the cycle, so that the only justification for buying at those prices (and lending money to buy at those prices) is the expectation that you can sell the asset at an even higher price in the near future.  As long as more banks keep making more loans to fuel debt funded purchases at ever higher prices, the arithmetic appears to work and the bubble can keep expanding.

The historical alternative to regulatory forbearance and monetary easing is hysteria and war.

But ultimately some shock ($700k for a bungalow!  No way!) pops the euphoric fantasy of infinite money and infinite wealth, debt growth slows and then reverses, and the inflated assets begin to deflate, rapidly sinking all those Ponzi phase borrowers and lenders underwater.  As Pettis puts it, “sharp monetary contractions that led to a banking system collapse or retrenchment”.

Yet Wall St and Eurobanks are still standing amidst their shattered assets.  Why?  Two factors: regulatory forbearance, and monetary easing.  The historical alternative is hysteria and war.

The Engine of Bubble Creation and Destruction:  Banks . . .

Pettis describes how each period of globalization is associated with an increase in liquidity (MV is “liquidity”), and that the increased liquidity is drawn out by some promising technology that excites risk appetite in the financial centers, which are otherwise known as the “banking” centers where the money gets created.

War is the ultimate Keynesian “stimulus” spending, where government borrowing and spending not only replaces private sector credit contraction, but massively exceeds it, reflating an even bigger credit bubble.

Of course repaying loans and calling in loans for repayment “uncreates” that same money and sets MV into an accelerating reversal that reverses GDP growth - which, as Keen explains (as did Fisher, Minsky, Koo, et al), is the inevitable deflationary backside of the prior inflationary frontside of credit money expansion and contraction.  Inflated and deflated by commercial banks, not by Ben Bernanke, I will remind any sound money Austrians who have read this far.

. . . Except for Wars

But Pettis notes that WWI was an exception to the rule of post-euphoric monetary contraction.  War is the ultimate Keynesian “stimulus” spending, where government borrowing and spending not only replaces private sector credit contraction, but massively exceeds it, reflating an even bigger credit bubble.  Spending borrowed money is “deficit spending”, whether it is done by the private sector or by governments.  In a credit contraction private sector deficit spending growth goes negative.  But if the decrease in private sector deficits is exactly offset by an increase in government deficits, GDP growth will flatten but not decline.  War puts the entire economy to work at full production, maximizing GDP, funded by massive government deficit spending.


Anti-Keynesians argue, often justifiably, that governments misallocate the deficit spending into unproductive channels that add spendable income money into the economy without adding wealth to purchase with that new money, which dilutes the value of money and “inflates” the prices of all the wealth that is available to buy.  This is perhaps unfortunate, but we will see that it is also inescapable.

Money is a zero sum accounting equation, and arithmetic doesn’t care about our political values.

If a private sector credit bubble is inflated by euphoria, a government war debt bubble is inflamed by hysteria.  But the hysteria wears off and the war ends and everyone wonders how the government is going to reverse those enormous deficits to start paying off its debts.  In the meantime all that money the government spent into the economy is still there, in the hands (more accurately, in the bank accounts) of all the people who earned incomes contributing to the war effort.

The Workout:  Either "Taxing" or "Earning"

Money is a zero sum accounting equation, and arithmetic doesn’t care about our political values.  In order to repay its debts, government has to get the money back from the people who now have it, by “taxing”.  Ouch.  Damned arithmetic.  Private sector debtors get their deficit-spent money back out of the economy by “earning”.  But either way, you can’t “earn” or “tax” from people who have no money.  You can’t earn money when people aren’t spending money.  And you can’t tax incomes when people aren’t earning money.

So when MV crashes in the monetary contraction, incomes and taxes collapse along with it.  Debts become impossible to repay because there is no spending to earn and no earning to tax.  And businesses don’t invest in increasing their productive capacity when sales have collapsed.  SOMEBODY has to restart the spending-cum-earning-cum-taxing train, or it stays stalled at the station called Depression.

Banks earn income by charging interest on loans of bank deposits.  Like the rest of us, banks want to maintain and increase their income, so they are continuously alert to new channels to lend money to earn income and profits.  Now that the post-war government has stopped borrowing oodles of money to buy stuff that blows up other stuff, to whom are banks going to lend new money?

