A Copernican Turn in Macro

July 18th, 2012
in Op Ed, syndication

by Derryl Hermanutz

copernicusThe commenter quoted below is laboring under a very common (actually it’s pretty much universal) misconception about how our economies work. This is why the “authorities”, who are laboring under this same misconception, do not know how to “fix” the current monetary problems. The misconception prevents people from seeing what is actually happening in our economies, because it creates a false “worldview” that sees things that aren’t there and is blind to things that are there.

Picture is of Nicolaus Copernicus.

Follow up:

Criticizing the conclusion of Gavin Kakol’s article, “Public Employment: This Time Is Different”, that the federal government should fund local governments so they can restore public sector employment, the commenter wrote,

If you do not care about the National Debt that all makes total sense. But if you do think the National Debt matters, then government expenditures have to contract. This is clearly a drag on GDP and employment. So there is a choice to be made. Pain now or Credit crisis later. Neither is a happy outcome. Fairly obvious but not to many who post here. Living beyond one’s means has consequences.”

Household Economics

Yes, from the microeconomic perspective of a household, living beyond one's means today by borrowing money to spend more than their income requires that they live below their means tomorrow because they must devote their income to debt pay down rather than spending. A household's ONLY long term source of spending money is its income, if we assume that the household will in fact eventually repay all the money it borrowed rather than default and go bankrupt, suffering a household scale “depression”. Repaying its debts causes the household to suffer a “recession”, where total spending decreases and causes the standard of living that is purchased with that spending to decline. But if the household eventually pays its way out of debt it can resume spending its income to purchase its standard of living.

Recessions vs. Depressions

“Recession” implies a dip and a recovery. There is no “orthodox” way out of a “depression”. Escape from depression requires a paradigm shift out of the flawed orthodox paradigm that caused the depression and into a new paradigm that “works”.

A Nation is Not a Household

Spending borrowed money may be harmful to a household’s long term economy, but from the macroeconomic perspective of a national economy, one person's spending is another person's income. A reduction in household spending to pay down debt directly causes a reduction in national income, unless the nation can sell its economic output to foreigners ("export") and capture the spending money from a foreign economy to add to their own national income.

Permanent Positive Balance of Trade is Unsustainable

Of course this is unsustainable as the foreign incomes whose spending you are capturing will soon collapse because the foreigners are not earning incomes by producing their own consumption goods but are drawing down their savings and increasing their debt in order to purchase the outputs from your nation. Once their savings are exhausted and their credit limit is reached you can no longer rescue your national balance sheet by "exporting".

This is what happened to Greece (importer) and Germany (exporter). Eventually the net importer runs out of borrowed money to spend buying your exports. This "mercantilist" approach, trying to export your way out of an arithmetic problem, necessarily ends like this, under our current zero sum global monetary system.

Seeing What You Believe

The universal monetary misconception of classical, neoclassical and Austrian economic theory blinds adherents to the simple arithmetic realities of our zero sum money system. People who have learned and believe in these economic models are seeing a “barter economics” world that isn’t there, which blocks their view of the “money economy” world that IS there. This includes pretty much everybody, except for a smattering of “heterodox” economists who understand money and are gleefully guilty of heresies against orthodox economic beliefs.

So pretty much “everybody” is wrong. Orthodox understandings of economics, all the “received wisdom” of the past two and a half centuries of economic thinking, pretty much everything that is taught in university macroeconomics courses, pretty much all of the economic and monetary policy making authorities, are simply and fundamentally wrong about how macro economies work. We need to abandon these false worldviews and start over with a true understanding of how our economies work, or we will reap the financial-cum-economic whirlwind of our monetary ignorance.

Economics is Numerical, Not Theological

Macroeconomics is written in arithmetic equations with positive and negative numbers so ALL of the solutions are necessarily numerical. Not political. Not economic. Arithmetic. Money is numbers. Our solutions will be monetary, not economic.

A nation's macro economy is described as: GDP = C + I + G + X.

Net Exports

X = net exports = exports minus imports + net flows into your economy of foreign investment capital buying your national bonds or companies or real estate or other assets + tourism, where foreigners come and spend their money enjoying your economy and leave their money behind when they go home.

Your central bank converts the foreign currency that is invested or spent in your country into your national currency which becomes a net addition to your national money supply, and a net loss to THEIR national money supply.

GDP is a Record of Spending

Each of the letters in the equation above represents a sector that is SPENDING money into your national economy, your national monetary arithmetic equation: consumers, investors, governments and foreigners.

GDP is simply an account of the total net spending into an economy in a year, money spent in minus money spent out of your economy. Saving your money is not unconditionally virtuous and spending is not some evil act of profligacy as some miserly schools of moral economy suggest.

Without spending there is no GDP and no “economy”. If oil is the economy’s lifeblood, money is its nervous system. Money that is being spent or invested into the economy signals and “commands” the economy to act according to the will of the spender. Without the spending of money no commands are being sent and the economy sits there doing nothing.

So where do these C, I G and X sectors GET the money they spend? C and I get their money by "earning" it as incomes or from sales or by "borrowing" it as debt. G gets its money by "taxing" or borrowing, but taxing merely redistributes private sector incomes and does not add any new spending power to your national economy, so G can only ADD to GDP by borrowing and spending. And borrowing adds no full cycle net spending power either, as the borrower is essentially agreeing to tax his own future income in order to repay the borrowed spending: the borrower is redistributing spending power FROM his own future TO his present, without any net ADDITION to his total full cycle spending.

Horizontal and Vertical Redistribution of Money

Where taxing is a “horizontal” redistribution of spending power across a population, debt-funded spending is a “vertical” redistribution of spending power over time. “Redistribution” is not “addition”. No net new spending power can be added by redistribution. Only addition can add net new spending power. Under the current operation of our monetary and economic system, no addition is being done. This failure is the source of our current crisis.

Ultimately, “earned income” is the economy’s source of spending power. Earned income can be redistributed by taxation, and earned income can repay in the future debt-spending that was done in the present. Income is “earned” by working for or selling goods and services to “Investors”; and Investors earn their income from selling their outputs to Consumers and Governments and to other Investors. Investors are the businesses who hire the economy to produce the national economic output, and in the process pay out the national earned income. Without the earning and spending of income money there can be no C, consumption spending. Consumers have to earn income BEFORE they have any power to consume the economic output (or reduce future consumption by borrowing for consumption now).

Sovereign Currency

Government is also a large scale employer of the economy, but under the current system government can only fund itself by redistributing earned incomes both horizontally (present taxation) and vertically (future taxation to repay today’s debt-funded spending). Here is where we might find part of our solution. Monetarily sovereign national governments who have the constitutional authority to issue their national money can partially fund themselves by creating their own debt-free money and spending it into the economy where it becomes “incomes” to the people who receive the money. This is one way of net “adding” to the national income.

At present the government’ main source of income (aside from fees for services) is taxation. Deficit spending, where governments spend more than they tax, is funded by bank debt, by borrowing money via “bond sales” from their banking systems or from domestic and foreign financial markets. So the current mechanisms of government deficit spending merely redistribute their national earned incomes vertically over time without adding any net new spending-cum-incomes into their economies. Funding this deficit spending with money they create themselves debt free, rather than with money they borrow as new debt, is one way of adding net income into their national economies.

Balance of Trade

X might be either a government or a private sector buyer from a foreign country but it doesn't matter to your own national GDP equation because all that counts is that they are adding positive money numbers into your national spending equation. Or they are adding negative numbers if you have a trade deficit or capital account deficit rather than a surplus: if you are spending and investing more of your own national income and borrowed money into foreign economies than they are spending and investing into yours.

