MMP Blog 2: THE BASICS OF MACRO ACCOUNTING

By L. Randall Wray

In this blog we are going to begin to build the necessary foundation to understand modern money. Please bear with us. It may not be obvious, yet, why this is important. But you cannot possibly understand the debate about the government’s budget (and critique the deficit hysteria that has gripped our nation across the political spectrum from right to left) without understanding basic macro accounting. So, be patient and pay attention. No higher math or knowledge of intricate accounting rules will be required. This is simple, basic, stuff. It is a branch of logic. But it is extremely simple logic.

A note on terminology: a simple table at the bottom of this post will define some terms that will be used throughout this Primer. You might want to refer to it first, then come back and read the blog.

One’s financial asset is another’s financial liability. It is a fundamental principle of accounting that for every financial asset there is an equal and offsetting financial liability. The checking deposit is a household’s financial asset, offset by the bank’s liability (or IOU). A government or corporate bond is a household asset, but represents a liability of the issuer (either the government or the corporation). The household has some liabilities, too, including student loans, a home mortgage, or a car loan. These are held as assets by the creditor, which could be a bank or any of a number of types of financial institutions including pension funds, hedge funds, or insurance companies. A household’s net financial wealth is equal to the sum of all its financial assets (equal to its financial wealth) less the sum of its financial liabilities (all of the money-denominated IOUs it issued). If that is positive, it has positive net financial wealth.

Inside wealth vs outside wealth. It is often useful to distinguish among types of sectors in the economy. The most basic distinction is between the public sector (including all levels of government) and the private sector (including households and firms). If we were to take all of the privately-issued financial assets and liabilities, it is a matter of logic that the sum of financial assets must equal the sum of financial liabilities. In other words, net financial wealth would have to be zero if we consider only private sector IOUs. This is sometimes called “inside wealth” because it is “inside” the private sector. In order for the private sector to accumulate net financial wealth, it must be in the form of “outside wealth”, that is, financial claims on another sector. Given our basic division between the public sector and the private sector, the outside financial wealth takes the form of government IOUs. The private sector holds government currency (including coins and paper currency) as well as the full range of government bonds (short term bills, longer maturity bonds) as net financial assets, a portion of its positive net wealth.

A note on nonfinancial wealth (real assets). One’s financial asset is necessarily offset by another’s financial liability. In the aggregate, net financial wealth must equal zero. However, real assets represent one’s wealth that is not offset by another’s liability, hence, at the aggregate level net wealth equals the value of real (nonfinancial) assets. To be clear, you might have purchased an automobile by going into debt. Your financial liability (your car loan) is offset by the financial asset held by the auto loan company. Since those net to zero, what remains is the value of the real asset—the car. In most of the discussion that follows we will be concerned with financial assets and liabilities, but will keep in the back of our minds that the value of real assets provides net wealth at both the individual level and at the aggregate level. Once we subtract all financial liabilities from total assets (real and financial) we are left with nonfinancial (real) assets, or aggregate net worth.

Net private financial wealth equals public debt. Flows (of income or spending) accumulate to stocks. The private sector accumulation of net financial assets over the course of a year is made possible only because its spending is less than its income over that same period. In other words, it has been saving, enabling it to accumulate a stock of wealth in the form of financial assets. In our simple example with only a public sector and a private sector, these financial assets are government liabilities—government currency and government bonds. These government IOUs, in turn, can be accumulated only when the government spends more than it receives in the form of tax revenue. This is a government deficit, which is the flow of government spending less the flow of government tax revenue measured in the money of account over a given period (usually, a year). This deficit accumulates to a stock of government debt—equal to the private sector’s accumulation of financial wealth over the same period. A complete explanation of the process of government spending and taxing will be provided in the weeks and months to come. What is necessary to understand at this point is that the net financial assets held by the private sector are exactly equal to the net financial liabilities issued by the government in our two-sector example. If the government always runs a balanced budget, with its spending always equal to its tax revenue, the private sector’s net financial wealth will be zero. If the government runs continuous budget surpluses (spending is less than tax receipts), the private sector’s net financial wealth must be negative. In other words, the private sector will be indebted to the public sector.

We can formulate a resulting “dilemma”: in our two sector model it is impossible for both the public sector and the private sector to run surpluses. And if the public sector were to run surpluses, by identity the private sector would have to run deficits. If the public sector were to run sufficient surpluses to retire all its outstanding debt, by identity the private sector would run equivalent deficits, running down its net financial wealth until it reached zero.

Rest of world debts are domestic financial assets. Another useful division is to form three sectors: a domestic private sector, a domestic public sector, and a “rest of the world” sector that consists of foreign governments, firms, and households. In this case, it is possible for the domestic private sector to accumulate net claims on the rest of the world, even if the domestic public sector runs a balanced budget, with its spending over the period exactly equal to its tax revenue. The domestic sector’s accumulation of net financial assets is equal to the rest of the world’s issue of net financial liabilities. Finally, and more realistically, the domestic private sector can accumulate net financial wealth consisting of both domestic government liabilities as well as rest of world liabilities. It is possible for the domestic private sector to accumulate government debt (adding to its net financial wealth) while also issuing debt to the rest of the world (reducing its net financial wealth). In the next section we turn to a detailed discussion of sectoral balances.

Basics of sectoral accounting, relations to stock and flow concepts. Let us continue with our division of the economy into three sectors: a domestic private sector (households and firms), a domestic government sector (including local, state or province, and national governments), and a foreign sector (the rest of the world, including households, firms, and governments). Each of these sectors can be treated as if it had an income flow and a spending flow over the accounting period, which we will take to be a year. There is no reason for any individual sector to balance its income and spending flows each year. If it spends less than its income, this is called a budget surplus for the year; if it spends more than its income, this is called a budget deficit for the year; a balanced budget indicates that income equalled spending over the year.

From the discussion above, it will be clear that a budget surplus is the same thing as a saving flow and leads to net accumulation of financial assets. By the same token, a budget deficit reduces net financial wealth. The sector that runs a deficit must either use its financial assets that had been accumulated in previous years (when surpluses were run), or must issue new IOUs to offset its deficits. In common parlance, we say that it “pays for” its deficit spending by exchanging its assets for spendable bank deposits (called “dis-saving”), or it issues debt (“borrows”) to obtain spendable bank deposits. Once it runs out of accumulated assets, it has no choice but to increase its indebtedness every year that it runs a deficit budget. On the other hand, a sector that runs a budget surplus will be accumulating net financial assets. This surplus will take the form of financial claims on at least one of the other sectors.

Another note on real assets. A question arises: what if one uses savings (a budget surplus) to purchase real assets rather than to accumulate net financial assets? In that case, the financial assets are simply passed along to someone else. For example, if you spend less than your income, you can accumulate deposits in your checking account. If you decide you do not want to hold your savings in the form of a checking deposit, you can write a check to purchase—say—a painting, an antique car, a stamp collection, real estate, a machine, or even a business firm. You convert a financial asset into a real asset. However, the seller has made the opposite transaction and now holds the financial asset. The point is that if the private sector taken as a whole runs a budget surplus, someone will be accumulating net financial assets (claims on another sector), although activities within the private sector can shift those net financial assets from one “pocket” to another.

Conclusion: One sector’s deficit equals another’s surplus. All of this brings us to the important accounting principle that if we sum the deficits run by one or more sectors, this must equal the surpluses run by the other sector(s). Following the pioneering work by Wynne Godley, we can state this principle in the form of a simple identity:

Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0

For example, let us assume that the foreign sector runs a balanced budget (in the identity above, the foreign balance equals zero). Let us further assume that the domestic private sector’s income is $100 billion while its spending is equal to $90 billion, for a budget surplus of $10 billion over the year. Then, by identity, the domestic government sector’s budget deficit for the year is equal to $10 billion. From the discussion above, we know that the domestic private sector will accumulate $10 billion of net financial wealth during the year, consisting of $10 billion of domestic government sector liabilities.

As another example, assume that the foreign sector spends less than its income, with a budget surplus of $20 billion. At the same time, the domestic government sector also spends less than its income, running a budget surplus of $10 billion. From our accounting identity, we know that over the same period the domestic private sector must have run a budget deficit equal to $30 billion ($20 billion plus $10 billion). At the same time, its net financial wealth will have fallen by $30 billion as it sold assets and issued debt. Meanwhile, the domestic government sector will have increased its net financial wealth by $10 billion (reducing its outstanding debt or increasing its claims on the other sectors), and the foreign sector will have increased its net financial position by $20 billion (also reducing its outstanding debt or increasing its claims on the other sectors).

It is apparent that if one sector is going to run a budget surplus, at least one other sector must run a budget deficit. In terms of stock variables, in order for one sector to accumulate net financial wealth, at least one other sector must increase its indebtedness by the same amount. It is impossible for all sectors to accumulate net financial wealth by running budget surpluses. We can formulate another “dilemma”: if one of three sectors is to run a surplus, at least one of the others must run a deficit.

No matter how hard we might try, we cannot all run surpluses. It is a lot like those children at Lake Wobegone who are supposedly above average. For every kid above average there must be one below average. And, for every deficit there must be a surplus.

Notes on Terms. Throughout this primer we will adopt the following definitions and conventions:

The word “money” will refer to a general, representative unit of account. We will not use the word to apply to any specific “thing”—ie a coin or central bank note.

Money “things” will be identified specifically: a coin, a bank note, a demand deposit. Some of these can be touched (paper notes), others are electronic entries on balance sheets (demand deposits, bank reserves). So, “money things” is simply short-hand for “money denominated IOUs”.

A specific national money of account will be designated with a capital letter: US Dollar, Japanese Yen, Chinese Yuan, UK Pound, EMU Euro.

The word currency is used to indicate coins, notes, and reserves issued by government (both by the treasury and the central bank). When designating a specific treasury or its bonds, the word will be capitalized: US Treasury; US Treasuries.