. . . if WWII had started in 1930 instead of 1939 we could have avoided that nasty Depression by reflating with another bout of public sector deficit spending.

Post-war savers are feeling wealthy with fulsome bank accounts, having endured rationing and a paucity of consumer goods production during the war that prevented them from spending their incomes. So, unless suicidal government decides to tax those savings to repay its war debts, savers are now ready to not only spend their savings, but to leverage their consumption and investment with new debt.

World War II was Mis-timed Economically

The industrial scale money injection of WWI inflated a public sector debt bubble that collapsed with the short sharp 1920-21 recession/depression, but we see almost immediate reflation via a renewed bout of private sector credit expansion. The credit contraction and debt-destruction asset-collapse depression that "should" have followed the prewar credit expansion is forestalled first by public deficit spending on war then by private deficit spending on consumer durables and stock market and real estate speculation. Of course this bubble inevitably pops in 1929, but if WWII had started in 1930 instead of 1939 we could have avoided that nasty Depression by reflating with another bout of public sector deficit spending.

The Central Bank Model - Just-in-Time Money Inventory for World Wars

The current US bank-debt monetary system was formally implemented with passage of the Federal Reserve Act on December 23,1913. While modern era bankers have been continuously creating money as "credits" at least since the 14th century Medici bond merchants, despite efforts of monetary sovereignists like Thomas Jefferson, Andrew Jackson et al to ban the private creation of money as a power grabbing abomination against democratic government, the Federal Reserve Act and associated commercial banking legislation formalized private banks' legal right to create US dollar money. Just in time for the largest financial undertaking the world had ever seen to that point: World War I.

In Our System Money is Zero Sum . . .

"Commercial" banks, or "private" banks, or more formally "depository institutions", which I will simply call "banks", create money on their balance sheets as a zero sum equation that adds a positive number as a "credit" to your bank deposit account, which is exactly offset by a negative number "debt" that is charged against your loan account. So on the one hand the new money is created as "credit-money", but on the other hand this same money is owed as "debt-money". I use the terms "credit-money" and "debt-money" interchangeably because both terms are referring to the same money.

. . . private sector debtors get their money back out of the economy by "earning"; governments get their borrowed money back by "taxing".

A borrower spends his new credit money into the economy where it adds to demand pressure (i.e. it is "inflationary"), but then he has to remove that money back out of the economy to repay his debt which is "deflationary". When a bank makes a loan, or purchases a security such as a newly minted Treasury bond, the bank "funds" those loans or purchases by "creating money". This adds to the "circulating" money supply because borrowers "spend" (or "invest", which is also a form of spending) their borrowed money into the economy.

When the borrowers take money back out of the economy to repay their loans or to redeem their mature bonds, the banks use the repayment "money" to extinguish the "debt", which leaves zero money and zero debt on the bank balance sheet. As was noted earlier, private sector debtors get their money back out of the economy by "earning"; governments get their borrowed money back by "taxing".

. . . Except for Inflation

Bank-debt money is a zero sum balance sheet equation that creates money as loans of bank deposits and destroys that same money when loans are repaid, creating a dynamic cycling of inflationary credit-money expansions followed by deflationary debt-money defaults and repayments.

WWI was the first large scale expansion of debt-financing by the modern US private money creation system, followed by the Roaring Twenties debt-financing of the stock market and real estate bubbles, followed by debt financing of WWII. We see a pattern emerging of a public sector debt bubble collapsing (1920-21) and being reflated by a private sector debt bubble that collapses (1929) and is reflated by a public sector debt bubble (WWII).

This same pattern is carried on after WWII, with the immediate postwar threat of renewed collapse being forestalled by the combination of peace time public deficit spending on education and physical infrastructure (GI Bill, interstate highways, etc.) plus the large scale increase in private deficit spending created by financing the construction of suburbia with mortgages and auto loans. This private credit expansion petered out in the 1960s and was reflated by Vietnam war public debt, but in 1971 Nixon unleashed the dollar from the constraints of gold and the 1973 quadrupling of oil prices by OPEC added so much cost-push inflation that even wage and price controls could not contain the resulting inflation.