Money Creates Demand

You will note that there is no “real economy” in these equations. We are seeing flows of money numbers but no flows of real economy goods and services. Indeed, macroeconomics is about nothing other than the economy’s money system, which is a numbers system. Money is the “demand” side of every economic transaction. If there is no money flowing from buyer to seller, there is no “sale”, and no “economic” exchange occurs.

A Fallacy of Composition

Microeconomics deals with the “supply” side of transactions, producing the stuff that is available to buy: issues in the real world economy such as supply and demand of resources and flows of real goods and services, resource scarcity, “value”, etc. All of the fallacious schools of macroeconomic theory: classical, neoclassical, Austrian, etc., try to build a macro theory by scaling up their micro economics: “A national economy is simply a household or firm writ large.” they believe.

This can’t work, because the macro economy is about the money system, the demand side of transactions, and all of these schools of microeconomics leave banking and money entirely out of their economic models: as they should, for they are dealing with the real economy, the supply side; not the money system, the demand side of economic transactions.

Effective Demand – A Macro Concept

Macroeconomics is a purely arithmetic description of the flows and stocks of money, credit, debt, and the distributions of these across a population and across time. Macroeconomics is about banking and the money system where “effective” demand gets created and distributed by the creation and lending of “money”. “Real” demand, people “wanting” stuff, is naturally occurring and virtually unlimited. “Effective” demand is real demand that is backed up with having “money” to pay for the stuff you want.

Production – A Micro Concept

Microeconomics is about the real economy that produces the supply of all the stuff that is available to buy with the money. The real economy produces real goods and services, real wealth, but it produces exactly zero “money”. Only “banks” (and governments, should they choose to do so) are allowed to produce money.

Money “activates” the real economy but money is neither an input into the production of real wealth like bread and houses nor is money an output of real economic production. Bakers and carpenters produce bread and houses, not “money”. How people get “money” by working with flour and lumber is an enduring mystery to the fallacious schools of macroeconomics.

Two Separate Worlds

The real economy transforms real resources into goods and services that are useful and desirable to people. The banking system creates all the money. The real economy and the banking system inhabit completely separate universes that work with mutually exclusive kinds of “stuff”. The real economy works with real physical stuff like wood and grain combined with mental stuff called “ideas”. The banking system works with immaterial numbers that have a $ sign on them. Banks produce no real wealth and the real economy produces no money. They are separate systems.

This is why microeconomics models moneyless “barter” economies where real goods and services are produced and “traded”, value for value, rather than “bought and sold”, value for MONEY. In the micro universe the money system doesn’t exist. “Value” exists and “wealth” exists, but no “money” and no bankers creating that money as loans then uncreating it as loan repayments.

The Marketplace – Where Accounting and Values Meet

“The marketplace” is where the micro and macro universes intersect, where supply meets effective demand, where money changes hands and real economy goods and services are purchased and thus distributed for final consumption.

But we need to remain vigilantly clear that macroeconomics is about the demand side of the economic equation, the money side that is described exclusively by arithmetic equations. Trying to add the real economy and subjective concepts like “value” into these equations merely confuses the arithmetic, which in itself is very simple and easy to understand.

Macroeconomics is totally amoral and apolitical, totally numerical and “objective”. Arithmetic equations do not care about and cannot describe our “values”. But arithmetic equations are the ONLY way we can follow the flows and stocks of MONEY, which is a system of positive and negative numbers: “money” and “debt”.

Locked in a Zero Sum Prison

So we see a zero sum macroeconomic equation where over a full cycle spending can only be equal to earned income, because borrowed spending merely redistributes the borrower’s spending of his lifetime income vertically over time, and taxing only redistributes present incomes horizontally to people other than the income earners.

To understand the problems that are caused by this zero sum monetary arithmetic you have to abandon the universal fallacy that all the money already exists in some big gigantic pile that God distributed around the Earth for people to find and that people somehow get this money and deposit it in banks as their “savings”, and banks then lend out their depositors' savings, in which case it would be true that ALL borrowing merely redistributes spending of the fixed supply of money rather than adds to it, as neoclassical and Austrian economics has mistakenly believed for decades and as classical economics has mistakenly believed for centuries. In fact bank loans are the creation of NEW ADDITIONAL money (as Adam Smith crowed in praise of “the Scotch banks”, which added credit money into their local economies allowing those economies to grow and mature at a delightful pace). So spending borrowed money adds to GDP. And repaying borrowed money contracts GDP.

Micro Does Not Extrapolate to Macro

Whether the spending creates “value” is an issue for microeconomics, the realm of political economy, and whereas I have called the traditional schools of economics “fallacious” because they have no understanding at all of the macro money economy, these schools nevertheless offer very finely honed understandings of the micro real economy. The micro real economy is the “political economy” where issues of values, etc. are argued and incorporated into the understandings. But masquerading as macro theories they are indeed fallacious, blind and pig headed in their arrogant inability to see outside their conceptual box.

The Source of Money

In fact “borrowed” money is our ONLY original source of money. If nobody borrowed any money from banks and spent that money into the economy, there would be no “money” in the economy. Bank loans CREATE bank “deposits”. That is where virtually all of the money comes from. It doesn’t come from God. It comes from banks, as loans, as “debt” to the people who took out the loans and spent the borrowed money; and who have to pay it back to the banks that created the money on their balance sheets as a positive number bank deposit (the “money”) and as an equal negative number loan account (the “debt”).

A “balance sheet”, by definition, balances to “zero”. Money = Debt. All of the positive numbers of money on one side of the balance sheet are offset by the negative numbers of debt on the other side. When positive repayment money is brought together on a bank balance sheet with the negative loan balance, the positive and negative numbers cancel each other out and sum to zero. Both the money and the debt cease to exist when the bank loan is repaid. A bank loan “creates” money as a bank deposit; and repayment of that bank loan “uncreates” that money when the repayment money and the debt account extinguish each other.

The Business of Banking

This is the business of “banking”, creating and distributing the national money, and micromanaging the flows of financial credit out from and back into the banking system. A prudently operated banking system is critically necessary to the functioning of any modern economy. This is why it is crucial that banking legislation and regulation get the “incentives” right, so that bankers are incentivized to operate prudently on the macro scale. Here we have utterly failed.

At the time that the new US Federal Reserve banknotes became the exclusive official US dollar under the 1913 Federal Reserve Act, people already had “money”, and all this money was originally added as credits into the new money system. So the 1913 system didn’t start with zero money. There was already some money there. But by today’s standards that original money is a pittance. In those days a “millionaire” was a rich person. Today a “billionaire” is a rich person. That’s a 1000 times inflation of “rich”.

Growth of Economy Has Required Growth of Money

Consider that the Federal Reserve dollar has lost over 95% of its purchasing power since its 1913 inception while the economy has grown enormously in real terms requiring enormously more of the inflated dollars so that today there is at least 100 times more US dollar money in the economy than there was in 1913 (I have no numbers: I’m guessing; the multiple might be MUCH higher than 100 times). If the multiple is 100 times, that means for every dollar that exists today that was not created as a bank loan, there are 100 dollars that were created as bank loans and that exist today as “debt” to the people and firms and governments who borrowed and spent the money into the economy, and who have not yet earned or taxed that money back out of the economy in order to repay their bank debts. Because the economy and the government remain in debt, the money that they borrowed and spent into the economy remains “outstanding”.