Net financial assets are equal to total financial assets less total financial liabilities. This is not the same as net wealth (or net worth) because it ignores real assets.

An IOU (I owe you) is a financial debt, liability, or obligation to pay, denominated in a money of account. It is a financial asset of the holder. There can be physical evidence of the IOU (for example, written on paper, stamped on coin) or it can be recorded electronically (for example, on a bank balance sheet).

75 Responses to MMP Blog 2: THE BASICS OF MACRO ACCOUNTING

  1. Over the last 30 years we have seen governments sell (privatize) public assets in part to pay down government debt.This discussion shows this to be pointless — if I have understood things correctly. You can of course make debatable claims about increased efficiency of the private sector and so on but based solely on the so-called need to pay off debt the accounting looks like a zero sum game (but good for lobbyists, bankers, fee earners and so on).

  2. Great start.As part of the definitions I'd like to see some consistency in how we refer to the sectors.For example the (I-S)+(X-M) combo is referred to across the blogosphere variously as the 'private sector' or the 'non-government sector'.(I-S) is referred to as the 'private sector', sometimes the 'domestic private sector', and above is 'domestic private balance'.(X-M) is referred to variously as 'rest of world', 'external sector', 'current account balance, 'capital account balance', 'foreign balance'.About the only one with any consistency is the 'government sector' and then the only argument (Post Keynesian rather than MMT) is whether that sector contains the Central Bank.In the primer it would be really useful to pick a term for the sectors and combinations of sectors, define them and then stick with it throughout the series.One of the problems I've found with MMT descriptions is that the nomenclature is not consistent – probably because it has evolved over the years.Fixing the terms here would certainly help.

  3. Good solid start. I have a couple of observations.When stating the identity you use the word 'balance' for the three sectors yet it seems clear you are describing surplus/deficit in a period of time. This may be confusing to the reader.You have set yourself a big task in trying to present accounting speak to the layman. have you considered a 'key points' or 'summary' at the end of each article. Perhaps something like :So for Households, Businesses and banks. The Domestic Private SectorFinancial Assets Deposits Bonds Shares IOUsLessFinancial liabilitiesOutstanding mortgagesPersonal loan balancesCredit card balancesBusiness capital (owed to shareholders)= net financial assetsAny shift in the level of net financial assets for the period will result in a deficit or surplus for the domestic private sector for that period and a corresponding surplus or deficit in the other sectors according to the identity.Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0Don't judge the content here. I will leave that to the experts. I just think a short summary of the key points would improve presentation.Thanks

  4. We could all run real surpluses, right? There are gains from trade of financial assets even if they net to zero in an accounting sense.

  5. Mike;Yes, though we must always distinguish between national governments and state, local or provincial governments. Privatization is usually a bad idea at any level, but states with balanced-budget requirements can at least make a case that a privatization contributes to a necessary budgetary action. Not to jump the gun, but the next threshold is whether a national government doing some privatizing issues its own sovereign currency or uses someone else's. The latter puts them in a position similar that of an American state or locality.

  6. This is Paolo Rossi Barnard. Please Prof. Wray, define precisely who you think will be able to read and understand this Primer. Not the illegal immigrant. Not the cab driver. Not the Burger King cook. Not the hotel receptionist. Not the fireman. Not the hair dresser. Not the history teacher. Not the osteopath. Not the professor of comparative literature. That's for sure. Not even many bankers, as you told me personally after your frustrating conversations with them.I'm being brutally frank to be useful, not to offend. This is targeting a 0,2% of net surfers in the know (of MMT) and the comments are unmistakably theirs. Here's a solution:I think this effort must be urgently modified by adding at the beginning of each session a 40 lines box 'for mums' version with the clear elementary pillars of each topic. Please, think about it.

    • Excuse me, Dr. Barnard, but as a sometime teacher of history and philosophy I find this exegesis perfectly comprehensible. You might also be surprised at how many intelligent, educated people find themselves forced to earn a living driving cabs, waiting tables, or even (gasp!) being Mums. Please consider whether your preconceptions accurately reflect reality, or your own sense of self-importance.

    • This blog was suggested to me by a non-native English speaker who was foreign born, not college educated and employed as a touring musician for a pop star. She understood it without difficulty. I am a writer/musician and I understood this first entry also. Still, your suggestion to unpack MMT in language that is accessible to the average Joe, who isn’t naturally curious about the subject, is a wise one. Simplified soundbytes that succinctly convey key points about the way money works on a macro level would help educate such non-interested people, who, otherwise, would likely be susceptible to agreeing with government spending austerity speak simply because it would be true for them on a personal financial level.

  7. One technicality. Modern national accountants use "Net Lending" instead of "Net Acquisition of Financial Assets". For them NAFA is slightly different. In addition, they use "Net Incurrence of Liabilities" and hence NL = NAFA – NIL. A sector's Income minus Expenditure is thus Net Lending instead of NAFA. Ref: http://www.bankofengland.co.uk/publications/fsr/fs_paper10.pdf

  8. Excellent that you led with a description of assets and liabilities. One of the crucial distinctions that non-MMT’ers need to get is that the private sector cannot create net financial wealth. But to that same point, I find the points about “real assets” in this primer confusing. It seems to me the sector balances approach is only valid if the underlying assumptions are true, in this case, that the private sector cannot “net save” on its own. From that respect, this primer seems to indicate that the private sector can create “real assets” and therefore increase net wealth (worth) on its own. I’m not sure this is the case, but if true, many of the prescriptive elements of MMT would appear to be invalid from a small G proponent. It may be helpful to say that all “real assets” are contained within the (stock) boundaries of financial assets. I have seen comments from JKH which seem to indicate this, although I could certainly be misinterpreting this or flat out wrong. I am still left wondering how to conceive of “real assets” within the global balance sheet and how net worth is created within the circuit. I don’t want to muddy the water of this intro, but any further comments or examples of additional literature to aid my understanding are appreciated.

  9. It's good seeing an attempt to make some sense of MMP by using logic. But so far, I'm afraid, I'm not seeing much evidence of it. Accounting happens to be a deductive discipline, and thus is based on a set of assumptions (check its wiki if you like). So accounting identities, where these pertain to a single firm, are true if and only if its assumptions hold. What convinces the writer that macro-accounting can follow the same set of assumptions? What about fallacy of composition? The first assumption of accounting is that the subject firm is a "going concern". This would mean that e.g. Y=C+I is true if and only if the economy as a whole is a going concern, i.e. in equilibrium. What has now become of this identity? Is it yet secure enough to build a paradigm on? It's still true, but only precariously so until contradictions prove it false. And we all know of the paradoxes that are inherent in Keynesianism. So, please be consistent. By all means, apply logic. But that means stop at the very first contradiction, and come up with another set of first principles that are more promising. You may find that (C) determines the value of (I), through the circular flow of (Y), with (I) being indeterminate anteriorly. For further reading please see: …/MMT_Critique

  10. Sorry if this is a repeat. Please delete it if it is."Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0"I believe it is easier for people to understand:current account deficit = gov't deficit plus private deficitBetter yet, here is what most people are seeing:savings of the rich = dissavings of the gov't (preferably with debt) plus the dissavings of the lower and middle class (preferably with debt)IMO, it should be savings of the rich plus savings of the lower and middle class = dissavings of the currency printing entity with currency and no bond/loan attached plus the balanced budget(s) of the various level(s) of gov'tWhere is the currency printing entity that could dissave with currency and no bond/loan attached?I don't believe in the central bankers/bankers' credo that all new medium of exchange has to be the demand deposits from debt, meaning it has to be borrowed into existence.

  11. I am going to offer a qualifying opinion to Paolo Rossi Barnard's comment. I think a 40 line summary is maybe fine as an addition, but I do not think the rest of the blog should be "dumbed down" for the average Joe to understand. If it is, I think MMT does itself a disservice by hurting its credibility, because "dumbed down" explanations can be misconstrued as "bogus economics" by those able to think at a higher level. And ultimately, I believe MMT needs buy-in from economists and professionals. A bunch of Burger King cooks running around espousing a theory based on a couple one-liners will make MMT look like an extremist, populist joke. Economics wasn't meant to be easily understood with a snap of the fingers. Explaining the theory in a very clear, well-organized manner is fine, but content and academic integrity should not be sacrificed for watered down generalizations and imprecise descriptions, which will lead to a misrepresentation of MMT in the hands of those who do not fully understand it. I have no problem if an illegal immigrant wants to learn this stuff, but if MMT is to be taken seriously at this point in time, he or she should do it properly, which requires putting in lots of time and diligence. Remember, this blog is on the world stage, and it has a reputation to build and maintain, particularly as it is written by an academic and cofounder of MMT. Already, we've seen super-charged, politically extremist, accusatory statements regarding "the status quo" that frankly will only make the intelligent mainstream roll their eyes, no matter how true they are. Let's keep this intelligent, respectful, and academic, as if it were a college classroom.

    • “Economics wasn’t meant to be easily understood with a snap of the fingers.”

      Why not? ‘Oikos’ originally meant “household” (ancient Greek) and the Dismal Science was developed out of roots in basic household management, which is understood by any working-class Mum. I suggest alternatively that attempts to make what is fundamentally simple look complex and technical primarily serve to stoke the egos of an academic in-group without contributing substantially to our understanding of reality. Further, many such attempts bear no resemblance to reality at all, being rooted in abstract mathematics and ignoring the facts of human behavior (i.e., classical and neoclassical concepts of rational behavior by individuals and marketplaces). Economics is fundamentally a problem of human social behavior, not abstract physics, and economists would do well to remember that.

  12. Dale,Yes I was thinking solely at the national level.Also generally it might be nice if some YouTube videos of this could be made — maybe with Q&A at the end from students in the classes of professors on this blog.I know there are some MMT videos out there but given that the objective here is to provide structured learning, accompanying videos and/or podcasts might be useful.

