A Background to the Origination Of Soft Currency Economics aka Modern Monetary Theory

by Warren Mosler

Cross posted from Soft Currency Economics.  Editorial changes 14 March 2013 12:01am New York Time.

As you will read in Soft Currency Economics, in November of last year, I was invited to speak at a Government Debt conference in Rome along with Mario Draghi. My speech received a lot of publicity in Italy and Modern Monetary Theory (MMT) blogs started popping up all over Italy. Many of the bloggers appeared to understand how Modern Monetary Theory works and how governments with their own free floating non-convertible currencies can never default on their debt obligations. After reading Soft Currency Economics, they also understood that government can function for a public purpose without any revenue constraints. All that was required was determining the public purpose.

On an Italian Blog I made the post below to further explain Modern Monetary Theory and how it initially originated outside of economic thinking, but rather in the trading of sovereign debt.

First, let me remind that MMT was originally ‘Mosler Economics’ which began with ‘Soft Currency Economics’ (1993). Note too that ‘Soft Currency Economics’ was a result of my first-hand experience after 20 years in banking and monetary operations.  I had never read Keynes, or even heard of Lerner, Knapp, or had any knowledge of any ‘post Keynesian’ economics.  So while it may be true that MMT can be derived from one school of thought or another, it didn’t happen that way.  And, for example, when I put forward my ‘real vs nominal’ discussion of fiscal transfers in a monetary union earlier this year, explaining how the production of public goods and services for the benefit of the entire union is in fact a real cost to the region that receives the funding to produce these public goods and services, that was also ‘original MMT thought’ (fully recognizing the shortcomings of such a statement!).

Second, if there is a ‘fundamental’ contribution of MMT to ‘the literature’ it’s the explicit recognition that a currency like the dollar is in fact a simple public monopoly, and all the rest follows.  Along those lines I have lectured on the long standing ‘Keynes vs. the Classics’ discussion, where the Classics argued there can be full employment with no monopoly, and Keynes argued that in fact there can be persistent unemployment in the absence of monopoly, due to the effects of unspent income, etc. in the monetary system.  My response is they both failed to explicitly recognize the currency itself is a public monopoly. Notional demand is from taxation and from savings desires, and notional supply from state spending and/or state lending. And unemployment is the evidence of a restriction in supply from the monopolist- the failure to spend enough to satisfy the need to pay taxes and the desires to net save in that unit of account.

So the classics were right in that unemployment does come from monopoly, but they failed to recognize the applicable monopoly. And Keynes was right, the problem was on the monetary side, but he failed to recognize the currency itself was a simple public monopoly, even though he described it much along those lines. If Keynes had recognized the currency was a monopoly, he surely would have explicitly said so in this discussion, and many other places as well to support many of his contentions.

With regard to circuit theory, when I first met the Post Canadians in the mid 1990′s, who I very much respect, especially the M&M’s (Mario and Marc), and read a bit of circuit theory, it seemed so ‘intuitively obvious’ – a case of ‘goes without saying’- I wondered why it was even worth writing about! And my first comment was that while I fully agreed with what they were saying, it didn’t ‘start from the beginning’ in that it began with firms borrowing to pay workers, but never discussed why anyone would work for the currency in the first place. I explained to them that it about the currency being a simply public monopoly, with tax liabilities the ‘driving force’ behind the ‘government circuit’ where, at the macro level, taxation creates sellers of real goods and services, including labor, which is why people work for businesses, etc. Professor Alain Parguez immediately picked up on this and added it to his model in his next paper, only to be severely criticized and isolated by much of the ‘Circuitist’ community for many years! Most came around to accept it over the years, though some continue to fail to do so.

From Emiliano Brancaccio, Advantages and Limitations of the Modern Monetary Theory (MMT), Constructive Criticism (translated from the Italian):

“I think it’s worth remembering that this thesis is a rigorous foundation of the theory of relative prices and distribution in the development of the so-called “theory of production”, which, among others, Leontief and Sraffa have made outstanding contributions above (see Pasinetti 1975; Kurz and Salvadori 1995, cf. Petri also 2004). In particular, in the light of the theory of production and the above-mentioned argument and its implications can be extended to so-called “long term”, and the objections of Krugman (2011) to the MMT can be effectively criticized.”

Relative prices, yes, but MMT reveals the source of absolute nominal prices. And it’s very simple. As everyone knows, a monopolist is ‘price setter’ rather than ‘price taker’.