Those same “outstanding” bank loan balances are also held as “money” by other people. That money, still owed as outstanding debt by its borrowers, has become the “savings” and “operating capital” and “financial liquidity” when held by the people who earned or otherwise received the money that was borrowed and spent into the economy. Today the people who have the money are not the same people as the ones who owe the money as debt to their banks. The only way the private sector debtors can get their borrowed money back out of the economy is if the current holders of the money spend or invest it back into the economy where the debtors can earn it back by, essentially, working for the spenders; or if the indebted governments tax it back from the people who now have it, or sell services to the people who have the money.

Savers and Spenders

The problem is that some people are by nature savers and others are by nature spenders, so over time the savers accumulate all the money—and they won’t spend it—while the spenders have all the debt, and the savers won’t spend so the debtors can’t earn the money back to repay their debts. Under these conditions the debts become simply unpayable, unless prudent ants suddenly decide to become profligate grasshoppers and grasshoppers suddenly decide to become ants, which is not going to happen. Savers save and spenders spend until we reach a crisis of money and debt distributions, where we are at now. Ancient cultures solved these distributional impasses with “clean slates” and “Debt Jubilees”. If we are going to get out of our current straits without first suffering the historical pattern of collapse, depression and world war, we will have to do something similar.

This is Not a Question of Morality (or Justice or Fairness)

Remember, macroeconomics is the wrong venue for “morality”. Our macro solutions involve accepting the arithmetic realities of our situation, then taking appropriate numerical measures to solve the arithmetic problems. If you don’t “like” the answers, that doesn’t mean the answers are arithmetically “wrong”, even if you think they are morally wrong.


National Treasuries mint coins and “sell” them to their banking system in exchange for credits of bank deposits in the government’s bank accounts, so coins are actually a net non-zero sum addition to the money supply. But coins are only about one ten thousandth of the total money supply. All the other money is originally distributed into the economy as the spending of money that was created and loaned out by the nations’ commercial banking systems.

Even US dollar paper money is loaned into the economy, because government printers sell the banknotes to the Federal Reserve banks for the cost of printing, and the central banks then lend or sell the banknotes at face value to the commercial banks in their region, and bank customers “out in the economy” can only get their hands on banknotes by converting a deposit balance in their bank account into currency by “making a withdrawal” (or by borrowing against a credit card or line of credit, etc., but that just takes us back to the vertical zero sum equation of future repayment, without adding any additional money into the equation over the full cycle).

Repeat after Me: Today Virtually All Money is Lent into Existence …

And as we saw, bank “loans” CREATE all the bank “deposits”, so even though many people have a positive bank account balance that they can convert to banknotes, other people owe that same money as debt to their bank, so on the macro view even the banknotes get into the economy by “lending”, not by “spending”. Some schools of economics believe that governments or central banks “spend” paper banknotes into their economies and thus add net money into the economy, but this is another fallacy.

Banknotes in modern central bank banking systems are lent into our economies, not spent into our economies. So like other forms of borrowed money, banknotes are not a source of full cycle ADDITIONAL money. They are merely a convenient way to convert your bank account balances into “walking around money”. Your bank account balance goes down by the same amount that your pocket money supply goes up. There is no “addition” in this equation, only “conversion” of your money from one form into another.

… By the Banking System

“The banking system” is the entire supply side of money. “The economy and the government” are on the demand side of money. They want and need money, but they don’t “produce” any money. Banks produce all the money as zero sum balance sheet equations. This is a problem.

Aside from the money that already existed in 1913, and coins, and money that central banks created to buy whatever gold they purchased from the economy at the start of the modern money system, ALL of the economy’s money exists as loans of bank deposits that were created by our commercial banking systems. Some schools of economics believe that government bond sales add permanent net money into our economies, but this is another fallacy.

In the US system there are 21 national and international “primary dealer” banks who are authorized to bid on auctions of new Treasury debt. These banks pay for the new Treasury bonds, bills and notes in the same way all banks fund all their loans, by CREATING DEPOSITS in the government’s bank accounts. The PD banks might then turn around and sell those bonds to non-PD banks who likewise create money to buy them. Or the PDs might sell the bonds to parties in the economy who actually have savings to invest such as individuals or pension funds, etc. In this latter case the bond sale generated no additional new money. It merely redistributed spending power from savers who bought the bonds to the government who spends the money. But when banks buy and hold bonds they pay by creating new money, and this adds to the money supply when the government spends its new bank account balances into the economy.

So like a private home buyer who takes out a 30 year mortgage, spending $300k of freshly created bank deposit money into the economy “today” and removing that same $300k (+ interest) “out” of the economy over 30 years (a vertical zero sum equation), government sales of Treasury debt cause the primary dealer banks to create new bank deposit money to buy the debt, but when the bonds/bills/notes “mature” the government has to “redeem” them, by paying “money” to the holder of the debt instruments, and governments can only get their debt redemption money either by taxing money out of the economy or by additional new borrowing via new bond sales.

The Government Does Not Create Debt Money

So government debt is exactly the same kind of vertical zero sum equation as private sector debt. All the money that was borrowed by governments and private sector debtors added to “today’s” spending-cum-national income, but it all has to be paid “back”, out of future incomes/taxes. Banks create money by making loans and by “purchasing securities”. US Treasury debt is composed of “securities”. Primary dealer banks CREATE the money they use to buy the Treasury debt. In support of this assertion, which would be heatedly disputed by devotees of the MMT school who believe that the government spends money into existence by “marking up accounts” somewhere within the banking system, I offer the following:


Graham Towers was the first governor of Canada’s central bank, the Bank of Canada, which began operating in 1935. Canada’s monetary system is substantially the same as the US system, as well as all other modern central bank money systems (except perhaps China, as the Chinese government owns China’s commercial banking system which gives the government monetary and fiscal policy powers that other governments have relinquished to their private banking systems). During the Depression, which was a failure of the monetary system just like the post-2008 failure we are in now, there was heightened awareness of money and the money system, again just as there is now. Towers gave testimony to a 1939 Royal Commission on Banking and Commerce about the nature and structure of the monetary system. The following questions (from Canadian Members of Parliament) and testimony (from Graham Towers) are quoted from this link: http://www.sustecweb.co.uk/past/sustec16-4/a_monetary_education_for_mps.htm

Page 223 Question from Landeryou (SC from Lethbridge): "Ninety-five percent of all our volume of business is being done with what we call exchange of bank deposits – that is, simply book-keeping entries in banks against which people write cheques?"

Towers: "I think that is a fair statement."

Page 285 Question from McGeer: "When you allow the merchant banking system to issue bank deposits – with the practice of using cheques – you virtually allow the banks to issue an effective substitute for money, do you not?"

Towers: "The bank deposits are actually money in that sense."

Page 287 Question from McGeer: "But there is no question about it, that banks create that medium of exchange?" [i.e., bank deposits]

Towers: "That is right. That is what they are for. Each and every time a bank makes a loan or purchases a security, new bank credit is created — new deposits — brand new money.  Broadly speaking, all new money comes out of a Bank in the form of loans.  As loans are debts, then under the present system all money is debt."

McGeer: "And they issue that medium of exchange when they purchase securities or make loans?"

Towers: "That is the banking business, just in the way that a steel plant makes steel."

Fishing for Concessions

One of the infrequently heard members observes on p. 400 that "McGeer and the social credit people are circling around ‘debt-free money.’" McGeer affirmed that his purpose was to persuade the Committee that there is a costless (or at least lower cost) way of mustering the money (finance) to get men and materials into operation for important productive activities. (Towers freely acknowledged that although an "easy monetary policy" had been in place for several years, there was still plenty of under-employed labor and materials. He defined "easy money" as no need to impose bank rate restrictions or cash reserve requirements on banks – they had plenty.) McGeer kept returning nonetheless to this question: Why should a government with the power to create money give that power away to a private monopoly? And especially, why should it then borrow from the banks and pay interest? Towers’ response: "If Parliament wishes to change the way the banking system operates it is certainly within Parliament’s power to do so."