  13. Given Michael Hudson's latest article, am wondering if it would be pertinent to include the financial sector in the analysis, if it has an impact as definitive as the ROW's impact on a nation's real economy. In particular, an enumeration quantifying these effects in some of the illustrative examples.

  14. Hi this is cyaker and I would like to both take issue and agree with Paolo Rossi Barnard. While a college graduate I do not fully understand MMT or what I read including Mosler's book 7 Deadly Innocent Frauds but I do understand enough to recognize it's simplicity and preference over what others are claiming. (see Mosler's post at his site and Huffington post today" Furthermore we have tried other systems resulting in pain is it so outlandish to try something that promises so much. Paolo Rossi Barnard is under estimating the common person but the need still exists to get this out to what is essentially an Eighth Grade audience and make it relevant to them. Just like the crummy roads we all drive on but this probably isn't the place to do it.Unfortunately that needs to be the focus of a different effort which should start immediately if not sooner.

  15. "I am going to offer a qualifying opinion to Paolo Rossi Barnard's comment". Thank you."…I do not think the rest of the blog should be "dumbed down" for the average Joe to understand. If it is, I think MMT does itself a disservice by hurting its credibility, because "dumbed down" explanations can be misconstrued as "bogus economics" by those able to think at a higher level." I remind you that Environmentalist Science, every bit as sophisticated as economics, change the way we run the planet precisely when Greenpeace turned to the average Joe with its "dumbed down" version of that science. Otherwise they would have remained a bunch of squabbling nobodies easily ignored by the polluting industrial giants. "… I have no problem if an illegal immigrant wants to learn this stuff, but if MMT is to be taken seriously at this point in time, he or she should do it properly, which requires putting in lots of time and diligence." Perhaps you should fast realize that MMT is not a beautiful piece of theory, it's a life saving, nation saving, urgent means that the illegal immigrant, and the millions of desperate folks out there, need to survive. No one here is thinking of having those folks engaged in lofty debates."Remember, this blog is on the world stage, and it has a reputation to build and maintain, particularly as it is written by an academic and cofounder of MMT". There are far too many reputable but utterly futile exercises around and I seem to remember that those that have changed History along many centuries never enjoyed that much of a good reputation in their times, from Galileo to Marx, Voltaire, Dostoevskij or Nelson Mandela (on the Terrorist list of the Pentagon in 1989). They just had courage, and cared for humanity."Let's keep this intelligent, respectful, and academic, as if it were a college classroom." Sadly, this seems to be precisely that. That is, irrelevant for all those that are not attending.Paolo Rossi Barnard

  16. p.s from Rossi Barnard: I had already said I was going to be brutally frank. Forgive me. But the situation is horrid out there, I hope you all realize.

  17. I'm almost entirely new to this and economics in general so bear with me. There's at least one new face reading this!In this model all currency in circulation is an asset held by the owner matched to a public liability. Slightly mindbendingly, it is the equivalent of a loan from the owner to the government. 'I promise to pay the bearer on demand the sum of', etc.So the difference between the government running a deficit by 'printing money' or by taking out loans that it must pay interest on is illusory, and is a purely political decision. A relic of outdated understandings of money like the gold standard.Is this correct?As a note, the idea that there is no net financial wealth in the economy takes a little getting used to, and I found it helpful to remind myself that money is worthless in itself. Its only use is as a common means of exchange, it has no 'use' aside from that. If you're stranded on an island, banknotes are just kindling. So since money is worthless, it makes sense that it contributes no net wealth to the economy.

  18. I think Paolo Rossi Barnard has a good point.All of this makes sense to me, but that is because I have read MMT blogs on and off for more than a year. When I first discovered MMT, my head spun as my perspective on economics turned upside down. I was one of those who "got" it pretty quickly after initial exposure and then filled in the details, but not everyone is like that.But when I first discovered MMT, I would not have understood (to pick out a random example) the sentence "Flows (of income or spending) accumulate to stocks." Ordinary people who do not have previous exposure to MMT or who do not have significant previous exposure to economics generally are going to have no idea what you are talking about here. When you say "stocks," they would think you are talking about the stock market. If they are truly the target, then I think this is already too complex.MMT strikes me as being a lot like the Theory of Evolution. It is very logical when one understands it, but it is initially extremely counterintuitive to 99.9% of people who hear of it. MMT says to most people that "everything you know is wrong." One has to be very open minded and self-critical to even consider a theory like that. Even though the entire worldwide scientific community unanimously agrees that evolution is correct, huge numbers of Americans believe that the Theory of Evolution is a lie. And most of the people who are not evolution skeptics don't understand. In Europe, for example, many more people believe in Evolution than in America. But that is less because many people actually understand evolution than because people are more respectful of elite authority.Since the vast majority of the worldwide economic elites proclaim more or less the opposite of MMT, the task is even harder for MMT than for evolution – MMT does not have the people who believe in evolution because they defer to elite authority. It won't get those people unless it first persuades the elites. And it won't get the regular people unless it can somehow become intuitive (which strikes me as next to impossible).I think MMT needs someone to do whatever it is that Charles Darwin did.

  19. In my opinion is better not to use acronyms.Dario

  20. Paolo,If the student is ready, the teacher will come. I think those interested enough to find this blog will be able to sort it out. It's not like it's being posted in the village square.Your mmt for mums was great. Everyone connects to different metaphors in various ways. Stephanie's teeter-totter was great. Right now each individual winds there way thru the blogosphere on their own, perhaps with word of mouth(or fingers) guidance.Let's keep it rolling!

  21. Paolo,I thank you once again for your efforts to make MMT more accessible and more suitable for sharing with a wider audience. But there is no reason to see that goal as competing with this primer. A fair number of us have been waiting very eagerly for this program to start, and I, for one, am utterly thrilled at how well it is beginning. This is a "primer" in the sense that it is aiming to build up and solidify MMT as a rigorous economic theory – starting from an iron-clad set of financial and accounting axioms that can be defended on any turf against all comers.What you are doing is very important. But this is worth doing too.

  22. "I think MMT needs someone to do whatever it is that Charles Darwin did." You could argue that Richard Dawkins did that in 'The Selfish Gene'.What he did not do was write a book called 'Evolution for mums'We don't need mums to understand this stuff. MMT developers have looked at how monetary systems actually work and are describing it. They are saying what they see. That's it. Yes , the logical conclusion is a job guarantee scheme or policies designed to bring about full employment but surely what the MMP is all about is just describing the operational reality that currently exists and, as a by-product, exposing the madness of the current policies.

  23. I agree with Paolo Barnard's comments

  24. "Money “things” will be identified specifically: a coin, a bank note, a demand deposit. Some of these can be touched (paper notes), others are electronic entries on balance sheets (demand deposits, bank reserves). So, “money things” is simply short-hand for “money denominated IOUs”.The word currency is used to indicate coins, notes, and reserves issued by government (both by the treasury and the central bank). When designating a specific treasury or its bonds, the word will be capitalized: US Treasury; US Treasuries."Eventually, you are going to need to explain medium of exchange. Specifically, the difference between creating more of it from currency/demand deposits with no bond/loan attached and creating more of it from currency/demand deposits with a bond/loan attached (making it debt).IMO, reserves (central bank reserves) should not be called currency. It is more accurate to describe it/them as 1-day gov't debt.

  25. I'm new to reading economic stuff in any depth, and am so happy to see this primer get off to a great start.And I hope Paulo continues writing in a way more aimed at "mums". Being a mum, I appreciate the intent of both Wray's and Paulo's efforts.Finally, Neil brought up the Central Bank. It would be really helpful to understand his point a bit more. Hope Neil sees this. Also, I'd much appreciate a basic understanding of how MMT deals with the Central Bank — both economically and politically.Thanks,Katie

  26. Randy et al.,This is an excellent initiative on the NEP's part. Thanks for your efforts in seeking to teach this approach to macroeconomics and public finance to us all. This primer is already quite useful to me. My only comment is similar to those made by Neil, Andy and Ramanan above, and it is simply to ask that the terminology used be consistent (as much as possible) with national accounting formulation. It would help me tremendously when discussing these issues with colleagues or when seeking to locate data on my own for analysis. Keep up the great work!Thanks, Kevin

  27. Terms get messed up so often. This is a great opportunity to settle on certain terms and stick to them, at least in this primer.The text uses the word saving and means "current income not spent on goods and services."National income accounting uses the word saving and means the excess of current income over consumption : S = Y – C.Two different meanings attached to the same word. I would propose to stop using the word saving to refer to the excess of current income over consumption.

  28. John V"The first assumption of accounting is that the subject firm is a "going concern". This would mean that e.g. Y=C+I is true if and only if the economy as a whole is a going concern, i.e. in equilibrium."One of the amusing things about economics is this regular assertion that things must be in equilibrium. Take a look out the window. The world is a dynamic place. Personally if I owned a company that was a going concern I wouldn't want it to be in equilibrium, I would want the business growing w.r.t. to time.You need to clear this equilibrium fog away. Try "The Futility of Utility: how market dynamics marginalize Adam Smith"http://arxiv.org/abs/cond-mat/9911291All the many definitions of economists equilibrium are discussed and debunked.