The Great Bubble Machine

OPEC petrobillions were recycled by Western banks into Latin American commodity plays, and when the mines all came onstream at once this excess supply helped decimate commodity prices which collapsed revenues of the indebted Latin governments. Meanwhile Volcker was raising interest rates over 20% to snuff out 1970s inflation, which bankrupted Latin governments who were financed by short term debt, which rendered 7 of America's 8 largest banks, and 4 of Canada's Big 5, technically insolvent after the Mexican default of 1982.

Bank-debt money is a zero sum balance sheet equation that creates money as loans of bank deposits and destroys that same money when loans are repaid, creating a dynamic cycling of inflationary credit-money expansions followed by deflationary debt-money defaults and repayments.

The decision was taken to quietly bail out our banking systems. The era of "financial innovation" and financial and industrial globalization then began in earnest as the banks sought profits globally to cover their losses and restore themselves to solvency via "casino capitalism" in the 1980s "greed" era of Michael Milken and the corporate raiders. By 1991 these avenues of monetary reflation were petering out and the resulting recession would be reflated by the dotcom bubble, which burst in 2001 to be reflated by the real estate bubble that collapsed in 2007-2008.

Real Estate:  The Mother of All Asset Classes

As Minsky explains, real estate is far and away the largest asset class of every economy, so when the credit-money creating financial system gets to the point where it has to mortgage all the nation's real estate as collateral for the, by this time, truly colossal sums of debt-money that are required to keep the monetary expansions happening (i.e. when you get to the vertical part of the exponential curve of debt-money creation where billions become trillions become quadrillions...), you have reached the terminal phase of the debt supercycle. Both the private sector and the public sector are financially exhausted so their game of credit expansion "handoff" has come to its end and there is nobody left solvent to reflate again.

The Great Depression 2.0

This is where we get to Great Depression 2.0 with extreme monetary contraction of all the unpayable debt-money: the collapse of all the underwater debtors and all the banking systems who lent them unpayable sums of credit-money, and the collapse of sovereign debtors and economic depression and anarchy, all of which is 'solved' by WWIII to reflate the debt-money monetary system and put our unemployed economies back to work building more stuff that blows up other stuff and kills off our "excess" supply of workers.

. . . the need for monetary “profit” creates a Ponzi arithmetic equation, where everybody needs to get more money “out” of the economy than the amount they spent or invested “in” to the economy.

Austrian School and other advocates of “sound money” actually welcome extreme deflation as not only inevitable but actually desirable to destroy all the unpayable debt and associated malinvestments and collapse the economy’s price structure back down to “sound footings”. I suppose we must simply accept the ensuing chaos and war as the penance we pay for our credit creating violations against “sound money”.

Money Supply Must Grow or There Can Be No Net Profit

Or we could grab a brain and recognize that you don’t need to hysterically blow up the world as an excuse to add money into your economy.  And we could recognize that monetarily sovereign governments like the US have the constitutional authority to “create” their national money, exercising the same authority by which they have legislatively authorized commercial banks to create credit money, so governments don’t have to go into infinite debt in order to keep the inescapable Ponzi arithmetic of a money economy working.

Ponzi arithmetic?  Yes, the need for monetary “profit” creates a Ponzi arithmetic equation, where everybody needs to get more money “out” of the economy than the amount they spent or invested “in” to the economy.  The only way for old investors to recover their capital plus earn additional money as their profits, is if new investors add new money into the economy that can be captured by the old investors.  But eventually you run out of new investors who have money to donate and the jig is up and the Ponzi economy collapses into those oh so predictable depressions.

“Profit” is not the problem.  As human creatures we “need” to profit.  A caveman who invests 3500 calories per day hunting game, and only captures 3000 calories per day of food, is a money loser in the currency of his existence and on his way to extinction.  But a profitable caveman who invests 3500 calories and captures 4000 or 10000 calories is on his way to becoming a family patriarch and tribal chief.  Or at the very least he will survive to hunt another day.  We “need” to profit.

But our current monetary system makes systemic profit impossible, because the money system is a zero sum or even negative sum (depending on how you want to account for the interest banks charge on the deposits they create) system.