Austerity Now Equals Pain Later …

The critic of Kakol’s article believes it's either "Pain now or Credit crisis later". But what he advocates, "austerity", a reduction of deficit spending by G, causes BOTH pain now AND a credit crisis, because the money government borrows and spends adds to the incomes that people earn (or receive as unearned entitlements) in your national economy, and if their income is reduced or eliminated (in the case of layoffs) they will have no source of money to spend (which becomes other people's incomes, part of which becomes the taxes governments use to repay their debts) or to repay their bank debts, which causes systemic loan losses to the banking system that created all the nation's money by "lending" it into existence. And you get the 2008 financial crisis and bank bailout because when borrowers are no longer making their payments the banking system loses its source of revenue and income and suffers a "liquidity" crisis because not enough repayment and interest money is flowing back "in" to the banking system.

Then, because debt/money growth has gone negative, all the bubbled asset prices that were inflated by people buying them with newly created bank loans start to deflate. For a bank, its actual “assets” are the promissory notes borrowers sign when they get loans, promising to pay interest and repay the principal according to the terms of the loan. Government bonds are a form of “promissory note”, just like our private sector bank debts. Banks create deposits by “purchasing assets”, but the assets are really nothing more than our signed promises to pay interest and repay loan principal.

… As Debt Peonage …

But most bank loans are created against the “security” of “collateral” assets: real assets like houses and commercial buildings and cars, assets that the bank can “repossess” and sell in case the borrower fails to make his payments. Bonds are secured by the issuing government’s power to tax its economy. YOUR TAXABLE INCOME, present and future, is the “collateral” securing your government’s debts. You have been sold into debt peonage, and for the rest of your life you will pay every last nickel of interest by your sweat, unless the monetary paradigm is updated to accommodate the modern world.

… Combined with Endemic Defaults that Destroy Banks

The banks are holding those collateral assets on their balance sheets, but if the value of the assets declines by 30% (as in the case of US real estate post-2007) then the liability side of the banking system balance sheet will exceed the market value of the asset side, and no bank holds 30% of its own money and its shareholders’ money as its capital that it can use to pay its loan losses in the event of the kind of systemic loan default that began after 2007, so deflation of the market value of the post-bubble collateral assets renders the banking system insolvent .

Then, unless central banks create new money to add “liquidity” into their banking systems to fend off the liquidity crisis (where banks have no money to pay the debts they owe to other banks and the global payments system seizes up and the economies stop working because nobody is getting paid), and unless government banking regulators exercise regulatory forbearance rather than force their insolvent banking systems to foreclose and liquidate all their collateral assets in a vain attempt to restore solvency (the Andrew Mellon version of monetary innumeracy), you get financial system collapse and economic collapse.

Churches of Divine Money

The various schools of orthodox macroeconomics, more properly seen as Churches of the Divine Money for their complete ignorance about money and their absolute faith in the correctness of their fatally mistaken worldviews, believe in a variety of futile approaches to resolving a financial collapse. Most believe that economic “growth” will solve the problems.

But we have a macro problem, not a micro problem; a problem of money numbers, not a problem of a lack of economic goods and services available; an effective demand problem, not an economic supply problem. Indeed, we are swimming in oceans of excess “economic output”, and there is an entire large scale industry devoted to hauling our overflowing household goods to garbage dumps. In the 1930s farmers were encouraged to destroy their crops to reduce supply to raise prices to profitable levels, while people went hungry. In 2009 Americans were encouraged to have their perfectly good older cars destroyed and buy new ones as a Cash for Clunkers “stimulus” measure to get people spending money and to rescue the auto industry from its demand doldrums.

If destroying perfectly good stuff that people actually want sounds stupid, it’s because it is stupid. It is a policy based on the economics of monetary ignorance oppressed upon us by the numerically blind but vigorously self-righteous Churches of the Divine Money. Economic “growth” adds new money into your national monetary equation when investors and consumers borrow new bank money and spend it into the economy. In other words, economic growth restores the upward trend of debt growth. But financial collapse happens at the terminal stage of a debt supercycle where both public and private sector borrowers are financially exhausted and cannot afford to pay interest and make principal repayments on any additional debt.

It’s like ‘rescuing’ a drowning man by getting him back in the water swimming again. He’s been staying afloat by treading water for 3 days in the heaving seas and if you put this poor exhausted soul back in the drink he will die, not “recover”.

Creative Destruction

Other economic faith traditions, notably the Andrew Mellon/Ludwig von Mises schools, believe that collapse is just the medicine the economy needs to restore it to “sound footings”. A hurricane blows your house into the sea, killing half of your family, leaving you with “sound footings”. Then you get the economy going again by rebuilding your house and family upon your “sound footings” that were not blown away. But why rely on the vagaries of nature when we have the military capacity to blow the world to hell at our leisure?

The Shiny Objects Sect of the Church of Divine Money

These magnificently perverse policies are the direct consequence of monetary ignorance combined with the misplaced desire to preserve the purchasing power of money. Unlike all other economic wealth that deteriorates over time until it is rotted and rusted and worthless, money’s value must be held sacred, according to the economic worldview of this Church. If we have to destroy the real world in order to save the value of money, then that is a sacrifice that our god demands and we must do it. This god loves gold because unlike other economic goods gold never deteriorates or loses its luster. Let’s call this the “shiny objects” sect of the Church of the Divine Money.

Debt Bondage

Still other branches of the faith believe that governments must resume and massively increase deficit spending, to add new money into the private sector economy. But under the current operations of our money systems all this government borrowing has to be paid back, and even if the government simply gets its repayment money by selling even more new debt rather than getting the money by taxing the economy, this doesn’t save the taxpayer from the burden of paying interest on trillions of dollars of national debt. Right now the US taxpayer is paying nearly half a trillion dollars per year in interest on the national debt.

This is because the 1913 banking system legislation granted exclusive authority for creating US dollar money to the private banking system. So now commercial banks create the money and the government borrows that money from the banks, just like you and me when we want to spend more than our income. This system puts the taxpayer in a state of permanent debt bondage, supporting half a trillion dollars (and rising) of bond merchant unearned annual interest income. Good deal for the bond merchants who create the money. Not so good for beleaguered taxpayers who pay the interest.

Non-Debt Money

The government still “could”, but doesn’t, issue its own non-debt money. Until the government actually begins issuing its own debt-free money, there can be no solution to our macro problems of monetary arithmetic. The issuance of debt-free government money is the sine qua non for ANY viable solution to our current macro ailments. Any proposed ‘solution’ that does not include something along these lines, any solution that merely adds to or reshuffles the distribution of existing debt, simply will not work. We have reached end-of–paradigm. More of what got us here will not save us from what is coming next.

The Federal Reserve banks are owned by and work for the private banking system, not for the US government or the people (increasingly it looks like the politicians are financed by and working for the banking system). When the Fed (and euro equivalent) practices quantitative easing, all of the newly created central bank money is injected into the “banking system”, not into “the economy”. The only way the economy gets its hands on any of that money is in the usual way of “borrowing it” from the commercial banks. Fed money injected into the banks will not solve our problems of excessive unpayable debt, because Fed money can only enter the economy as even more debt.