  29. 9:12 P.M. Anonymous:I don't see any responses that directly address your questions, so I will have a go. (Also, if you post using any kind of name or alias, you make it easier for others to answer you.)First, regarding "…all currency in circulation is an asset held by the owner matched to a public liability."You are correct, but you do not go far enough. In a modern fiat monetary system, *all* money, whether circulating as currency or not, constitutes one vast liability of the government. All dollars are U.S. government I.O.U.s. Very shortly, I am sure the course will explain why anyone accepts the state's intrinsically worthless fiat money in the first place, so I won't pre-empt that point. It may help to think of it this way, though: In your mind, rename the National Debt Clock in New York City. Call it as the Dollar-denominated Worldwide Wealth Clock instead. What it measures is the total *demand* for U.S. dollars.Second, "… the difference between the government running a deficit by 'printing money' or by taking out loans that it must pay interest on is illusory, and is a purely political decision. A relic of outdated understandings of money like the gold standard.Is this correct?"Almost. It is correct to conclude that the sale of Treasury bonds is not necessary to "fund" government spending. The government's capacity to spend dollars is not increased by such sales and would not decrease if the bonds were never offered. The *idea* that bond sales ("borrowing") is necessary is entirely a relic of gold-era thinking. However, bond sales do serve a policy purpose unrelated to "funding" government. This gets technical and, again, I will defer to the course leaders regarding to correct time to really go into it, but in brief: selling bonds drains excess reserves from the banking system and contributes to the central bank's ability to set a target interest rate.If you want to skip ahead and enjoy a really fine read at the same time, seek out:"The Seven Deadly Innocent Frauds" by Warren Mosler. It is available as a pdf download at moslereconomics.com.

  30. Thanks for responding Mike. I guess I didn't make myself clear enough. I fully agree with you that the world is a dynamic place. So much so that it cannot sensibly be captured by static identities like Y=C+I, without the latter overdetermining it. The fog you're talking about obscures the perspective of virtually all economists; MMTers included. The economy is a means toward an exogenously located end, according to a set of first principles of mine. And if the end is – the obtaining of a standard of living, a determinate reality, then the components of the means have to adjust and cannot be determinate. The dynamic equilibrium condition that allows this, renders the economy a "charged field", fed by external impulses. No pathway through time, with endogenous forces, exists. Utility is exogenous to the economy. It doesn't have a role to play within it. The economy itself is ruled by accounts; debits and credits, negatives and positives, without shades of grey. The accounting profession however, implicitly recognizes that their assumptions render their quantities indeterminate at any given point in time. Economists cannot work that way. They need their identities to be true and this can only be so if the end is indeterminate; i.e. unreal. So take your pick, you can't have it both ways. PS, I forgot to add .pdf last time. You may find the file an interesting read. It criticizes Randy's thoughts on money as expressed in a working paper of his. So here it goes again… http://www.vcn.bc.ca/~vertegaa/MMT_Critique.pdf

  31. I was very pleased with the clarity of this post. It may not be for 'Mums,' I'd probably say for 'Grandmas' (See: http://my.firedoglake.com/letsgetitdone/2010/04/21/talking-to-grandma-about-fiscal-sustainability/ ). But I do think it is simple and direct enough for readers of good Newspapers, and political and economics blogs, and I congratulate you Randy on writing it so well.I agree with Paolo's suggestion that Mum's (or Grandma's) versions of these MMP posts would be very good for getting the Word out, especially if these versions were always qualified with warnings that they're loose interpretations and with links back to the original posts that inspired them. I also think the Mum's versions should be posted elsewhere, so we don't have the problem of Paul Krugman and Brad DeLong quoting them as official versions of MMT that are legitimate targets of criticism.Finally, while I think this post is very understandable, I recommend a very simple expedient to make it easier to digest for people not used to reading economics. That expedient is just to make the paragraphs in the text as short as possible. I don't think the above post has really long paragraphs. But some are fairly long, and their material might be more digestible if they were made a little more bite-sized.

  32. Here’s my own attempt to make sense of this post, and it might help others as well. I'm not sure it's "Mum-ready," but perhaps with some tweaking it could be.Caveat: I’m sure there are mistakes here—I’m clearly not an economist. But, I think I got the gist of it right.1. ASSETS, REAL AND FINANCIALIf you want to figure out how much wealth you have, you might construct a two-column list. On the left side you could list your cash, investments, property. On the right side would be all the things you’re on the hook for—all money you owe to others. To figure out how much you’re worth, you’d simply subtract the right side from the left side.“Assets” are what we call all those things you put down on the left side, such as your house, your checking account, your investments, and the money in your wallet. We can divide all of these assets into two groups: financial assets and real assets. Financial assets are claims you have on someone else, whereas real assets are material, tangible things. A government or corporate bond, or an IOU from your poker buddy, are financial assets: they represent money you lent out to someone else, money that you now have a claim on. A checking account is also a financial asset: it represents money you gave to the bank, money that you now have a claim on. A house, on the other hand, is a real asset—it’s not an immaterial “claim,” but is instead a material, tangible thing. Good, that’s all pretty clear. But, what about the dollar bill in your wallet? What kind of asset is that? At first glance it might look like a real asset. It is a tangible thing after all, and it doesn’t seem to be a claim on someone else’s money—it is a real piece of money in your own hand right now. MMT describes a dollar bill as a claim on the government, however. You can think of it as a bond that doesn’t bear any interest. This will be discussed later in the primer, but for now you can just take MMT’s word for it: a dollar bill is a financial asset, a claim on someone else (the government), and not a real asset like a house, a car, or a nice juicy steak.2. ACCOUNTING IDENTITIESNow let’s look at the right side of your sheet: we will call these your “liabilities.” These could include your mortgage, students loans, credit card debt, and so on. An important thing to realize is that each one of your liabilities is an asset for someone else. Your mortgage is your promise to pay the bank, and so it’s a liability you’re responsible for. The bank, however, counts this same mortgage as an asset: it is the bank’s claim on your money. Same with your student loans: you’re on the hook to pay back the loans (they’re liabilities for you), and the government has a claim to those loan payments (the government counts the loan as an asset). It works the other way around, too. If I hold a government bond (which would be my asset, my claim on the government’s money), the government has a corresponding liability, since it has promised to pay back that loan—it’s that promise by the government that gives my bond value, and the confidence to count it as an asset. Likewise if I have a checking account, I have an asset (a claim on the bank’s money, equal to the amount on my bank statement), and the bank has a corresponding liability: it promises to pay me the money in my account should I request it. This is an important point: for any financial asset someone holds, another person will have a corresponding liability.A little further thinking will tell you that since every financial asset has a corresponding liability, if you add up the total number of financial assets in the world (“aggregate” financial assets), and subtract the total amount of liabilities, you will have $0. This “adding up to zero” is a fundamental axiom of MMT—it is called an “accounting identity.”

  33. 3. SIDEBAR: WHAT HAPPENED TO REAL ASSETS?You will notice that the accounting identity has nothing to say about real assets. My mortgage liability and the bank’s corresponding asset add up to zero, but somehow the actual house is left out of this equation. MMT’s greatest power lies in its focus on financial accounting, and so for now we will set aside the question of real assets. But, this does not mean that real assets don’t matter. After all, once financial assets and liabilities have all canceled each other out, the only things left are the “real” things in life: your food, shelter, transportation, entertainment, and so on.In fact, MMT claims that it is only once we have a truly accurate, factual description of money (financial assets), that we are able to answer the most important questions, which inevitably concern real assets: how can we maximize our production of real assets like housing, food, or energy? How do we get more people to work on producing these real assets, so that they will then be able to purchase and enjoy the fruits of their labor? How can we ensure that these real assets are in fact used and enjoyed, rather than wasted or hoarded? These and other questions are crucial, but to answer them economists and politicians—and voters!—need to first understand how money works. This is why MMT is often called a “descriptive” theory (it describes the way money works today), and not necessarily a “prescriptive” theory (the theory itself does not necessarily make policy recommendations, although individual MMT economists usually do). You could think of it this way: money is a “fiction” we create on top of the “real” world of things and labor—the world of houses, crops, factories, and cars. But even if it’s a fiction, its extraordinarily useful. It helps us organize labor and production, move goods around the world, and get everyone to show up for work on time. Therefore even if it’s not “real,” learning its rules is absolutely necessary for figuring out the best, most efficient and productive way to run the economy. And the most basic and important rule is the accounting identity: for every financial asset there is a corresponding liability, and when all of these liabilities are subtracted from all of those financial assets, nothing is left over.

  34. 4. SECTORSLet’s look a little closer at this accounting identity. Suppose you wanted to divide the economy into two parts, or sectors. One common way to do this is to talk about the private sector, which includes households and private companies, and the government sector, which includes all levels of government: federal, state, local, and everything in between. So, let’s say you counted up all of the assets held by the private sector, and subtracted all the liabilities they had. Because the private sector is only one part of the economy (it’s not the whole world of dollar-denominated assets), you might not end up with zero. In fact, you probably won’t. For the sake of argument, let’s say the entire private sector on Economy Island consists of 10 people and their private businesses. Maybe Amy has total financial balance of $50, and Bill has $200, but Cate is in debt with -$30, and so on. When you add all the assets and subtract all the liabilities, you get a total of $100. Where did the money come from? Well, if aggregate assets minus aggregate liabilities must equal $0, then there must be someone else, outside of the private sector, walking around with a $100 debt. And it just so happens that in addition to our 10-person private sector, our little community also has a government, named Sam, who prints out little pieces of paper in his basement. He calls these pieces of paper “notes,” but you can think of them as government IOUs. Because everyone trusts Sam, these notes are what everyone uses to buy real assets, pay off debts, hire workers, and so on. As it turns out, of course, there are 100 of these $1 pieces of paper floating around the island. The mystery is solved. Sam’s $100 government debt is exactly equal to the total aggregate assets of the private sector, and so our accounting identity holds: total assets minus total liabilities equals $0. The point of the story is this: if the private sector wants to have positive net financial assets (have more money than it owes), the government must be in debt for that same amount of money. This is another central thesis of MMT, so it bears repeating: if the private sector wants to have positive net financial assets (have more money than it owes), the government must be in debt for that same amount of money.(NOTE: If you’re wondering how Bill could accumulate $200 in assets when there’s only $100 of cash notes in existence, keep in mind that Bill keeps most of his money in Amy’s bank, and Amy only has about $10 cash in the bank’s vault. And if Bob needs to buy $20 of produce from Cate’s farm, it’s not a problem for Amy’s bank. Bill just writes a check to Cate, and when Cate deposits the check Amy will just move some numbers from Bill’s account into Cate’s account at the same bank.)