... try moving into the woods where you can barter beaver pelts for colored beads and there is no generalized price inflation, just constantly shifting supply and demand curves for pelts and beads.

The solution is to make our money system positive sum to accommodate the needs of our for profit economic system.  The obvious way to make our money system at least arithmetically compatible with our for profit economy is for governments to create their own free non-debt money, in quantities about equal to the amount of profits (including interest on bank debt, which is profit money to banks) the economy needs to earn, and spend that money into the economy.  Nobody is suggesting this will be a scientific calculation, but I suggest somewhere in the neighborhood of 10% of GDP might be about the right place to start.  Which Obama is doing right now, come to think of it.

INFLATIONARY!!!  They scream in horror.

Conclusion:  Ponzi or Barter

Since our bank credit money system was formally implemented in 1913 the US$ has lost over 95% of its purchasing power.  That is called “inflation”.  So stop screaming.  We already have inflation, just like our granddaddies did.  And we have stupid hysterical wars and depressions too.  If you want to live in a for-profit economy where stuff is bought and sold for money, then embrace the Ponzi arithmetic of money numbers and the arithmetic necessity of ongoing monetary expansion.  And try calming yourself with “heuristics”, where you convince yourself that the $100 toaster you bought today is 95 dollars “better” than the $5 toaster your grandma was so happy to own.

If that doesn’t work, try moving into the woods where you can barter beaver pelts for colored beads and there is no generalized price inflation, just constantly shifting supply and demand curves for pelts and beads.  You don’t “have to” live in a money economy.  But if you want the high tech hyper-wealthy fruits of a complex money economy like iPads and air travel, well, you can’t get that by bartering in the forest with your friends.

Related Articles

Globalization and Minsky by Michael Pettis

Analysis articles about money

Analysis and Opinion articles by Derryl Hermanutz

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  1. ****-

    EIC : ""banks", create money on their balance sheets as a zero sum equation that adds a positive number as a "credit" to your bank deposit account, which is exactly offset by a negative number "debt" that is charged against your loan account.""

    Excuse me, the IOU signed by the borrower is NOT for the same amount as the loan.
    It is for a greater "principal-plus-interest" balance that is NOT created by the bank.

    The 'interest' ponzi factor is more determinative for instability than that of profit.

  2. jack hepler says :

    Fine explication, rarely seen.
    I'd like to read Part 2, looking at attempts to create debt-free money on larger scales than the community money we see today (Berkshares, Ithaca dollars or whatever. There are already plenty of articles on the small efforts). And some theoretical musings on say a 50-50 share of debt money and debt-free money

  3. DrBernard says :

    This "argument" is hedged--"a la mode du jour."

    I'd rather see "the truth, the whole truth, and nothing but the truth" as a point of departure.

    Some American Hero must have the ambition, nerve, and sinew to deal death to the beast of "Extraction Capitalism" before "We" can progress in earnest.

  4. Admin (Member) Email says :

    Comment submitted by e-mail:

    Great comments, guys. Most people's eyes glaze over when you start
    talking about the mechanics of our money system, so it's encouraging
    to see that you actually read and understood the article!

    Joe, Yes, you are right. I am very aware of the problem of
    interest. In the article I noted that the bank-debt money system
    could be seen as negative sum rather than zero sum, "depending on how
    you want to account for the interest banks charge on the deposits they
    create". In other articles I have pointed out that banks create
    "money" as loan Principal, but they create "debt" as Principal +
    Interest, and P + I is greater than P. Banks systematically create
    more monetary "debt" than they create monetary "money", and since
    nobody else is adding any additional non-debt money into this
    equation, our bank-debt money system is actually a negative sum
    system. Textbooks and acolytes argue that because the banks spend the
    interest back into the economy as their income the problem solves
    itself. It doesn't; it can't; but just to avoid those objections in
    order to make the point about profit I called the money system zero
    sum. I also avoided pointing out that "savings" remove money from the
    income-spending-income stream, and make the system even more negative