And with the “Keynesian” solution of increasing fiscal deficits, total national debt for both public and private sectors can only ever go “up”, because when debt/money growth flatlines or declines we get the kind of financial crisis we are in now. If evermore debt is the only ‘solution’, then we are headed ultimately toward infinite debt and infinite interest payments. Not an attractive prospect, even if it was arithmetically possible.

What we actually need to solve the problems we are currently immersed in is additional non-debt income money injected directly into the economy by governments who create, not borrow, that money. More debt cannot resolve a debt crisis. Only additional income money can empower the indebted economy to repay its debts and resume its spending. The government will have to spend or simply “give” this money into the economy.

None of this is designed to generate a monetary “profit” or a monetary “return” of any kind to the governments who issue the money. This is a “new paradigm” solution to the old paradigm failure. And the new paradigm violates the religious beliefs of the old failed paradigm, such as the belief that all spending must generate economic wealth and/or monetary profits in order to preserve the purchasing power of money.

Quantitative Easing for the Economy

The purpose of the exercise, Steve Keen calls it “quantitative easing for the economy”, is to add positive quantities of new money into the economy and leave it there permanently (though the money that is used for debt pay down is simply extinguished as the loan is extinguished; those positive and negative money numbers simply cancel each other out and cease to exist when repayment money and debt come together on a bank balance sheet). This money, paid out equally to everybody so that you don’t reward the ‘profligate’ debtors to the detriment of the ‘prudent’ savers, comes attached to the condition that any recipient of the “solvency checks” money will automatically have his money paid out against any outstanding loans he has.

Debtors will get liquid and then solvent as their debts are paid down. Savers will get more money added to their savings. Debtors whose loan payments are restored to “performing” status bail out and deleverage the insolvent banking system the old fashioned way, by resuming making their loan payments on time, which solves the banking system’s illiquidity-cum-insolvency problems. This large scale debt pay down program deleverages both the economy and the banking system, pulling us back from the brink of the collapse cliff. And people who aren’t in debt get “free” money to save, spend or invest. Good deal for everybody.

We Don’t Need More Debt, We Need More Income

The government adds income money into the economy without simultaneously taking on more bond debt owed to the banking system and financial markets. More debt cannot resolve a debt crisis. Only money created and distributed freely and received by the economy as “income” can permanently extinguish debt, because neither the party who paid out the money (the money-issuing government) nor the recipient of the income money owes the money “back” to anybody. The new money can pay out the old debt, WITHOUT having to take the money away from the savers who have accumulated all the borrowed money that was spent into the economy.

This is a positive sum “addition” to the economy’s money and income, making the money system positive sum to match the arithmetic structure of our for-profit economic system where participants need to get more money “out” of the equation than they invest “in” to the equation. Investors collectively pay out the national income as their “costs”, but they have to sell their outputs at cost + profit. But Costs = Income. There is no additional “income” money in this equation to allow for sales of the outputs at profitable prices. Nor is there any money created by the banking system to pay the “interest” that banks charge on the bank deposit money they create. We have been adding the additional needed money to pay profits and interest as ever rising “debt”, but we have reached the end of that myopic Ponzi road and a vast expanse of nothing opens up below us, beckoning us over the edge to our doom.

A Zero Sum System Means No Profits Systemically

A zero sum money system cannot accommodate the economy’s need for profit and the banking system’s need for interest income. So the money system must be made positive sum to match the economic and banking system. Or else we can choose the Mellon/Mises solution and proceed over the edge of the Wile E Coyote cliff until we reach our “sound footings” on the rocks far below. Wile E always lived thru the fall. Maybe we can too. Or maybe that’s just a cartoon fantasy after all.

The ONLY ultimate source (aside from net exports) of a nation's EARNED income is I, Investment spending. The nation's businesses hire labor and buy materials and services and capital goods in the process of producing the national output of goods and services. That investment spending becomes the national earned income. Governments tax and horizontally redistribute some of that earned income money, but taxing does not ADD to total national income. Consumers borrow and spend enormous amounts of money beyond their current incomes as mortgage debt to buy real estate and as car loans, student loans, etc. But this debt-funded spending is vertically zero sum over the long term, removing as much spending-cum-income money “tomorrow” as they add “today”.

The full deficit spending - debt repayment cycle is a vertical zero sum equation over time. The additional positive GDP boost (and the additional money for Investors and bankers earn as profits and interest) from deficit spending-cum-income you get today is offset by an equal and opposite negative GDP contraction when the borrowed money is earned or taxed back out of the economy and used to repay the debts. So we are back to, "The ONLY source (aside from net exports, which is unsustainable on a global scale, or regional scale as the eurozone is discovering) of a nation's EARNED income is I, Investment spending."

We Cannot Continue with Debts that Cannot be Paid

And we have arrived at “tomorrow”, the time to repay debt rather than add to it. The time has come where both the private sector and the public sector have reached their credit limits and cannot afford to finance a new round of debt-funded economic “growth”. But due to the implacable arithmetic of our zero sum money system, any flat-lining or decline of debt-money growth causes a financial-cum-economic collapse.

Under current operation of our money system the private sector’s and government’s debts simply CANNOT be paid, because the savers have all the money and won’t spend it and nobody is solvent enough to borrow and spend more new money into the equation, so the debtors have no way to earn or tax the money back to repay their bank debts. As “rogue economist” Michael Hudson puts it from his usual refreshingly clear-eyed perspective, “debts that can't be repaid, won't be”.

Time to Remove the Micro Blinders

We have reached end-of-paradigm - the final failure of microeconomics masquerading as macro. The solution, the new macro paradigm, requires monetary literacy and numeracy. And this can only be achieved by removing the conceptual blinders by which micro models encircle the minds and cover the intellectual eyes of all the economics professionals and policy makers who mistakenly believe they are seeing in macro. What they are really seeing is a reflection of their conceptual universe, and this universe is very much unlike the real world in which we are trying to live.

Related Articles

Analysis and Opinion articles by Derryl Hermanutz

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Analysis and Opinion articles on Modern Monetary Theory

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  1. Frank Li (Member) Email says :

    An excellent article! But the premise is wrong. A nation/country is a household is a business, in general. It means 2 things:
    (1) Balance the budget
    (2) Some deficit is Okay, so long as the growth is there.

    Or it will go bankrupt. However, this generality does not apply to the U.S., which can print money! In other words, the U.S. is an exception and unique, not a rule. But that will change, because I believe the Chinese RMB will become an alternative reserve currency within a decade. In fact, it's already being widely used by the emerging economies. I will write about it in detail soon ...

  2. Derryl Hermanutz says :

    I think China is already practicing what I am preaching. It may be wisdom or it may be by luck, but China's government is exercising its monetary sovereignty via ownership of its banking system to implement policies that support the Chinese economy. The US and Europe pretend they are not systematically supporting their grossly insolvent "private" banking systems to prevent financial-cum-economic collapse of their systems. China pragmatically does whatever is required to achieve its policy goals, without pretending its banking system is "private" and "profitable". Sun Tzu recognized that in war there are no "principles". Whatever is required to achieve the outcome you desire, that is what you do, and that is how you win. A loser holds to his "principles" while the opponent is annihilating him. If China continues to use its sovereign monetary powers to support its economy, and if the US and Europe continue to relinquish their sovereign monetary powers to support their banking systems at the expense of their economies, then China will emerge from this victorious and the West will lose.

  3. Dig Deep says :

    Wow - you provide very good reasoning for a VERY interesting solution. It does seem we're in the end-game for debt based money creation.

    My thoughts have been to allow defaults to clear debt...as deflationary as that would be. Also have thought a 're-set' of sorts will eventually be required.

