Monthly Archives: December 2011

Response to Comments: Retrospective on MMT

By L. Randall Wray

Of course, I didn’t expect comments this week on the keynote talk. I know many will agree with the comment on Billyblog—I’m sure many of you found our site after following Bill’s posts.

There was one substantive and flawed comment, so I will deal with that here.

Comment: The “Sotty” principle. That’s twice Prof. Wray has used the term. Referring, it would seem unknowingly, to the radiochemist Frederick R. Soddy, who demonstrated that interest continues to compound on the books after the bank money that offsets it is destroyed. Directly contravening the MMT notion that inside debts net to zero.

The money sovereign isn’t, as financial institutions have the power of money creation and leverage. That’s the power imbalance — a mathematical and financial imbalance — this piece is futilely attempting to deny. 

Response: Yes, sorry, Soddy not Sotty, Nobel Winner in chemistry who also wrote a lot on economics. Michael Hudson has used Soddy’s ideas in his own approach to debt and debt cancellation.

But the commentator is in way over his/her head on balance sheets.

First, here is Soddy’s idea:

Debts are subject to the laws of mathematics rather than physics. Unlike wealth, which is subject to the laws of thermodynamics, debts do not rot with old age and are not consumed in the process of living. On the contrary, they grow at so much per cent per annum, by the well-known mathematical laws of simple and compound interest … For sufficient reason, the process of compound interest is physically impossible, though the process of compound decrement is physically common enough. Because the former leads with the passage of time ever more and more rapidly to infinity, which, like minus one, is not a physical but a mathematical quantity, whereas the latter leads always more slowly towards zero, which is, as we have seen, the lower limit of physical quantities.

You cannot permanently pit an absurd human convention, such as the spontaneous increment of debt [compound interest], against the natural law of the spontaneous decrement of wealth [entropy]

And so the fundamental problem is that “real” economic growth cannot match compounded interest growth—so debts increase faster than ability to pay.

Now I don’t want to get into a debate about the links between “real” and nominal, laws of entropy applied to economics, and so on. The idea is rather simple: if the nominal interest rate is higher than growth of ability to pay debt, then we’ve got a problem. And there is indeed a tendency for that—it is hard to achieve income growth rates that are consistently above nominal interest rates. Problems are compounded as debt ratios grow, as they have done.

But to return to the Commentator’s claim that this violates MMT: at a point in time, inside debts = inside credits. Every financial I owe U is offset by a financial U owe Me. It is an identity that is violated only by an arithmetic error.

Any theory that holds that the two are not equal is just plain wrong. You do not have to accept MMT to accept identities—they hold regardless of theory.

Here is the Soddy claim: over time, those debts will grow faster than ability to pay. That does not mean that debts don’t equal credits. When one defaults on a debt, the credit is also written down. If IOU $100 but can only pay $50, your credit against me is no longer $100—it is $50.

Debt cancellation wipes out the debts and the credits; at the same time; by the same amount.

It is elementary, dear commentator. It does not violate MMT—or any other theory.

Nor does bank leveraging violate MMT. Indeed, MMT has much to say about banks leveraging the state’s high powered money. You have not been paying attention!

A Scribbler’s Response to Marc Lavoie on MMT

By Philip Pilkington
(Cross-posted from Naked Capitalism)

Recently the eminent monetary economist Marc Lavoie published a paper engaging with Modern Monetary Theory (MMT). The paper was interesting for a number of reasons, not least the discussion of the European banking system; speculation about which in the media has generated much mythology in the past few months.

Lavoie is largely supportive of MMT and sees it as being essentially correct. However, he also finds that it has much ‘excess baggage’ that he thinks it needs to do away with. At the same time Lavoie notes that MMT has succeeded in appealing to a broad non-academic audience (Naked Capitalism being mentioned by name) which post-Keynesian economics has so far failed to do.

Unfortunately, Lavoie does not consider that what he calls the ‘excess baggage’ of MMT may well be the reason for its embrace by non-academics. In this Lavoie may well be sidestepping the underlying ideological issues that must be taken into account when considering the embrace of a given economic doctrine.