    Jack, Ellen Brown is leading the charge toward public banking, and
    this will be part of the solution. But public banks are at best a
    zero sum system that adds and then removes credit money from the
    economy. The real solution to this problem of monetary arithmetic has
    to involve the monetary sovereign, the federal government who has the
    constitutional authority to create its own money and spend or
    otherwise distribute that money into the economy free of debt and free
    of interest charges. There is a long history of monetary reformers
    who saw the arithmetic problems long before you and I were born, and I
    have written extensively about their various reform proposals. My
    perspectives on the problems of monetary arithmetic are most directly
    based on the analyses that were exhaustively presented by CH Douglas
    with his "social credit" monetary system that gained a wide airing in
    Europe and Canada during the last Depression. In his "100% Money"
    proposal, Irving Fisher argued that banks should not be allowed to
    create ANY money, and the government should create all the money (i.e.
    100% reserves) and lend it to the banks interest free, to directly
    control the expansion and contraction of the money supply. Both
    Douglas and Fisher lived in the era when engineering looked like it
    could solve all the problems of the world, so their solutions are
    technocratic and their early proposals seemed to ignore the political
    reality of the old behind the scenes government known as "the money
    power". In his 1935 address to the king and government of Norway,
    titled "Money and the Price system" (available online as a free pdf),
    Douglas clearly stated that any monetary reform had to go through this
    money power, and they would use all the awesome power they could
    muster to maintain their illegitimate privilege. Once you understand
    the arithmetic of money it is technically easy to solve the zero sum
    arithmetic problems, but centuries of effort have failed to unseat the
    money power.

    DrBernard, You're right. I'm advocating action that doesn't include
    a full frontal assault on the reigning money power. That battle has
    been lost too many times already, and I don't think it can be won
    right now. I'm trying to show how some incremental adjustments based
    on monetary literacy can save us from blindly plunging into the abyss
    of depression and war. I'm trying to avoid the worst case outcome.
    I'm not trying to create a best case but politically out of reach


  5. TimR says :

    I have a question.. Not sure how to phrase it exactly but I'm wondering about US government debt in terms of this sort of analysis. I can see how private sector debt must be paid back with earnings, but with public debt it seems like it's sort of optional or something whether it's paid back with taxes... Can't the US government pretty much always get the Fed to buy treasuries (or whatever the exact mechanism is), essentially printing money to cover interest payments? And because of the unique role of the dollar (I don't understand exactly, but having to do with its status as global reserve, and its petrodollar status, perhaps) it never gets penalized (at least not terribly penalized) with higher borrowing costs? Is public sector "taxing" really equivalent to private sector "earnings" for repayment of debt-money? Can you expand on the role of taxes and their real economic function?

  6. jack hepler says :

    Upon fuller reflection......
    We have three key words here that have at least definitional issues if not conceptual

    As pointed out in an earlier comment, you have used the word "interest" perhaps once in this article. Your response that it depends on accounting methods puzzles me. Interest is essential to the loan process in the hands of private banks. This is the dog chasing its tail and losing ground every minute. Money is created by a loan but MORE must always be paid back-- this A central Ponzi, if not THE

    You use the word "profit" to describe the more efficient caveman's mode of getting ahead. "We need to profit", you say but my notion of profit is different. Why not use the word "wage" or "earnings"?
    And of course when the old caveman can't make his daily 3500 calorie wage, he dies off. When our modern urban caveman comes up short, he either borrows or gets some kind of assistance/charity.

    And that leaves us with "inflation" which i think may be called a natural condition of human life. If the caveman can take even clay and make blocks to make a shelter, he is increasing his wealth, and thus the community wealth. Sounds benign, but the profiteers and uber-kapitalists ALWAYS take for granted the immense natural bank account from which all "natural" inflation derives. The world's greatest lumberjack aint worth a lick if he's on a desert whence all the trees got gone 15 centuries ago.
    I think that this fact bears noting, and repeating: All wealth has a natural component, water, soil, minerals. Even labor should not be separated into sweat labor, enterprise, invention-- all of it is labor, some more mental than others.