    So - what would be the unintended consequences of issuing fiat on a fairly reasonable basis? Can we assume that debtors will do the right thing and pay down debt? If not, certainly inflation kicks up - but demand for jobs should as well... What mechanics should be in place to stop the new money from being exported by way of new imports - losing the real profit - and multiplier effect - from manufacturing in the U.S.

    Again - very interesting and you've presented a plausible solution. Next step - unintended consequences.....

    Mr. Li - I think you jumped over the mechanics of Derryl's premise with a (credible) question of reserve currency status. No doubt implications of reserve status are valid - but are beyond the initial concept of being tapped out with debt - and the implication of a direct injection to bring debt levels lower....


  4. Admin (Member) Email says :

    Dig Deep - - -

    You have brought up what I call the "right-sizing problem". The theory says that excesses of money creation are to be removed through taxation (and the money "burned") to avoid inflation.

    Taxation is a political process - good luck with making that work effectively.

    The reason that the direct (non-debt) money creation process should not be rejected out of hand is that the debt creation of money process has had the same poor inflation control history that is the risk with the new proposal. And the debt creation of money process results in excessive oligarchy enrichment when banking power becomes consolidated in the hands of a few.

    Studies have estimated that 40% of costs in our current system are ultimately due to the cost of credit. That is a terrible price for a society to pay to use "its own money", especially since the cost is an even bigger burden than the cost of inflation which the privately created money system was supposed to control.

    In the current system we are paying far more for failure to deliver than it seems would be reasonable to pay for absolutely perfect delivery. It's like paying the Mafia for protection when all that is produced is protection from theft by non-Mafia entities. You pay the protection and then the Mafia takes what they want in addition.

    John Lounsbury

  5. Dig Deep says :

    Thanks John
    Plenty to chew on, which I plan to do. I'm going to boil Derryl's articles down to bullet points and concepts - and come up with some consequences and conclusions. Out of the box stuff that is fascinating to me.

    The 'Be patient with Treasuries' article has some tie-ins and a few other pieces/concepts ... I'll revert back for your thoughts after I organize & learn a few things in the process.

  6. EconCCX says :

    Greetings Derryl

    Previously you’ve argued for the Fisher proposal of 100% reserve money created by the state. Here it seems you’re arguing for infusions of positive money to balance the negative sum equation of deposit creation vs loan+interest.

    I think balancing the equation this way is impossible. The new positive money will change hands a time or two before it is used to pay back a bank debt and thereby extinguished. Sure, some households will meet a payment where there otherwise would have been a foreclosure, but the result will be the same: burgeoning indebtedness and impoverishment.

    Moreover, there will be a Minsky effect as with every Keynesian or QE scheme. An infusion of easy money will encourage entities to bid higher for assets by borrowing more. Positive money in a debt-based scheme just kicks the can along.

    In fact debt deflation can’t be solved with greater debt, Keynesian stimulus, lower interest rates, quantitative easing, positive money, commodity money or jubilees. But I believe it can with SBDM, service backed-and-denominated money. Example: digital bridge tolls, subway fares and Forever stamps used as a means of exchange throughout the economy. SBDM is money whose underlying value is created in the economy fresh daily. And whose value depends not on scarcity but on utility. Consider: a Forever Stamp or subway token doesn’t gain or lose value with the quantity issued.

    You’re an economics writer with an enormous depth of understanding. I’m hoping to enlist you as an SBDM proponent, and would be interested in hearing your thoughts.

    Rgds -- EconCCX

  7. Derryl Hermanutz says :

    You're right. In the past I have supported Fisher's 100% Money proposal. One of my motives for that was my desire to stress the fact that under our current system, the system that was also current in Fisher's time, BANKS, not "governments", create all our money. I was hoping that heterodox monetary thinkers from the MMT school in particular would see that if Fisher is proposing government money creation as an ALTERNATIVE and as a solution to the Depression era failure of our CURRENT system, they would recognize the reality that under our current system banks create all our money as debt. As I noted in the article, MMT currently claims that government creates money by spending it into existence, which is simply not true. MMT further claims that bond sales do not "fund" government deficit spending, but are merely an optional formality that government currently practices for some inexplicable reason This is also not true. If you were actually creating money, why would you then agree to call that money your "national debt" and pay interest on that money to bankers and other bond merchants, and to agree to "repay" the money that you "created"?

    MMT's claims defy logic. And the claims contradict the straight observation that governments sell bonds to replenish their BANK accounts out of which governments PAY their spending. Governments (except China) exercise no power to reach into their banking systems and "mark up accounts" as their method of "paying". Only BANKS can reach into their own balance sheets and mark accounts up and down.

    I was hoping MMT would be an ally in the effort to reform our money systems to prevent collapse-depression-WWIII. But MMT falsely teaches that governments are ALREADY creating their own money simply by deficit spending and 'marking up accounts' as if they are bankers who are in control of banking system balance sheets. MMT is not advocating monetary system "reform". They are advocating that we simply 'reform' the way we understand government "debt".

    This can't work. The problem is arithmetic, not epistemological. Changing our mind is not sufficient to change the money system that our mind is observing in its present process of collapsing. I agree with monetary reformers like Fisher and CH Douglas and Steve Keen, that under the current system collapse is arithmetically inevitable and the only kind of solution that can work is adding positive money numbers into the equation in the form of debt-free government money (or some arithmetically identical form of debt relief). Governments COULD take full control of their money creation process, as Fisher advocated, but they DO NOT do so. Fisher's 100% Money is a good technical solution, but it is unrealistic due to human limitations.

    Turn of the 20th century German political scientist Max Weber said, "There are no permanent solutions in politics." Politics is always a contest between competing agendas. In "Global Brain", Howard Bloom warns us not to allow the "conformity enforcers" to gain dominance over the "diversity generators" in our culture. Our liberty, our freedoms, are WON, and held by ongoing EFFORT, not given. Thomas Jefferson did not originate (according to wiki.answers) the statement, "The price of freedom is eternal vigilance." ("Thomas Jefferson"... Actually that's not correct. This is often misattributed to Jefferson, but those words were never uttered in that way by anyone of note.
    The earliest statement that reflects this sentiment was made by John Philpot Curran in a speech upon the Right of Election in 1790 (published in a book titled "SPeeches on the late very interesting State trials" in 1808). He said:
    "It is the common fate of the indolent to see their rights become a prey to the active. The condition upon which God hath given liberty to man is eternal vigilance; which condition if he break, servitude is at once the consequence of his crime and the punishment of his guilt." )

    The "active", in the context of money, are the bond merchants-cum-bankers who profit and rule the world via their monopoly of money issuance. The "indolent" is everybody else who quietly accepts the tightening grip of our servitude to these very active, very aggressive power mongers. MMT acts like this is not a 'real' problem, that democratic governments representing the legitimate interests of their national populations can simply reach into the bankers' realm and 'mark up accounts' in the banking system. This is a woefully naive perspective.

    In his note above John acknowledged our awareness of the "right sizing" issue regarding how much money to inject how fast. I have written about this extensively in the past. But this Copernican turn article was already booklet length and neither John nor I wanted to make it book length by getting into all of the implications and consequences of the debt-free government-money funded debt paydown proposal. I think Steve Keen, who champions this "debt jubilee" solution as arithmetically inescapable (unless we want collapse-depression-WWII) is presently working on the math, putting numbers to the ideas. Steve will be able to tell you how much inflation this policy will cause.