Excess baggage

While I will not go into too much detail about the arguments that Lavoie raises in what follows (the interested or critical reader can weigh my assertions against Lavoie’s paper themselves if they wish), I can sum up Lavoie’s gripes with MMT quite easily: he distinguishes between where the MMTers see what ‘is’ and where they see what ‘ought to be’.

This distinction revolves around the consolidation of the government sector in MMT – which basically means that the MMTers claim that it is theoretically valid to see the Treasury and the Central Bank as a single entity which they refer to as ‘the government’.

Lavoie raises criticisms against this which have been raised oftentimes in the past before – not least by the MMTers themselves. Basically what he is saying is that many governments that operate under their own currencies create institutional arrangements that separate the actions of the Treasury and the Central Bank.

This may seem like a nuanced point to the outside observer, but much of the MMTers rhetoric about taxes not funding spending and about governments spending by crediting bank accounts flows from here. If we accept a strict division between the Treasury and the Central Bank we can no longer make certain rhetorical claims about how the monetary system works.

MMTers consider the institutional arrangements facilitating such divisions to be ‘voluntary restraints’ imposed by ill-informed central bankers and policymakers and in this, so far as I can tell, Lavoie does not disagree. But this is where we see a distinction between what ‘is’ and what ‘ought to be’.

In academic fashion Lavoie insists that we must simply describe existing institutional arrangements and we should not prescribe what we think should, in fact, be the case. And it is on this point, I think, that he is fundamentally in disagreement with the MMTers.

MMT as a political program

My central point is that it is such rhetoric that gives MMT its strength. Ideally, MMT would like to see these constraints – which are weak and fairly inconsequential anyway –be done away with as they are viewed as leftovers from the gold standard-era. With these constraints out of the way all the MMTers rhetoric would be perfectly true.

Every heterodox economist should recognise what gives neoliberalism its strength. It is not its perfect logical consistency or fidelity to the real world (far from!), but its prescriptive capacity. It has, since the mid-1970s, given policymakers the world over – from both the right and the so-called left – a prism through which they could view the world. MMT turns this prism upside-down and that is what makes it so appealing to people who have seen the world economy led into such destruction through misguided neoliberal ideology.

Neoliberalism operates in a very similar manner to MMT in that it essentially gives policymakers a vision for what the world should be like and a toolkit to achieve this. In this regard MMT is far more humble and, rather than chasing the spectre of self-equilibrating markets or some other such imaginary entity, it merely asks that we reform the monetary system so that a functional finance approach can be taken to policymaking.

In this, MMT sees a far more stable and prosperous world in which policymakers understand that, among other things, taxation should be used as a means to stabilise aggregate demand rather than to raise funds for government spending. Without changing the very terms of debate – as the MMTers seek to do – such would be impossible, as it is clear to anyone today that politics is largely dominated by soundbites and ideology.

In my experience MMTers are aware of this and in this they are far more politically savvy than their academic post-Keynesian colleagues. If the frame of reference is not changed there is simply no hope that we can ever change the direction taken by government.

Policymakers and opinion-makers (and many economists) are not rational people. When they hear the term ‘government spending’, for example, it triggers a reflex in their mind that activates the term ‘inflation’. This is never going to be changed through rational argument – as I said a moment ago: these are not strictly rational people. Instead it has to be changed by shifting the very terms of debate.

In the past politically savvy economists recognised this. Certainly Keynes spent as much, if not more of his life trying to shift the terms of debate than he did writing academic treatises. And Abba Lerner, I think, was clearly aware of this need – and this was one of the reasons for formulating his functional finance approach (note that when examined carefully, this approach is mainly about a change in nomenclature rather than a new theoretical approach).

Where does post-Keynesianism fit in?

Post-Keynesian economists must be praised with being easily the most rational in their discipline. They should also be credited with doing some of the most impressive work undertaken in many fields – from theories of capital to monetary economics. However, they have failed to reach an audience beyond their own immediate group. Indeed, they have failed to even have their critiques and constructions taken seriously by their own colleagues and, from the point of view of an outside observer, seem to spend a great deal of time squabbling amongst themselves (which is probably more so an effect of isolation than a cause).