  7. Derryl Hermanutz says :

    Yes, the Fed functions as a "bank" so it can also create money on its balance sheet. You've likely been hearing alarm from "sound money" quarters at the Fed's recent expansion of its balance sheet, where the Fed creates new money to buy assets from the commercial banking system. Those "assets" are debts instruments like securitized mortgages and Treasury securities. The commercial banks created the bank deposit money that they used to buy those debts from the original issuers (mortgage borrowers and new issues of Treasury debt), but now the banks are deleveraging their balance sheets and the Fed is leveraging up its own balance sheet.
    The Fed is not allowed to directly purchase new Treasury debt instruments from the government, but the Fed can buy this debt from banks who initially bought it. That was QE2, where the Fed was buying Treasuries that the banks had held for as little as 2 weeks, which is not a long way from the Fed directly "monetizing" Treasury debt. ALL of our money is created when a commercial bank "monetizes" somebody's debt, because credit and debt are just the two sides of every money creation equation. A borrower signs a promissory note, promising to pay interest and repay the loan principal, and that note is the "asset" that the bank "buys". The bank "pays" for its purchase by "creating" a bank deposit.
    The primary dealer banks buy new Treasury debt at auction by "monetizing" this debt on their balance sheets. They are not buying this debt with money they already have. The PDs can then sell these Treasuries to pension funds or other parties who actually do have money to buy them, and this sale deleverages the PD bank balance sheet by selling the asset and using the money to extinguish the debt on its balance sheet. There is no limit to how much debt the Fed can buy, so in principle there should be no limit to the government's ability to deficit spend, if the Fed is willing to keep buying Treasuries from the PD banks as soon as the PDs buy them from the government.
    Treasury debts like bonds have maturity dates, which means the government has to repay the principal money to the bondholder when the bond matures. If the government is not going to get this money by taxing, then it has to get it by selling new bonds. As long as the Fed and/or the financial markets are willing to continue to allow the government to repay its old debts with money it gets by selling new debts, then the government never has to recover its deficit spending money by taxing it back out of the economy.
    As for "reserve currency" status: Because the US dollar has been used since 1946 as the currency of international transaction settlement, there has been a vast demand for US dollars in foreign countries. So when a postwar French businessman pays francs to buy US machine tools, the French central bank converts his francs to dollars to settle the transaction. But France has to get those dollars from the Fed because France is not allowed to create money denominated in US dollars, so the Fed just prints the money. Decades later when the US becomes a net importer of the world's goods, the Fed continues to print dollars to settle international transactions, and because nations need to hold dollars as reserves, and many countries use US dollars as their money, and people want to save their money in dollars, the US can basically buy stuff from the world and pay for it not with exports but by printing money. But that source of demand for US dollars may not last much longer.

    MMT sees taxation and the sale of Treasuries ONLY as a way of draining liquidity out of the economy. In fact, under the current operation of the money system, the government actually uses taxes and the proceeds of its bond auctions to fill its bank accounts to pay for its spending. The government COULD just spend money into existence, which MMT says the government is already doing, but the fact is that taxes and debt actually do fund government spending under the present system.

    MMT believes government deficit spending adds ALL of the "net financial assets" into the economy, because they see that in fact government never taxes to repay its debts but always just pays off old debt by selling new debt. So if government never takes its deficit spending money back out of the economy by taxing, that money is available for everybody else to save as their "financial assets". By maintaining a permanent "national debt", that national debt money is left in the economy for the use of the economy.

    But exactly the same thing happens when private parties in the economy keep spending borrowed money into the economy. Sure, some people earn money out of the economy and use it to repay their debts, but at the same time others are borrowing new money and spending it into the economy. So if you take the private sector as a whole, just like MMT sees the government sector as a whole, then private borrowers are also adding "net financial assets" into the economy because in fact everybody doesn't try to repay their debts all at once. There is a permanent private sector "national debt" just like there is a permanent public sector national debt, and private sector debt is many time more than government debt, so private debtors add much more "net financial assets" into the economy than does deficit spending government.

    If government created its own money and spent it into the economy, then taxes could be used as a way of taking some of that money back out if price inflation got too hot. A government that creates, rather than borrows and taxes, the money its spends, does not need taxation or Treasury debt to fund its spending. But no government in the world is actually doing this, except perhaps the Chinese where the government actually owns the banking system. So MMT is talking about a monetary system that "could" be, not the one we are actually using at present.

  8. TimR says :

    Fascinating, thank you.



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