  35. 5. FLOWS AND STOCKSNow say the economy on Economy Island is going gangbusters. Cate’s harvest was bountiful, productivity is off the charts, confidence is way up, and Dale just invented a new coconut-picking robot that is certain to transform life as we know it. With all the economic activity, Sam’s tax revenues are up, and he runs a government surplus that year, taking in $10 more than he spent. His total debt is now only $90. His tax revenue “flow” accumulates to his balance sheet “stock,” and so his $100 debt has gone down to only $90. Everyone on the island is pretty happy about this—no one likes government debt, and if things keep going this way he might just be able to pay it off one of these days.Now, at the same time that Sam’s revenues are going up, Dale has been burning up the seed money Amy lent him to start developing his coconut-picking robot (it doesn’t matter that she doesn’t have the cash on hand to lend, since Sam doesn’t feel it’s his place to regulate how she does her business—she just adds some numbers into Dale’s account at the bank). Dale’s money has been great for the economy—it was one of the biggest reasons that Sam’s tax revenues were so high. Dale spends his startup money all over the place, and whenever he does the government takes a little slice. We saw that with all the extra tax revenues, the government sector balance went from -$100 to -$90. Now let’s think about what happens to the private sector balance. Dale’s liabilities are offset by Amy’s assets (she has a claim on his liabilities, so in aggregate the loan adds up to $0), so the loan by itself doesn’t impact the private sector balance. But, those little slices the government takes off the top of Dale’s purchases cause the total amount of money in the private sector to decrease, from $100 to $90—exactly the same amount that the government debt decreased. No one really minds too much, since there’s no lack of productivity, real assets are abundant, and everyone has a job. Even if people are saving a little bit less less and maybe running up the credit card a bit more than before, everyone’s lifestyle is better, so no one’s complaining. There’s so much money to be made right now, debt isn’t seen as a problem—we’ll just pay it off once the profits start rolling in.A year later, however, everyone’s a bit worried. Dale’s machine turned out to be a piece of junk, Cate’s harvest was screwed by a major drought, and with a stagnating economy and lower income those credit card bills are getting a bit out of control. Suddenly everyone wants to start hunkering down and saving their money. Well, the only way that’s gonna happen is if Sam starts spreading the money around. By virtue of the accounting identity, the only way to increase aggregate private sector assets is to increase the government sector’s debt. If the private sector wants to save money, Sam is going to have to put more dollars into circulation, and run a government deficit. The private sector cannot run a surplus if the government is running a surplus. So, Sam spends $10 more than usual that year (he decided to splurge a little when getting yard work done on his governor’s mansion). His total government debt is now back up to $100, and the private sector seems to be more confident with the extra savings it has. As a result they’ve started spending and hiring again, and things are pretty much back to normal. Real assets are once again flying off the shelves at BillMart.

  36. 6. THE FOREIGN SECTORFinally, let’s consider what happens when Economy Island finds a trading partner, Sinopolis. The first thing to note is that in order to have an impact on our sector balances, this trading partner must be willing to hold Sam’s dollars. If we trade only using Sinotes, then Eve Exporter might build up a big stockpile of Sinotes in her basement, but the way we calculate dollar balances won’t change. If, however, Sinopolis agrees to take dollar bills in payment, then we need to take this foreign sector balance into account. Suppose that in the first year of trade with Sinopolis, Bill spends $10 stocking his shelves with their fantastic phones, and Sinopolis in turn spends $5 at Eve’s Emporium for a barrel of Dale’s juicy coconuts. Sinopolis has $5 left over, which it puts into a vault. So now we have three sectors: the foreign sector has $5, the government sector still has a -$100 debt, and ever since Bill sent some cash over to Sinopolis, the private sector is left with a total balance of $95. As the accounting identity predicts, everything adds up to $0.Some people aren’t too happy with this decrease in total wealth, so Bill and Eve lobby their friend Sam to give them a little tax break, since after all they did give the economy a little boost: Dale’s selling more coconuts, and BillMart’s phones are now half the price and twice the quality of those clunkers that Fred the Phone Guy used to make. Surely encouraging more trade with tax breaks will help generate some more wealth, they argue. (Hopefully you can see the fallacy of their argument by now—tax breaks will work, but not for the reasons they give).With the new $5 tax breaks, Sam’s debt goes up to -$105, and Sinopolis still holds their $5. As a result, the private sector balances go back up to $100. Looks like everything’s back on track, just as predicted.CODAIt might be worth noting that although the private sector of Economy Island has held onto its wealth in aggregate, this wealth isn’t in the same place it used to be. Bill doubled his $10 investment by selling those great phones. Eve also pocketed $4 from the coconut deal (Dale sold them to her at wholesale for a $1). Bill and Eve also got to split the $5 tax break (it was targeted at increasing foreign trade, so they were its only beneficiaries). So in all, Bill’s and Eve’s wealth (what we might call the “retail sector” part of the private sector) increased $19 last year – nice work! Unfortunately, that $19 had to come from somewhere, since the total private sector’s balance is still only at $100. And looking around, we see that the manufacturing and farming sub-sectors aren’t doing to well: Cate and Dale are still struggling to make ends meet, and Fred lost his phone manufacturing business. Luckily, though, Amy’s been giving out a lot of home-equity loans recently. So while Amy’s assets are going up in proportion to the liabilities that Cate, Dale and Fred and now taking on with their new home-equity loans, at least they’re able to afford those great new phones everyone’s talking about!

  37. APPENDIX: THE GRAPHAs a final note, you should check out the remarkable chart prepared by Scott Fullwiler: http://1.bp.blogspot.com/-1a0JLvj-BOw/TZh9prS8StI/AAAAAAAAAYU/wyr_DMPnmWo/s1600/balances.png More than anything else this chart helped me grasp the notion of sector balances and account identities. It was my own personal aha! moment with MMT.Here are some observations to get you oriented with the chart:- In general, you’ll notice that when the private sector saves (when the blue bar is positive), the government runs a deficit (red bars are negative). – The green bars represent the foreign sector, and when they are included with the government and private balances, you can see that everything adds to zero: all positive balances (above the zero line) are offset by negative balances of the exact same size (below the zero line). – Take note that from the 80’s onward the foreign sector bars generally appear on the positive side, indicating a trade deficit for the US (like in our example above). In other words, they are holding onto our dollars, and so, like our own domestic savings, these dollars in foreign hands must be offset by increased private or government deficits (or both).- Take a look at the brief moment in the late 1990s when the red bars peak above the zero-line. These were the famed Clinton-era budget surpluses. While everyone was quite happy at the time, you can see that these surpluses necessarily coincided with a huge increase in private-sector debt.- Also note the huge increase in private-sector debt during the housing boom (roughly 2004-2008). In this case there was no corresponding government surplus. You have the foreign trade deficit to thank for this—the dollars that left the private sector didn’t go to the government, they went overseas.

  38. Oops! #4 got left out!Please read this section in the right place (otherwise it won't make sense):4. SECTORSLet’s look a little closer at this accounting identity. Suppose you wanted to divide the economy into two parts, or sectors. One common way to do this is to talk about the private sector, which includes households and private companies, and the government sector, which includes all levels of government: federal, state, local, and everything in between. So, let’s say you counted up all of the assets held by the private sector, and subtracted all the liabilities they had. Because the private sector is only one part of the economy (it’s not the whole world of dollar-denominated assets), you might not end up with zero. In fact, you probably won’t. For the sake of argument, let’s say the entire private sector on Economy Island consists of 10 people and their private businesses. Maybe Amy has total financial balance of $50, and Bill has $200, but Cate is in debt with -$30, and so on. When you add all the assets and subtract all the liabilities, you get a total of $100. Where did the money come from? Well, if aggregate assets minus aggregate liabilities must equal $0, then there must be someone else, outside of the private sector, walking around with a $100 debt. And it just so happens that in addition to our 10-person private sector, our little community also has a government, named Sam, who prints out little pieces of paper in his basement. He calls these pieces of paper “notes,” but you can think of them as government IOUs. Because everyone trusts Sam, these notes are what everyone uses to buy real assets, pay off debts, hire workers, and so on. As it turns out, of course, there are 100 of these $1 pieces of paper floating around the island. The mystery is solved. Sam’s $100 government debt is exactly equal to the total aggregate assets of the private sector, and so our accounting identity holds: total assets minus total liabilities equals $0. The point of the story is this: if the private sector wants to have positive net financial assets (have more money than it owes), the government must be in debt for that same amount of money. This is another central thesis of MMT, so it bears repeating: if the private sector wants to have positive net financial assets (have more money than it owes), the government must be in debt for that same amount of money.(NOTE: If you’re wondering how Bill could accumulate $200 in assets when there’s only $100 of cash notes in existence, keep in mind that Bill keeps most of his money in Amy’s bank, and Amy only has about $10 cash in the bank’s vault. And if Bob needs to buy $20 of produce from Cate’s farm, it’s not a problem for Amy’s bank. Bill just writes a check to Cate, and when Cate deposits the check Amy will just move some numbers from Bill’s account into Cate’s account at the same bank.)

  39. In a sense MMT is like Darwinism. In their book "SuperCooperators" Martin Nowak and Roger Highfield argue there are three main driving forces or catalysts in evolution; adaption, selection and cooperation. If you consider money is like a catalyst embedding commands then the two creators of money government and banks have to cooperate with each other especially in the knowledge of Hyman Minsky's Financial Instability Hypothesis and the banks and regulators recent irresponsibility in blowing asset bubbles.

  40. As Jimmy Durante would say, "everybody wants to get into the act!".

  41. Ok. I think I get the basics. x+y must always equal zero and at the point another element appears and is added, the total must also equal zero. This suggests a closed system and implied equilibrium of the elements to the zero value.