Every one of them can formulate a reason why this has been the case. And I suspect many will think that politics and ideology plays more than a minor role. If they are smart they will see in MMT something that they can hang their flag on – and, possibly, have their theories taken seriously by the mainstream.

Already MMT oriented blogs have begun to pay attention to post-Keynesian theory more generally (I wrote a popularised exposition of the Kalecki profit equation for this site, for example) and things will likely continue in this direction given MMT’s ever-growing popularity.

Put simply: the shift from a broadly defined post-war Keynesianism to neoliberalism was long and complex, but it was undoubtedly a key feature that its main proponents (especially Milton Friedman) had a clearly defined ideological program for governments. This program – based as it was on tenuous assumptions and philosophical trickery – now lies in ruins and there stands nothing ready to take its place.

Something will have to step in to fill this intellectual vacuum and I suspect that, should the academic cloisters be left to themselves, I can confidently predict what this ‘something’ will be: namely, a new Samuelsonian Keynesianism that will be as weak and as watery as its post-war cousin (most likely with someone like Paul Krugman as its leading media light). If this occurs all the fine work of the post-Keynesians will again be confined to the dustbin of history and the ISLM model – which Lavoie rightly presents in the paper as the guiding principle for the majority of the profession – will remain king.

When Friedman stepped into the breach he was largely ignored by his colleagues. “Keynes,” they all assured themselves confidently, “had proved him wrong years ago”. But through a careful refining of his message – together with a formulation of a broad new program for society – he found himself well-placed to fill the intellectual vacuum leftover from ISLM-Keynesianism in the inflationary 1970s (even though, in retrospect, his arguments were at best a sideshow as to what were truly the causes of the inflations of the 1970s).

It was the moral clarity that Freidman gave that found him an audience. And while the MMTers (thankfully) do not construct the sorts of metaphysical systems that Friedman peddled, they do allow us to once again raise fundamental questions about the role of government in advanced capitalist economies. They allow us to raise these questions in a fundamentally popular, interesting, but also eminently post-Keynesian way. To retreat from this because MMTers currently have no say in obscure institutional practices between certain Treasuries and their Central Banks, is a gross error; the equivalent of Freidman fleeing from his prescriptions for controlling the money supply because central bankers were then not adopting this approach.

For too long one gets the impression that, closed in upon themselves and shunned by the outside world, the point of being a post-Keynesian was to win the argument. Today, as this fine tradition gradually emerges from out of the shadows, the point is to win more generally. And one cannot win unless one has a clearly formulated game plan. MMT is the only positive game plan currently being put forward.

Not only in Germany: The ECB now wants export-driven growth for whole Europe!

By Andrea Terzi
(Cross-posted from Mecpoc)

One claimed objective of the single currency area in Europe is (or should I say was?) to create a large single market for producers. But now the ECB is pressing national governments to gear their policies to enhance competitiveness so that they can “count on external demand” and increase their net exports! Mario Draghi, President of the ECB, and a key figure in the team now managing the European crisis, made this statement while responding to an Italian journalist, in the Q&A session of the ECB press conference of 8 December 2011.

Earlier, Draghi had described the ECB’s view of the 3-pillar recipe to end the euro crisis as follows:

Continue reading

The Twelve Days of Christmas

Bernanke’s 29 Trillion Dollar Fog of Deceit

By L. Randall Wray

As I reported over at Great Leap Forward,a new study by two UMKC PhD students, Nicola Matthews and James Felkerson,provides the most comprehensive examination yet of the Fed’s bail-out of WallStreet. They found that the true total cumulative amount lent and spent onasset purchases was $29 trillion. That is $29,000,000,000,000. Lots of zeros.The number is quite a bit bigger than previous estimates. You can read the first of what will be a series of reports on their study here: I want to be clear that this is a cumulative total—and for reasons I willdiscuss in this post it is the best measure if we want to understand themonumental Fed effort to restore Wall Street to its pre-crisis 2007 glory.
It is certain that no government anywhere, ever, hascommitted so much to benefit so few. Wall Street owes the Fed a big fat wetkiss. That’s a kiss Chairman Bernanke apparently does not want.
Last week he extended the Fed’s veil of secrecy over itsbail-out of Wall Street by trying to counter a recent Bloomberg analysis of theextent of the Fed’s largess with a fog of deceit. Apparently the Chairmanforgot the lesson we learned from Watergate: the cover-up is always worse thanthe original indiscretion.