And a monopolist is price setter for two prices. The first what Marshall called the ‘own rate’ which how his ‘item’ exchanges for itself. With a currency this is the rate of interest, which we know is set by the CB and not ‘the market’ as we know the CB is monopoly supplier of reserves to its banking system, and therefore is price setter as it prices the banking system’s marginal cost of funds. The second is how the monopolist’s ‘item’ exchanges for other goods and services, which we call ‘the general price level’

I say it this way – the price level is necessarily a function of prices paid by the issuer when it spends, and/or collateral demanded when it lends.

Continuing with Brancaccio:

“However, as Lavoie has shown, it is derived from a simple accounting convention: some modern monetary theorists analyze the central bank and the state as if they were a single sector consolidation. The mystery is easily solved, then. However, it should also add that this consolidation, in the current political and institutional reality, does not exist.”

First, I do very well know, recognize, and account for the institutional realities at all times. As I do know that no matter how you look at it, spending comes first before taxing of borrowing for the issuer of the currency, which includes his designated agents.

Congress is the issuing authority, and has assigned various tasks to the Treasury and Fed to carry out its will.

The Fed operates a spread sheet that contains the accounts of its member banks, as well as an account for the Treasury.

I begin, for purposes of this discussion, at inception, with no balances in any accounts.

Any payment of taxes would require the Fed to debit a member bank account and credit the account of the treasury.

This is impossible with no balances in the member bank accounts, unless they are permitted to have negative balances.

However, negative balances- overdrafts- are functionally loans from the Fed, an agent of Congress. This means paying taxes via overdraft is paying taxes via obtaining a loan from the Fed. That is, in this example, the Fed must lend the dollars that it accounts for as payment of taxes.

The way ‘insiders’ say it, there can’t be a ‘reserve drain’ without a ‘reserve add’

That is, the dollars to pay taxes and to buy treasury securities necessarily ‘come from’ govt. spending and/or lending.

There is no way around it:  A simple point of logic is that any currency issuer must distribute it before he can collect that which he issues.

Regarding trade, with a floating exchange rate there is ‘continuous balance.’ For example, in the case of the US, with perhaps a $400 billion trade deficit, it can be said that we have the goods and services we imported, and non-residents are holding the additional $400 billion of $US financial assets they received in payment, and at this point in time there is that ‘balance’ which has resulted in the current exchange rate matrix.

So I see only ‘balance’ at any given point in time, never ‘imbalance’, as a point of logic. Am I missing something? If so, rather than I write about every possible question I can imagine you might raise, can I ask for any of you to give me an example of why this is a ‘problem’ so to speak? Thanks!

Continuing with Brancaccio:

“In a period in which the theme of the insertion of foreign capital in the ownership and control seems to go beyond the scope of the last strategic assets in public hands and even get to lick the banking system, it would be good to do a lot more clarity on this point.”

Yes, at any time I see public purpose in sourcing matters of strategic purpose domestically. For example, you do not want to outsource the programming of your military software which could render it useless in time of war. And I see public purpose in producing goods and services with strategic military purpose domestically, like the steel that goes into maintaining the military and domestic sources of energy, food, etc. etc. Again, government is there for public infrastructure that serves public purpose, which includes strategic planning.

On the other hand, I don’t see the public purpose in not allowing nonresidents to sell us most of what we call ‘consumer goods and services’ where, for example, a cut off in time of war would not alter the outcome of the war.

Along these lines, I see a serious problem with the euro zone’s dependence on Russian energy supplies, even though Russia has ‘promised’ never to cut them off.  That and $20 will get you a cup of coffee in Rome.

I see the euro zone as paying a heavy price in regards to real terms of trade with Russia and others, due to arrangements that I don’t see serving public purpose, though they certainly do serve influential private purpose.

Remember, economically speaking, employment is a real cost to the worker. He is selling his time. The real benefit is the output. So I suggest you look at real consumption with regard to the euro members, to see whose winning and losing economically. But yes, any monetary union needs a system of fiscal transfers to ensure full employment and price stability. And I suggest the reason it doesn’t happen is because it’s not widely understood that if a region is assigned the production of public goods and services, in real terms that process is a real cost to that region, as it’s employed to produce real goods and services that other parts of the union are consuming. Instead, because that region gets funding, it’s assumed that region is benefiting in real terms. In other words, fiscal transfers can be affected to use the areas of higher unemployment to produce goods and services that are exported to the rest of the union. This all comes back to exports being real costs, and imports real benefits, etc.

Let me conclude that, as a matter of simple game theory, labor is not a fair game, and if not supported in some manner real wages will stagnate at very low levels. This is because people must ‘work to eat’ while business hire only if they can make a desired return on investment.

For me it suits public purpose to make sure people actually working for a living and producing real goods and services consumed by the majority are worthy of being supported with high levels of education, health care, and other such public services, as well as being fed, housed, and clothed at levels that make feel proud to be members of that society. The proposals on my website are intended to work to that end.

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