  42. Anonymous"The point of the story is this: if the private sector wants to have positive net financial assets (have more money than it owes), the government must be in debt for that same amount of money"Nicely laid out and from an accounting/ balance sheet perspective very tidy.But is it debt?And does it not give beginners the impression that that is why Govts need to borrow in order to lend.You would have to clarify the fiat currency characteristics at the same time in order to demonstrate and drill home that this is not the case. Might be better to keep it simple at this stage.

  43. I think it is misleading at best to not distinguish in the private sector the creditors and investors. Out of a U.S. population of some 300 million, the upper 10% own most of the financial wealth, and among them, the upper Thirty Thousand the bulk of that wealth. The rest of us 90% are the debtors. Now that we can't or won't keep extending our debts, or worse yet are paying them off, how are the Thirty Thousand to maintain their positive financial balance?Got the answer: The government can go into debt for us and our children and grandchildren.Wrong answer: it is the overhang of debt, which is just another way of saying the growth in income and wealth inequality, that is the problem. How is more debt going to solve the problem of too much debt?

  44. Great start.An immediate example of giving birth to non-financial wealth is when my goat gives birth. The new kid in the farm represents an increase in my real, net wealth without any offsetting liability elsewhere. Then, I decide to float the goat on the CBOT…

  45. Bravo! As a CPA in industry, I balance financial statements, budgets and various projections on a daily basis. My training has forced me to treat business transactions as a zero sum game. Using MMT to approach macroeconomics is a breath of fresh air. Mr. Wray, thank you for your hard work and dedication to MMT. Cheers.

  46. As a proud mother of two girls who teaches Economics to classes where roughly half of my students are female, I find it offensive and sexist that the efforts of some to disseminate the concepts of MMT to a wider audience are being termed "MMT for Mums."

  47. Agree about "Mums." And from a practical standpoint, MMT is doing a disservice to itself with this terminology – if the intent is to spread the word, it doesn't help to alienate half of the population.

  48. I have no background in economics or accounting (as a biochemist) and mostly understand this first installment. I understand how a checking account acts as a loan which balances out the owner's asset with the bank's liability, but I have a much harder time placing currency (physical cash) into this framework. I suspect this is due to my ignorance about what currency actually is and means; it would be valuable to understand better how currency can be a financial asset (what I think you're implying) with apparently some balancing (government?) financial liability.

  49. I am late to this discussion, so this comment might go unnoticed, but for me, this discussion starts too high up the abstraction curve.Balance sheet accounting works fine for organizations, private or private, within a monetary system, but I do not see how it can work for a nation. The assumption is that assets and liabilities are always in balance, but asset values can drop and liabilities remain the same. One can pretend the assets have not dropped in market value, or depreciated to no value or are functionally obsolete. If you mark to market, you are in balance sheet trouble. All debt is not offset by an asset of value, since much debt is due to consumption of non-depreciable assets.To my mind, sovereign nations can issue currency to enable trade among its citizens and via civilization they create societal value in the form of infrastructure, law and order to ensure stability over time so that long term, multi-generational investments of time and resources can be made that increase the net value of society. This is a relative value which can be measured in terms of the sovereign currency.The effective amount of currency in circulation should be proportional to the net value of the nation and the number of citizens which need to use currency to receive and make payment for goods and series.Trading with other nations requires some medium of exchange that works nation to nation.This perspective is a combination of thought, experience and reading. I worked for 35 years as a regional planner or local and regional development in the Shenandoah Valley. To build their attractiveness, the local governments had to use local tax dollars and whatever grants they could get from state and Federal sources to improve their schools, develop ready to go industrial parks, have more recreational amenities, etc. Every person and organization had to become more sophisticated. The value of everything had to increase to be attractive/competitive. It was also affected by the nearby Washington, D.C. metropolitan area as that market increased competition for land and housing, bidding up costs faster than local skills or wages for most people.Under the current system, high debt was incurred on new and existing property between 2001 and 2008. It appeared that the Valley had gotten rich, but that was imply due to easy credit. Now the balance sheets are wrecked.It is a balance sheet recession in that there are lots of imbalances in personal and private balance sheets. Due to fiscal conservatism in Virginia, few local governments are overly indebted and neither is the state.The assumption that all liabilities are offset by assets of equal value is clearly not the case in the real world. If the currency in circulation was issued by the nation and held to a percentage of its relative value, three to seven percent – I really don't have a number, then value creation by its citizens could proceed over time.For the record I have read Stephen Zarlenga's Lost Science of Money. I recommend it to anyone trying to understand why what we have now is not working and economics, as taught, does not produce the promised results.

  50. Good, clear, plainest explanation I've read yet, thanks.One thing I've noticed reviewing the MMT sites is that your ultimate conclusion is essentially the same as the monetarists. The monetarist, Milton Friedman for example, says, at least as I understand it, that in order for the economy to grow the money supply must grow, if the money supply shrinks then the economy will shrink. The MMTers and the monetarists both offer the same explanation for the great depression, one says government reduced its spending the other says government reduced the money supply. Both offer the same prescription for the current situation. One says the government must spend more the other says the government must increase the money supply.Where the MMTers have the upper hand is that they have a clear explanation of how the money supply is increased, i.e. through government deficit spending, while the monetarists have no clear explanation of how the FED, by changing interest rates or moving money from one account to another, actually increases the money supply. To put it more plainly under MMT it is easy to see who gets the new money created by increasing the money supply, i.e. the people the government sends the check to, but it's very difficult to see who gets the increased money supply from the FED manipulation of interest rates.

  51. Help me here:Isn't an increase in value [per the market] in equities a creation of [credit] money without an offsetting charge to someone else's balance sheet?When the stock market rises, the increased equity paves the way for more debt, because more collateral is available. I guess the answer is that for it to be used as credit money, a loan would need to be taken against it, and then there would be a balancing entry?Is that right?

  52. Some simple graphics would help a numbskull like me.

  53. It is not only the government budgect that is balanced. Depending on the particular model being used all the others sectors of the economy need to balance too. When this applies we can safely claim that the social system is in equilibrium. But different models have different balancing needs so by implication we first need to determine the model of the whole system, that correctly represents it in sufficient detail to cover all the things it does. The emphasis should be on the word “does” and the various entities of which comprise the whole, need only represent the functional or role-playing aspects of our social system.
    By my count there are only 19 of these spread between 6 entities that need balancing (see Google Images DiadFunMacroSyst.pdf ) , so although the problem is not so simple we can at least be sure that nothing of importance has been omitted.

  54. Vassilis Serafimakis

    What’s wrong with “MMT for beginners” ?

  55. The world of real assets need not be in equilibrium, even if the world of financial assets must be in equilibrium, as a matter of logic (matters of logic neatly apply to money because money is an construct of the human imagination, like the natural numbers). Logic does not apply so neatly to the world of real “money-things”, which are like real assets in their materiality. US dollar bills can be used to snort cocaine, or to send a message to a poorly performing waiter. indicate bad restaurant service. But a dollar bill’s main main utility is its logical value as money even if it can be so well-used that the vending machine rejects it despite its having been blessed by the treasury wizards, and even if you managed to lose your wallet in the Atlantic Ocean. Logic does not apply so neatly to the real world of financial transactions either since, for example, counterfeiters spend a great deal of effort making financial assets that do not arise out of another’s deficits. Of course, counterfeit money is not “real money” and a Platonic account of money needn’t be concerned with it, and indeed, given the governments’ interest in, and success at, preventing counterfeit money from circulating, and the extent to which people avoid losing money as much as possible, the Platonic account is going to be a pretty darn good approximation of how the system really works.

  56. Question: How does it balance when money is being created through fractional reserve banking and the actual creation of money at banks as Ellen Brown tells us happens.
    P.S. for a PhD Psychologist, the article was very informative but a real slog for the uninitated. Graphs might help .

  57. “It is a lot like those children at Lake Wobegone who are supposedly above average. For every kid above average there must be one below average. And, for every deficit there must be a surplus.”
    While the point is well taken in a general sense, it is not actually true. One child can be well over average while three others are slightly below average. There can be a large deficit in one sector while there are small surpluses in two other sectors.

  58. Ok…then tell you what:

    For the bond in YOUR HAND, may be an asset to you…but it’s a LIABILITY to the Government. (You agree with that one, right)

    But here’s the problem: YOU ARE the Government. the ones working in the Government REPRESENT YOU.

    You’re basically TAXING YOURSELF…just to pay yourself, TAX FREE.

    why do that?

    I’m not going to disagree, with your whole gist, “For every action, there’s an equal and opposite reaction,”
    per se….

    But I am going to challenge your (I don’t know whether it’s implied, or overt) assertion, that Government (as an institution, serving LAW to/for the Nation) must maintain a National Debt over the people it serves, so that people can have Private Assets to circulate.

    What I’m going to do, here…is put up a few postings that I posted in Facebook, under my page I call:

    “How to get rid of the National Debt…without breaking a sweat!”

    And this piece I’m posting here, with the introductory, is called “TWO BORROWS, and a LIEN”

    which I’m posting here for you to read, and consider:

    Remember, the application of LAW can work for you, or against you….and I chose to have it work FOR YOU.


    Dear Folks:

    I’ve been trying to post this certain piece in a TON of places, but in a lot of places I’ve posted (Like on Romney’s page, and Obama’s, as well as a few other places….they’ve been taken down,

    ….and it’s almost like they really don’t want anyone to know HOW EASY IT TRULY IS to BEGIN the PROCESS of LEGALLY RETIRING the NATIONAL DEBT,

    by Converting the Intergovernmental Holdings of the National Debt, into COD’s held at the Federal Reserve that total FIVE TIMES BIGGER than what that part of the DEBT owed, was, and, do it in a way, that not only RETIRES THAT PART OF THE DEBT, but, also begins relieving the FED from always needing to use “Fractional Reserve,” and begin to turn it into “FULL RESERVE,” that has the BANKS working for US, rather than the other way around…

    PLUS…free up the part of the MANDATORY SPENDING that Government has to do to service the Bonds that the “Intergovernmentals” Hold, PLUS, with How I’ve worked it out…The “intergovernmentals” can access EVERYTHING THEY WERE OWED, plus collect INTEREST from the REST of the COD’s, and not only THAT,

    …but GOVERNMENT gets INTEREST BACK TOO, where they can apply it to the REVENUE needed, where, they can begin to RELIEVE OUR BURDEN that we pay in TAXES (both directly….and indirectly, as well as through depreciation!)