MMT: A Doubly Retrospective Analysis

By L. Randall Wray

*We’re going to take a break from the regularly-scheduled MMP this week. In its place, I’m posting the keynote talk I gave at Bill Mitchell’s annual Coffee conference in Newcastle. As most of you know, Coffee is the sister center to UMKC’s CFEPS. Some of the participants asked for copies of my talk and I figured some of you might also enjoy it, so am posting it here. It has some of the history of the development of MMT—although it is based on my faulty memory so should not be taken too seriously! 

Next week we’ll return to “nonsovereign” currencies. 

MMT: A DOUBLY RETROSPECTIVE ANALYSISKeynote: Coffee Conference, University of Newcastle, Australia 2011

As always, I’m happy to be at the annual Coffee conference. I think I’ve attended all of them save one. What a long and at times strange trip it’s been.

Warren Mosler, Bill Mitchell, and I used to meet up just about every year to count the number of people in the world who understood what we were talking about. I remember just a few years ago at Vail, Colorado, we finally got beyond the fingers on two hands.

Now try googling MMT—millions of hits and what is more surprising is that there are blog sites all over the web devoted to MMT, run by people I’ve never heard of. That is a good thing, of course, even if they do not always get things exactly right.

And we’ve got Paul Krugman and Brad DeLong trying to explain what is wrong with MMT even as they “borrow” our ideas. And policy makers including Bernanke spouting off about government spending using keystrokes, sounding like good MMTers. Without attribution.

And it all goes back to PKT (Post Keynesian Thought) in the early 1990s—the first internet discussion group I ever heard of. It started off with all the stars of heterodox economics—Paul Davidson, Herb Gintis, Michael Perelman, Ed Nell; even Hyman Minsky contributed a post or two.

And then there was this strange profane guy named Bill Mitchell who swore like a drunken sailor.

He had little tolerance for Keynes but otherwise I found myself agreeing with him more often than with anyone else. On Kalecki, on Marx, on fiscal policy, and especially against the Austrians that were slowly but surely killing PKT.

 And one other guy stood out—a hedge fund manager named Warren Mosler who was continually pushing two things. First there was something he called soft currency economics. It sounded to me like good old Keynesian economics from the Treatise on Money, which followed Knapp’s state theory of money.

And then there was the job guarantee, which I immediately recognized as Minsky’s employer of last resort. I can’t remember what Warren called it but Bill called it BSE, buffer stock employment.

I had never thought of it that way, but Bill’s analogy to commodities price stabilization schemes added an important component that was missing from Minsky: use full employment to stabilize prices. With that we turned the Phillips Curve on its head: unemployment and inflation do not represent a trade-off, rather, full employment and price stability go hand in hand.

Unfortunately, a bunch of cows came down with a disease called BSE and we were forced to search for an alternative name. I never liked ELR, anyway, even though it had a long tradition in the US, at least back to the 1930s. So we tried PSE (public service employment). Bill settled on JG (job guarantee) and that is the one that mostly stuck.

What Warren also added was a much deeper understanding of bank reserves and treasury bonds. I came at this from the PK endogenous money, horizontal reserves view of Basil Moore. There’s nothing seriously wrong with that, but it never understood why a sovereign government would sell bonds. Warren explained bond sales as a reserve drain, and lightbulbs went off. Exactly right: government sells bonds to hit the overnight interest rate target.

I think it was Mat Forstater who brought the final piece of the puzzle: Lerner’s functional finance approach. I don’t think the basic conclusions were new to any of us, but it was nice to find that a rather mainstream economist reached the same conclusion in the 1940s. Affordability is never a proper concern of a sovereign government.

Soon Warren, Bill and I were having discussions off the PKT list. Warren asked to see some of my publications, including a 1990 book. In 1994 he said he wanted to sponsor my next book, giving me an advance against royalties.

