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posted on 29 December 2015

# Debt-free Money Vs. Balance Sheet Tyranny: Part 1

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MMT luminary Randy Wray calls debt-free money "a non-sequitur in search of a policy".

Prof. Wray does not "believe in" debt-free money. Why not?

Financial Assets

MMT believes money is a financial asset.

Within the zero sum arithmetic of balance sheet accounting, Assets = Liabilities. A balance sheet "balances" to \$0.

An asset that is "owned" in the left column, must be "owed" as a liability in the right column. Owned minus owed = \$0.

The entity whose financial condition is being described on the balance sheet has a "net worth" of \$0. Always. By definition.

Asset minus liabilities = \$0 is an "accounting identity": an equation that is true by the definition of what a balance sheet "expresses".

If the total of the positive numbers in the Assets-owned column, does not exactly equal the total of the negative numbers in the Liabilities-owed column, then you have not done your balance sheet accounting correctly. You will have to find some way to add or remove positive or negative numbers until you get the present total money price of Assets to exactly = the present total money price of Liabilities, so your balance sheet sums up to \$0.

So if money is essentially, necessarily, as an inviolable law of reality, a balance sheet asset, then Wray is right: it is "impossible" -- logically and by definition -- for money to exist unless the money is "owed" by somebody, and owed to somebody else.

But here's a conundrum. On the balance sheet, what if it is the same party who owns money as an asset, and who owes that money as a liability?

Personal "Balance" Sheets

The \$100 in my wallet is my "liability"??? I don't "owe" the \$100 to anybody. And it spends like it's my "asset" -- people will sell me real stuff in exchange for my \$100. I swapped my money asset for their real asset. They now own the money. I now own the real stuff. Neither of us "owes" anything to anybody as a result of our asset swap. There is no "debt", no "liability" in our buy-sell transaction.

Hmmm...

Here's a riddle for Mr. Wray. What kind of entity always owes everything it owns, so that its net financial condition always = exactly \$0?

The entity is certainly not a human being.

A "debt-free" human being can own a house and a bank account and a brokerage account and a wallet full of cash, whose present money price totals \$1 million. If he sold his house and cashed out his accounts, he would have \$1 million in cash. The human owes no debts, so his balance sheet reads,

Assets = \$1 million; Liabilities = \$0. Assets minus liabilities = +\$1 million.

A net positive number?! This human's balance sheet is way out of balance. He "has" money, but he doesn't "owe" the money. And nobody owes the money "to him". Nobody owes nuthin' to nobody. Yet the guy is standing there with net \$1 million of debt-free money in a bag. A horrific violation of the balance sheet's zero sum requirement.

A "deeply indebted" human being can live in an underwater mortgaged house with negative equity, owe money to his bank, and have \$0 in his brokerage account and \$0 in his wallet, so his balance sheet reads,

Assets = \$0; Liabilities = \$600k. Assets minus Liabilities = -\$600k. This guy owes \$600k to other parties. He is net \$600k "in debt".

What's going on here? One guy is a million bucks above ground, the other guy is in a \$600k deep pit of debt. Neither of their balance sheets balances to \$0. Their financial equations are very badly imbalanced.

But the equations are accurate descriptions of these humans' present financial condition.

Could it be that balance sheet accounting does not apply to entities called "humans"?

Yes, it could be that.

Zero Sum Balance Sheets

So what kind of entities always exist as zero sum balance sheet equations?

Corporations are that kind of entity.

A corporation is a non-human legal construct that is owned, ultimately, by human owners called "shareholders". The corporation's operating profits and net worth "belong to" its human owners.

Owning shares entitles shareholders to share corporate profits by receiving dividends paid out of the corporation's bank account or other financial accounts.

A corporation can own assets -- including money in accounts -- but the corporation owes all of its assets to its human creditors and shareholders, so the corporation's assets are owed as its liabilities.

I don't owe my assets to anybody. But my sole shareholder corporation owes all of its assets to me. I can legally "incorporate" my small business, so the business becomes its own legal entity that is separate from "me". But as sole shareholder, all of the corporation's profits and its net worth always belong to me. Everything my corporation "has", minus everything the corporation owes to parties other than me, the corporation owes to "me" as its liability.

There can be one shareholder or 10 million shareholders. Assets and liabilities can be in the billions or in the thousands. But Assets minus Liabilities always nets out to \$0, and the company's positive net worth is always owed as "shareholder equity" to its human owner or owners.

When a corporation's total assets exceed its total liabilities to non-owners, the corporation's positive net worth is expressed on a line on the balance sheet, "Shareholder equity and retained earnings". That is the present net worth of the corporation. But the corporation owes that amount to its human owners. So the corporation's net worth is recorded on the liability side of the corporate balance sheet.

The human owners want to maximize that particular corporate liability, because it expresses how much money their corporate legal construct owes to them -- the human shareholders.

If the owners decide to cease their corporate business: they can sell all the corporate assets, pay out all the corporate liabilities, then distribute the net proceeds among themselves according to how many "shares" each person owns. Then they can legally dissolve the corporation, so it no longer exists as a legal entity.

The corporation began with \$0, always existed as a net \$0 balance sheet equation, and ended as \$0.

But Zero Sum is not a "Pass-Through"

We have just seen that the balance sheet for a corporation must net to zero by definition. But the corporation was not a zero sum equation for its human owners. They invested their money legally creating the corporation and buying the new corporation's shares, then earned dividends for years or decades, then got all their investment (and more) back when they liquidated the corporation and distributed the proceeds among themselves.

The total money price of a corporation's Assets = the total money price of its Liabilities. If the corporation sold all \$5 million of its assets and paid all \$2 million of its non-owner liabilities, and distributed the \$3 million balance among the shareholders, the corporation would have \$0 assets and \$0 liabilities on its pristine balance sheet. But the owners would have +\$3 million of debt-free money.

Everything a corporation "owns", is owed to the corporation's creditors and ultimately its human owners. No matter how much "real" net worth a corporation builds up, the permanent balance sheet financial condition of a corporation is net worth = \$0.

Incorporated small businesses whose owners do their own corporate accounting, financial reporting and tax filing, are familiar with balance sheet arithmetic. It's not rocket science. It's not even "monetary theory", modern or otherwise.

It is accounting, which involves adding and subtracting sums of numbers. Some of the accounting is counter-intuitive, such as expressing the corporate net worth as its "liability".

Balance sheets are arithmetic equations. The equations must always sum up to \$0.

The financial condition of corporations is described on zero sum, "money = debt" balance sheets.

Corporations are legal constructs. Humans are not.

And governments are also not the same beasts as corporations.

Thus we have the question: Is it legitimate to demand that money definitions for sovereigns and individuals conform to the accounting rules of corporations?

That is a question to be examined further in subsequent parts of this series.

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