    So, What I’m going to do, is post it here, so please, Kids, copy this letter, and WHEN (not IF,) they try taking it down again, keep re-posting it, as many times, and as many places as you can….

    People have got to know that the Best way to get rid of the Debt off their backs, is something my Dad used to tell me: “WORK SMART…not HARD”

    They’ve GOT TO USE THEIR TOP-LEVEL GOVERNMENT TOOLS THEY HAVE *WISELY,* and not STUPIDLY…and the way they’ve used it up until now…is STUPID.

    and the unfortunate and probably the most damning part, is that We’re being TAXED, on TOP of being TAXED, on TOP of being TAXED…because If I’m remembering what I’ve read, and heard about correctly, per Johnson-era Act, the Social Security revenue gets mixed in with the General Fund, no matter HOW MUCH accounting tricks Government uses to try segregating the two incoming streams to Washington…

    and it’s not doing anyone any good…Not even the FED is truly enjoying all the supposed “INTEREST” that we think they’re getting hand over fist…Even though, when they state that “after their expenses, the money *goes back to the Government* making you think that Government’s getting it back into the General Fund Coffers somehow…that money goes away, being applied toward the Treasury Certificates (and those are IOU’s) that Government places, to make sure that money has a beginning, a life, as well as an ending….

    and not necessarily the Member Banks really rolling in the dough, because if they were, Don’t you think they’d HAVE THE MONEY to somehow cover all the TOXIC ASSET BUILDUPS, and all the DEFAULTS, from PRIVATE-SIDE insurance pools, instead of having to somehow swirl it around in the Derivative Markets, and hope that, with all the betting and the trading there, all those Bad loans all dissolve away, somehow?

    Now, Folks, I know that some of you hate the FED, and the IRS…and believe me when I tell this to you….

    Throwing the tools away, just because you hate how they’ve been worked, isn’t the answer….It’s changing HOW YOU USE THE TOOLS that make the difference between always facing impending failure, and succeeding…

    But I’m sure you’ll agree with me: The current crop of folks WE’VE PUT IN, probably can’t stop putting their heads in their behinds….and they’ve probably found comfort in smelling themselves….unlike US, who can’t seem to get a tight enough clothespin to pinch our noses closed.

    Now, Folks: What you’re next about to read, here, comes from my “nutty idea” that I call “How to Get rid of the National Debt…without breaking a sweat!”…and this part of the “nutty idea” I call: “TWO BORROWS, and A LIEN” It starts the whole process of my national debt solution…and in a big way.

    Remember what I said, “Not Gov PAY DOWN” but Bondholder make **DOWN-PAYMENT**?” Well, that’s one part of this “Two Borrows and a Lien” maneuver that I’m talking about….

    the other, “Whoever heard of BORROWING an IOU?” Well, you’re about to hear THAT one, too!

    As well as this: If one hand doesn’t know what the other hand is doing, it might actually be a GOOD THING!

    So, Here it goes, Kids, and I Hope you like it:

    “Two Borrows and a Lien: A Step-by-Step Guide to begin to get rid of the National Debt” – by (I-R-L Name Redacted for Privacy Concerns) aka KAPT BLASTO, on FACEBOOK!

    Step One: Fed Chief gets a burr under his saddle, (incidentally, by the Guy over at 1600 Pennsylvania, and a few of his buddies from the Hill, and over from the SCOTUS…) that it would be well worth his while to have the guy in Charge of CPPB, come over and have a talk with the Fed Chief, concerning a certain Errand or Service, that the Fed Chief feels the newly-made CPPB entity, is in a PRIME POSITION to perform, since by design, CPPB is an entity fully funded by the Federal Reserve System, and NOT under the Controls of CONGRESS…(I’ll explain why this is important, in a little bit!)

    What the Fed Chief would like CPPB to consider doing, is, to have a CPPB rep, head over, and see the guy representing all the INTERGOVERNMENTALS, and strike a deal where CPPB BORROWS all the holdings of US DEBT, that the INTERGOVERNMENTALS have, at 0%, leaving THEM, holding an IOU charged to CPPB.

    Step TWO: After the meeting and deal struck with the Intergovernmentals, the CPPB guy then walks over to the TREASURY, the ISSUER of all those IOU’s that CPPB just borrowed from the Intergovernmentals…. And, This is where a SECOND deal gets struck.

    What CPPB will do, is Borrow from the Treasury, to Deposit into the FED, what will constitute a series of CODs, of sorts, that, monetarily, stand at about FIVE TIMES BIGGER than what remains of that part of the NATIONAL DEBT, that the Congress has YET TO PAY upon those ISSUES that the CPPB just borrowed from the Intergovernmentals….

    The terms of the deal, this RECIPROCAL LOAN, that Treasury strikes with the CPPB should go like THIS:

    Just like what many would recognize a simple CAR LOAN, the COLLATERAL on this loan from Treasury, would be the COD…that’s to make sure that if CPPB Screws up, then the Treasury can claim what they’re owed…

    Now, you’ll have to understand that unlike BANKS, who ask “Well, how are you going to pay it back to us?” the RECIPROCAL LOAN between CPPB and TREASURY is DIFFERENT, because at that TOP LEVEL, the purposes is not so that CPPB can necessarily CONSUME or SPEND OUT what they’re borrowing for, but they’re using it to LEND OUT, with the FED’s help…to the BANKS, as well as relieve the FED from having to use FRACTIONAL RESERVE all the time….

    So, the terms of “payback” are simple enough to understand: As long as CPPB NEVER tries touching the BULK of the COD created, AND, allows a certain SMALL Percentage to be withheld from the returning interest TO that COD, then, Treasury will consider the LOAN “Always CURRENT, and in GOOD STANDING” Meaning: CPPB never has to pay a cent, as long as they’re honoring the terms….and that takes care of the “PRINCIPAL” and “INTEREST” portions of the loan…as well as the “TIME LENGTH”

    Now, the PERKS that CPPB, presumably, would enjoy, under the terms of this RECIPROCAL LOAN ARRANGEMENT done with Treasury:

    the right to SELL SHARES in the MARKET of the CLAIM to the COD….
    and the right to either pocket or recirculate all the remainder of Interest received, after the withholding….

    And, ALL just as TAX-FREE (or TAX-exempt, if it were), as what would be the YIELDS and MATURITIES that they would presumably gain, if they just sat on the IOU’s and collected like you would presume any other debt-holder would, normally…..

    And here’s the fun part, that will make you go “WOW, how’d you do THAT?”

    In order to secure the whole RECIPROCAL LOAN DEAL…CPPB presents to Treasury, right there at Signature time…all the DEBT holdings that they borrowed from the Intergovernmentals…..as DOWNPAYMENT upon the loan!

    Where when Treasury receives them back this way, can LEGALLY RETIRE THAT PART OF THE DEBT! How?

    You see, as long as the Debt is Held by someone other than Congress, the 14th Ammendment, Section 4 is in play, which is basically understood to be: The VALIDITY OF THE PUBLIC DEBT…SHALL NOT BE QUESTIONED!

    All this time we’re beating our brains in trying to figure out how to make GOVERNMENT PAY BACK LOANS given, when people purchase the BONDS or the T-BILLS, because the whole presumption is, as long as they’re held APART FROM GOVERNMENT, Government will continue to presume that they intend to be PAID upon the terms that they’re holding…

    But….if the terms held were presented back as any kind of PAYMENT TO GOVERNMENT upon something….then, the terms — those promises purchased from Government, CAN and SHOULD be considered HONORED, because the GOVERNMENT ACCEPTED THEM BACK!

    the 14th, Sec4, HOLDS! because if there’s any law upon the books right now, that prevent or forbid any bondholder from presenting/tendering them back TO GOVERNMENT, or preventing or forbidding Government from accepting them back and crediting the Holder with something in return…then, that law, or regulation, or statute, should be considered invalid RIGHT THERE on its FACE, because of 14th, Sec4!

    As long as holder holds the GOVT IOU…he can be assured of a few things…Yes, he’ll be paid per the terms TAX-FREE…but he will be TAXED OUT OF HIS MIND and his OTHER PARTS, just to BE PAID THAT TAX FREE SUM….

    And, should anyone make claim that the TIME TERMS are part of the Validity that Cannot be questioned…then, the application of a simple AUTHORITATIVE STAMPING upon the Face of the IOU, with those TIME TERMS….could CONVERT that supposed TIME-LADEN BOND, into a NON-TIME LADEN “quasi-” Treasury Certificate, that CAN BE USED as PAYMENT BACK to the GOVERNMENT

    ….leaving those naysayers who wish to have DEBT to hang over heads, for whatever reason…to go and SOAK THEIR HEADS…instead of “soaking the *rich*” because the promises were FULFILLED ALL AT ONCE at the point of presentment/tendering, rather than, OVER TIME….

    Now, Here comes STEP THREE:

    Once the ink is dried on the RECIPROCAL LOAN, and the DEBT OWED is accepted back by Treasury as DOWNPAYMENT upon the BIGGER COD that stands to make the holder MORE MONEY TAX FREE than what the “Guaranteed” Yields and Maturities would…and the COD is placed in the FED VAULT ready to be lent out to be paid back with interest….

    Then it’s time to “officially” notify the Intergovernmentals that CPPB cannot pay back the Held IOU’s because they have been retired, LEGALLY….