    In his note above John stated the fact that the current debt-money system has utterly and inescapably failed to contain inflation, as its advocates claim it is able to do. So our "solvency checks" proposal of adding debt-free government money into our national equations is not going to cause inflation that isn't already being caused anyway by the arithmetically failed bank-debt-money system we are currently saddled with. Again, I have addressed this concern in many previous articles and comments. We can't say "everything" in an article-length piece. But by leaving out those critical implications and consequences we can stimulate YOU to see the problems and figure out solutions for yourself. (:

    If it is ever to become a reality, monetary reform must become a "movement". And the movement can only be undertaken by people who have personally studied and come to understand the issues. Once you have learned and come to understand the money system it is very simple. But getting to that state of intellectual clarity and simplicity is a very long road of research and thinking. It requires eternal "vigilance". The alternative, the consequence of learning nothing and doing nothing, is servitude to the "active" element who spend all their time gaining monetary and political power over us.

  8. ****-

    "Taxation is a political process - good luck with making that work effectively."

    But just GIVING money to people to pay down their debts would NOT be a political act? It is the quintessential "voting themselves largesse out of the public Treasury." Let alone the moral hazard it would create, it is a political non-starter, which doesn't make it a bad idea (moral hazard does that), but leaves it no better off than taxation on that score.

    Moral hazard, however, cannot be ignored. I support Federal bail-outs of the states and cities precisely because those bail-outs could come with strings to prevent a repetition, i.e., they needn't give rise to moral hazard. But bailing out private debtors will not work. (And I'm not even addressing the inflationary impact of all that debt relief - I'll assume going in that the output gap is SOOOO big that we can handle as much new demand as the new money will create. But that IS where the political objections will arise.)

    Some debt is effectively perpetual. Yes, it needs to be rolled over, but it always IS rolled over, providing the same one-time boost as simple spending. How many utilities have reduced their outstanding debt over their existence? Debt is part of capital structure. It can last and grow with the debtor forever.

    I think it would be good to stop thinking of taxes as revenue. I do buy the right-sizing theory - that taxes exist to suppress demand so that the demand created by the government's spending does not cause inflation. But, more important, if I may indulge the corporate analogy for this limited purpose, I would treat taxes as capital not income. The government invests to produce a more perfect union and all those other good things in the Preamble to our Constitution. To the extent that it achieves that result, it is realizing "revenues." That's why the government's dollar books should not balance: It spends dollars to produce non-dollar "gains." Those gains are enjoyed by the people, who are able to engage in sufficient economic activity on account of them to absorb much of the money printed to bring them about. The rest is taxed back out of existence. Taxes as "revenue" simply point the brain in the wrong direction.

  9. Admin (Member) Email says :

    LJK - - -

    You wrote: Taxes as "revenue" simply point the brain in the wrong direction.

    Can you have that etched in a brass plate and make a gift to Congress?

    John Lounsbury

  10. "MMT is not advocating monetary system 'reform'. They are advocating that we simply 'reform' the way we understand government 'debt'. "

    This is true. Because that's what we need to do. I don't claim to be an MMTer, but I do believe I understand what they are saying on this score.

    The Fed is a creature of government. It's charter is Federal, and its powers are Federal. If the governing statute said that the Fed SHALL lend the Treasury whatever money the Treasury demands, then the central bank would lend the Treasury whatever money it demands.

    Because the sovereign has the power, not under its statutes, but under its Constitution, to cause legal tender to be credited to its bank account at a bank it has the power to create, the fact that it chooses as a matter of prudence to create an "independent" central bank is structurally irrelevant. That bank becomes HOW the sovereign spends money into existence, because, if it did not "lend" what the political branches of government wanted - including money to roll over expiring "debt to the central bank - it could be forced by political means to do so. And because the political branches can compel the central bank to roll over the national "debt," the debt is not "debt" as all. (Note that interest paid to the Fed returns to the Treasury.)

    The role of the PDs in this process is logically distinct from the mechanics of the process. All Treasury debt that remains in private hands, i.e., that the Fed does not buy through its open market operations, is money that private parties, including the PDs to the extent that they buy for their own portfolios, choose to hold. The PD knows that it can sell bonds to the Fed at the price the Fed has made known that it will pay. Therefore, the PDs bid on all of the bonds and keep as many as they and their customers want. The rest they sell back to the Fed. In logical terms, that is the same thing as the Fed "buying" all of the Treasury's debt - i.e., allowing the government to spend money into existence - and then selling off to the public whatever securities it may please the public to own at the interest rate that the Fed finds appropriate to its mandate.

    MMT separates the logic from the mechanics, deconstructing the PD's auction bid into its components: the net new money that the Fed is printing (i.e., the Treasury securities that the Fed buys in the open market) and the money that the PDs and their customers convert into Treasury securities.

    The MMT position is straightforward: if there were no central bank, the government COULD spend its money into circulation. The "loans" that the PDs make are, therefore, made in response to an offer they cannot refuse. That it suits the PDs to buy and hold or distribute some part of each new Treasury issue does not change the fact that the government is conjuring into existence the money that the PDs do not so convert.

    Perhaps the key to the MMT concept is the notion that the government does not spend into existence all of the money that it spends. To the extent that it receives taxes, it need not create new money. And to the extent that the government sells securities to the public, the Treasury need not create new money. But to the extent that it spends more money than the sum of taxes and bond proceeds, that money comes, indirectly from the Fed, which may pretend to be "lending" it to the government, but (i) has no more choice in the matter than the political branches as a matter of sound government have given it, and (ii) doesn't keep the interest, and (iii) will roll it over ad in finitem. That money is, for all intents and purposes, newly printed, and since it represents as much money as the government uses that is not offset by taxes or bond sales, it makes perfectly good sense to say that the government spends ALL of the money it uses into existence but then retrieves as taxes and bond sales as much money as it needs to destroy, adjusting tax rates through its political branches and/or interest rates through its banking branch. The logic of the process is print and retrieve; only the mechanics are retrieve and print.

  11. Admin (Member) Email says :

    LJK - - -

    Allow me to add a clarifying note and a link for your last comment for those who are seeing this discussion without a thorough background.

    The term you use (PD) is Primary Dealer. These are banks and shadow banks which have been designated by the Treasury to provide the Treasury securities trading interface between the government (and the Fed as designated representative of the government) and the public. For a more complete description see Wikipedia: http://en.wikipedia.org/wiki/Primary_dealer

    The NY Fed has a current list of PDs: http://en.wikipedia.org/wiki/Primary_dealer

    There are exceptions to the PD process. (1) Treasury Direct is a process where individuals and institutions, such as pension funds, can buy Treasury securities directly from the Treasury at the periodic Treasury auctions. Anyone can register for that process. (2) China was recently granted what is essentially a Treasury Direct "license". For recent news see: http://econintersect.com/b2evolution/blog1.php/2012/05/23/treasury-direct-for-china

    The Primary Dealers are required to buy all Treasury auction issuance that is not sold through Treasury Direct and serve as the conduit to the secondary market. The PDs thus serve as a market maker for transactions of The Treasury and the Fed. The PDs execute the transactions dictated by the FOMC (Fed Open Market Committee, see http://www.federalreserve.gov/monetarypolicy/fomc.htm).

    I hope this is helpful for readers who are not into the arcane details we are discussing here.

  12. Dig Deep says :

    Derryl; you wrote
    Non-Debt Money

    The government still “could”, but doesn’t, issue its own non-debt money. Until the government actually begins issuing its own debt-free money, there can be no solution to our macro problems of monetary arithmetic. The issuance of debt-free government money is the sine qua non for ANY viable solution to our current macro ailments.