    So what the Intergovernmentals will do, is PUT A LIEN upon the portion of the COD that they’re owed, and collect the TAX-FREE interest that CPPB would have gotten, off the entire amount (sans the withheld portion that goes to the Treasury), until the full amount of what they were owed from CPPB, upon the face of their held IOU, is collected by them…

    Which means…that since the Intergovernmentals were NOT PARTY to the RECIPROCAL LOAN, through the LIEN process, they CAN DRAW FROM THE BULK of the COD, up to the portion that they were owed on the IOU given to them BY CPPB, in the first place, and until they draw that entire amount owed, they can collect or recirculate back into the COD, the interest that CPPB would have gotten Tax FREE!

    Think of what this means!

    4-7 Trillion dollars of DEBT gets Retired…when it gets turned into 20-35 Trillion dollars of Lendable Capital that has the Banks working for us, rather than the OTHER WAY AROUND….

    SOCIAL SECURITY never needs to be in a position where Citizens have to be DOUBLE TAXED to keep it always afloat!

    And think of the Benefits that MEDICARE will receive, never needing to be the LOSS LEADER that so many claim it is!

    AND, Government can then RELEASE that portion of Mandatory Spending, servicing that debt owed, back to Discretionary, where it could be used for other purposes…
    Like: providing for the UNFUNDED MANDATES!
    Like: maybe providing FREE or LOW-COST Under-graduate tuition at ANY COLLEGE or UNIVERSITY….
    Or, LIKE: maybe provide for HEALTHCARE INSURANCE VOUCHERS, so that they wouldn’t have to have a MANDATORY HURDLE for people to jump, lest they get TAXED out of their minds….

    The possibilities are ENORMOUS, here!

    Oh, and did I forget to mention….TRULY LOWER TAXES, because Congress won’t need to raid the Social Security Trust Fund as much to “supplement” General Fund?

    All this, just because of what some might recognize as a SPIKE LEE word reversal line from his “Spike lee Joint” of a Movie called “Malcom X” starring Denzel Washington!

    You know the one: “We didn’t land on Plymouth Rock…Plymouth Rock landed on US!”

    Well….without that little line from Spike…this would have been a lot harder for me to conceptualize…let alone explain to you!

    But HERE is the SOLUTION that BEGINS the Process of RETIRING the National Debt….
    ==========================================

    Sincerely,

    Your FB Friend,
    KAPT BLASTO!

    And that piece came from this link:
    https://www.facebook.com/groups/YeahBuddyIGotYourNatlDebtSolutionRightHERE/

    Sincerely,
    Kapt Blasto! 17 Jan 2013

  59. Dear Sir, (Or Madam,) again:

    Look, it’s using the LOAN PROCESS with the right terms, with the right Creditor, in a SMART WAY, and not a STUPID WAY, that’s going to take this National Debt, off your back.

    What exactly stops any end-bondholder from doing something ELSE with the US Bond, than just, sitting and waiting?
    Is it the terms themselves?
    What you’d be doing is supplanting ONE SET OF TERMS for ANOTHER….and you should be able to do it!

    Let me propose to you THIS: If the Bond, is, what, you’re basically purchasing, or, acquiring from another who purchased it, from the Government, or third-party….with a certain amount of money, a EMPTY BOWL that has a certain capacity BIGGER than what you plunked down….then you’re expecting that BOWL to be filled, to that capacity….and what you’re basically purchasing NOW, along WITH the BOWL, is the PROMISE, that that BOWL would be filled, to that capacity, before a certain TIME in the future arrives.

    You’re trading in MONEY (which, TO YOU, is an already filled BOWL,) for an empty BOWL and PROMISES, that’s BIGGER in capacity than what you’re already filled bowl is now….(sorry i have to say it twice!)

    And in my proposal, is that you have a choice…you can hold that BOND, and sit and wait for it to be satisfied…OR, you can satisfy yourself….and use it as DOWNPAYMENT for an EVEN BIGGER BOND, that would make the BANKS OWE YOU, rather than the GOVERNMENT owe you…..

    Remember: LAW can be used to make things even out….

    but if you don’t USE THE LAW to your advantage…then someone ELSE will use the LAW to take advantage of YOU.

    Maybe THAT’s a little more in tune with “for every action there is an equal and opposite reaction” gist that you’re trying to convey….

  60. Thanks for the auspicious writeup. It actually was a amusement account it.
    Glance complex to far delivered agreeable from you!
    However, how could we keep in touch?

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  62. Patrick Conroy

    I may have missed someone else mentioning ‘real liabilities’. Just as there is a real car sitting in the garage that does real work that if it did not exist would require replacement services, there can be things like toxic waste dumps that require additional expenses in the future that, if they did not exist, would not have to be incurred. If MMT does not account for ‘real liabilities’ then it is as guilty of not taking proper account of externalities as traditional economics. I hope it does, because we desperately need a new way to getting along…

  63. I think I disagree with the headline which reads Net Private Financial Wealth equals Public Debt. I think the mistake here is that the origin of income is overlooked. Imagine a government computer that issues loans for the production of industrial goods (includes wages). Goods are sold and the loan extinguished. If part of the income is saved, this appears to be an increase in private wealth, but actually amounts to unsold goods and thus a loan to the government which remains unpaid. I think this is precisely the reverse of your contention. Am I wrong?

  64. “One’s financial asset is another’s financial liability”

    Just wondering is a share in general electric a financial asset? Where does the liability part factor in?

  65. “It is a fundamental principle of accounting that for every financial asset there is an equal and offsetting financial liability”

    Really? I own my car and my house free and clear – no liabilities. Any company, in order to be solvent must have assets that exceed its liabilities. And don’t tell me “stockholder’s equity is a liability”. You can’t owe something to yourself. You can’t be “liable” to yourself.

  66. Mr. Beaumont, you are confusing terms here. Your house and your car are not “financial assets” in the terms of this explanation, they are “real assets”. If you did not own them outright and had loans, then they would be “financial liabilities”. Real assets have varying liquidity, but almost always less than financial assets and they are almost always converted into financial assets when the buyer takes on the balancing financial liablity.

    Lots of companes have more liabilities than assets (real and financial), especially startups, and as long as those are not called in they are still solvent. If every company that had fewer assets than liabilities was declared insolvent we would have a huge run on bankruptcies.

  67. Let’s say I purchase a new issue at $40, the issuing firm has a liability of $40.
    The stock then shoots up to $110. It’s safe to say that financial assets are now bigger than liabilities.
    Correct?

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  69. You segregate well-behaved, non-appreciating, non-depreciating, conserved quantities (“financial” assets and liabilities) from the not-so-well-behaved kind (“real” assets and liabilities). I’m not convinced there’s a clear line between them. Suppose I lend you $100: now I hold a $100 financial asset and you a $100 financial liability. Then you declare bankruptcy, eliminating all or most of your $100 financial liability. What has happened to my $100 financial asset? Did it magically change from financial to real in the instant the judge approved your bankruptcy, so that it could depreciate in the next instant? Did it gradually change from financial to real as my faith in your repayment declined? Does it change partially back to financial when I appeal your bankruptcy filing?

    In short, it seems to me that the “accounting identity” that simplifies reasoning about financial assets and liabilities works only as long as they’re all “pure” and everybody has 100% faith in them — in other words, never in the real world. And certainly not in the critical 2007-2009 period, which was characterized by widespread loss of faith that debts would be paid.

    • OK, never mind: in my “bankruptcy” scenario above, the accounting identity still holds. The bankruptcy cancels all or part of your financial liability, while canceling an equal amount of my financial asset. The fact that I didn’t agree to, and may not have even known about, the bankruptcy is irrelevant.

      Indeed, even if your name were AIG and I lent you a bunch of money with no real expectation of getting it all back, your financial liability would still equal my financial asset: neither of us knows the exact amount of either, but (as with entangled quanta) we know that they’re equal to one another.

      So a “real” asset or liability is one that can appreciate or depreciate without an equal-and-opposite reaction somewhere else: farmland that produces food, a car or house or factory that wears out, etc.

      Where do things like shares of stock fit in (as “John” on Nov. 12 asks)? Initially, they feel very much like a (financial) bank account: I pay dollars to somebody (perhaps the company, perhaps somebody who previously bought from the company) and get in exchange a fairly-liquid thing which I could sell for approximately the same number of dollars. The dividends I earn on it are “financial”, because they accrue to me exactly as they’re owed by the company. But a month later the stock itself may be sellable for considerably more or less, which means it’s “real”. A bond, by contrast, represents a commitment to pay a fixed amount of money at a fixed time, and is therefore purely “financial”… except that one hears on the news about “the price of T-bills” varying inversely with prevailing interest rates (while not changing the nominal amount the government owes me at maturity), which means even they are “real” assets. Right?

      I’m still having trouble seeing the clear line, the “difference in kind” between real and financial.

      • On third thought, now I’m having trouble convincing myself that even a house or a car is a “real” asset.

        I justified calling the loan-that-might-not-be-repaid a “financial” asset by saying that if there’s a default, that event creates matching assets and liabilities that cancel the previous one. And if I lend money to AIG, I expect to get some money back, equal to what they pay back, but I don’t know in advance how much it’ll be, so the value of my financial asset is really “whatever I WILL eventually get for it.” The same could, I suppose, be said for daily fluctuations in stock prices: those events don’t actually create or destroy net value, but rather change the size of both my financial asset and the corresponding financial liability of whomever eventually buys my stock. But then why not apply the same reasoning to my house or car? When my house or my car appreciates or depreciates, that means I WILL eventually get more (less) money for it, but it also means somebody else WILL eventually pay more (less) for it. Everything balances, tautologically, and “financial” assets and liabilities have been defined so broadly as to be almost meaningless; I’m having a hard time thinking of anything that ISN’T “financial”.

        How do you draw the line between real and financial in such a way that financial assets obey those neat identities, but there’s still a meaningful distinction between the two?

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