    It would appear that despite the debt 'tag' on treasury purchases by the Fed from the PD's - the Fed balance sheet doesn't act like a typical creditor in expecting repayment and cancelation of the debt....when the Fed can continuously roll the old debt.

    Not seeing the consequence of the Fed expanding its sheet - or rather, functionally it seems to me net new money is added w/out the restraints of paying down (the) debt while having the ability to roll old debt over - at will.

  13. Admin (Member) Email says :

    Dig Deep - - -

    I don't want to tread on Derryl's toes - he might prefer that he gave his own wording for the answer - but I am jumping in anyway.

    Your observation is exactly correct. Federal debt that is held on the Fed balance sheet is debt-free money as long as it stays on the books. The balance sheet at the Fed is expanded by buying Treasuries from the PDs with newly created bank credits. Thus we have new money created to replace the money that the PDs paid to the government to fund government spending. The net effect is the same as if the Fed credited the Treasury directly, which it cannot do under current law.

    It is debt free because, although the Treasury pays interest on that debt, all income for the Fed is paid to the Treasury. (Note: There may be a little leakage because the Fed does incur expenses in carrying out these operations and only the net earnings of the Fed are paid to the Treasury.)

    But this debt-free money may be so only temporarily. If inflation increases and the FOMC decides to drain liquidity they do so by selling Treasuries from their inventory (their balance sheet) through the PDs. The Treasuries end up in hands other than the Fed and the interest paid by the Treasury then enters the economy.

    The net cost of interest to the government can increase in two ways in the scenario described:

    1. More interest paid by the Treasury is no longer being returned through the Fed.

    2. Market forces will put upward pressure on Treasury rates and future issuance will be done at lower prices (higher interest) raising the interest costs of future debt-supplied money.

    This entire set of relationships is why the idea of issuance of debt-free money directly and control of excesses through increased taxation to drain excess liquidity is so appealing in theory.

    In practice the problem is: Who (or preferably what) determines the right level of taxation to maintain the proper amount of money in circulation?

    Taxation is determined by political processes and which special interests will gain the upper hand in this?

    Ah, the right sizing problem again.

    I have had private discussions about this problem with leading MMT economists and there is general recognition that our current institution would be insufficient to "regulate" taxation properly. (The current institution is Congress.)

    Where is that devil again? Oh yes, the details!!

  14. John -

    I agree that taxes cannot be fine-tuned, but I would also argue that they SHOULD remain relatively constant, as people actually plan their activities around the tax laws, and fostering uncertainty about taxes is a negative externality of right-sizing through taxation.

    I would also look at the Fed's Open Market sales as an attempt to slow the velocity of money rather than just decrease its supply. The object of the anti-inflation game is to suppress demand. Draining liquidity while maintaining reserve requirements makes credit harder to qualify for, which may suppress demand more than the actual extraction of the money itself. I'd be interested to know whether economists believe that the actual reduction in reserves, as opposed to the interest rate implied by Fed tightening, is the principal reason that tightening tightens.

  15. John and DigDeep -

    I would caution against trying to be a little bit pregnant regarding MMT. Once you accept that US debt is not debt, I think you have to put aside related notions, like "debt-free money."

    I don't think of Treasury Securities as loans. I think of them as contracts not to spend. The owner of dollars, in consideration of the government's promise to pay him periodic compensation (called "interest"), agrees not to spend those dollars for the term of the agreement. The government gets no money from this arrangement. How could it? As a fiat monetary sovereign, the government NEEDS no money and is definitionally incapable of HAVING money. The government can destroy money (by taxation), and it can secure commitments for private parties not to spend money (sell bonds), but that's all it can do. So-called "loans" to the government are not extensions of credit and do not create money, debt-free or otherwise.

    This analysis does no violence to the bond market as we know it. If the holder of a No-Spend contract needs or wishes to spend the money he has committed not to spend, he must find someone else to assume his commitment (buy the securities from him), settling up with that person for the capitalized value of any change in the going rate offered by the government to people who make such commitments for the remaining term of the assigned contract.

    If the Fed tightens, it merely raises the price that the government pays people not to spend, and the sales thereby effected represent MORE people agreeing not to spend in consideration of the higher compensation being offered. Getting MORE commitments not to spend does not affect any money created by the earlier transaction, because, as mentioned above, no money was CREATED by the earlier transaction. The earlier transaction simply sequestered money created by government spending.

    Under this reading, money does not change from "debt-free" to "not debt-free" when the Fed sells a security; those concepts remain meaningless in accordance with MMT. Rather, it becomes clear that "loans" to the Treasury never are, and so never can become, "debt-created" money. Those transactions always represent the voluntary sequestration of money previously created by the government through spending or by a bank through lending.

  16. Dig Deep says :

    Off subject - In regards to taxation - it would seem better to channel capital toward "production/manufacturing" v "financial products. Currently the incentive being skewed to financialization....

    Would this not be accomplished quickly if cap gains of financial products were raised back to (25% v 15% ?).

  17. Admin (Member) Email says :

    Lawrence - - -

    I think I agree with you. The only time that things might differ would be when the Fed is expanding its balance sheet and increasing Treasury holdings. There are new dollars created (bank credits) and, because the interest paid by the Treasury to the Fed is returned by the Fed to the Treasury, the additional dollars are essentially debt-free.

    This is a point I made previously but will repeat. The debt-free status can be reversed at any time the Fed wants to tighten and then sells the Treasuries from the expanded balance sheet to the public. Now the interest paid by the Treasury goes into the public domain (instead of back to the government via the Fed return of profits).

    The term debt-free money in general would apply to a system we do not have today (but have had in the past) where the government actually prints currency or directly creates bank credit money, as it can under the constitution. Example of this is the greenbacks from the Civil War era.

    I think that we often start using terms in an adaptive way that doesn't help sharpen definitions. I certainly keep finding myself personally fighting this behavior.


  18. Admin (Member) Email says :

    Dig Deep - - -

    What you suggest is not only a logical point for discussion but such "investment directing activity" is in the tax code today. I am referring to the advantaged position of capital gains from home ownership. Of course, a lot of people who tried to take advantage of that got burned in the housing bubble.


  19. Dig Deep says :

    the concept of selling treasuries - at rates that attract $ in order to sop up liquidity vs financing a deficit - is foreign to 99%(my guess) of the headline broadcasts we see daily.

  20. Dig Deep says :

    Derryl's premise below, is what I question. The Fed sheet expansion can continue ad infinitum as there's no required repay consequence for the Fed debt on its sheet - functionally acting as new net non-debt money into the system.
    "So the current mechanisms of government deficit spending merely redistribute their national earned incomes vertically over time without adding any net new spending-cum-incomes into their economies. Funding this deficit spending with money they create themselves debt free, rather than with money they borrow as new debt, is one way of adding net income into their national economies".
    Derryl also explains;

    "So government debt is exactly the same kind of vertical zero sum equation as private sector debt. All the money that was borrowed by governments and private sector debtors added to “today’s” spending-cum-national income, but it all has to be paid “back”, out of future incomes/taxes"

    I argue it's not "exactly the same" as household debt with the Feds ability to roll and re-issue....

    Taxation (reduced for net effect of new free money, or higher taxes to drain liquidity) ....would apply to Derryl's thesis for the need of "net new non-debt" money in the hands of households.

    Japan's expanding central bank sheet is an example of the sovereigns ability to create new money - without the effects of debt repayment in the medium to long term...in effect new, non-debt money creation.

    The inherent problem with all of this - is that government central planning is in directional control of the new money - regardless how one views the attachment or not of the debt strings.

    This is where tax policy might be the best vehicle to put "new" money into the hands of the households.

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