I explained to him that economics books don’t earn money. But he argued this one would win me a Nobel Prize. I silently dismissed this as far-fetched and didn’t pursue it. Besides, I had one baby and another soon on the way. No time to write a book.

In 1996 Warren wrote again; he made a generous offer and I protested that there was no way he’d get his money back. It was at that point that I realized that he was not only serious, but seriously rich. I accepted and he bought me out of a semester of teaching. All he wanted in return was the chance to critique draft chapters. Which he did. Sometimes he convinced me; other times I was stubborn. Warren was always tolerant.

And then he invited me to his conference at Bretton Woods in 1996, where I got to help push MMT onto his hedge fund friends. We began to discuss a bigger project, leading to the creation of CFEPS, which eventually ended up at UMKC with Mat joining and later Stephanie Bell/Kelton.

Bill, meanwhile, was setting up COFFEE. I think I came over with Ed Nell and Stephanie and Warren my first time to OZ. And there were meetings in Florida and later the Virgin Islands. With CFEPS and Coffee and then Coffee Europe we had bases for subversion.

And to skip forward a few years, Bill started a blog. I had no idea what a blog was, and thought he was wasting his time. But if we want to credit one thing for spreading MMT all over the planet, it was Bill’s blog. While the academic journals and the policy makers and the mainstream press could mostly ignore us, the blogosphere was wide open to new ideas.

Let me go back to 1997 when I was finishing up my book titled Understanding Modern Money and I sent the manuscript to Robert Heilbroner to see if he’d write a blurb for the jacket. He called me immediately to tell me he could not do it.

As nicely as he could, he said (in the most soothing voice), “Your book is about money—the most terrifying topic there is. And this book is going to scare the hell out of everybody.”

Here we are a decade and a half later and we’re still scaring them. Why? Because nobody wants the truth about money. They want comforting fictions, fantasies, bedtime stories.

To be sure, on the left the story is about the evil Fed and bankers and conspiracies against the poor; on the right it is the evil central bank and government and Free Masons and conspiracies against the rich. 

The one thing they seem to be coalescing around is the need for a return to sound money although they don’t necessarily agree on what is sound.

What I want to do today is to argue that both the left and the right as well as economists and policymakers across the political spectrum fail to recognize that money is a public monopoly.

The shared bedtime story told by all sides is that money is a private invention of some clever Robinson Crusoe who tired of the inconveniencies of bartering fish with a short shelf-life for desired coconuts hoarded by Friday.

Self-seeking globules of desire continually reduced transactions costs, guided by an invisible hand that selected the commodity with the best characteristics to function as the most efficient medium of exchange. As everyone from Marxists to Hayekians all know, that turned out to be gold.

Self-regulating markets maintained a perpetually maximum state of bliss, producing an equilibrium vector of relative prices for all tradables, including the gold money that serves as a veiling numeraire.

All was fine and dandy until the evil government interfered, first by reaping seigniorage from monopolized coinage, next by printing too much money to chase the too few goods extant, and finally by efficiency-killing regulation of private financial institutions.

Especially in the US, misguided laws and regulations simultaneously led to far too many financial intermediaries but far too little financial intermediation.

Chairman Volcker delivered the first blow to restore efficiency by throwing the entire Savings and Loan sector into insolvency, and then freeing thrifts to do anything they damn well pleased.

That second blow, deregulation, actually dates to the Nixon years and even before, but it morphed into a self-regulation movement in the 1990s on the unassailable logic that rational self-interest would restrain financial institutions from doing anything foolish.

This was all codified in the Basle II agreement that spread Anglo-Saxon anything goes financial practices around the globe. The final nail in the coffin would be to tie monetary policy-maker’s hands to inflation targeting, and fiscal policy-maker’s hands to balanced budgets to preserve the value of money.

All of this led to the era of Bernanke’s “great moderation”, with financial stability and rising wealth to create Bush’s “ownership society” in which all worthy individuals share in the bounty of self-regulated capitalism.

We know how that story turned out. In all important respects we managed to recreate the exact same conditions of 1929 and history repeated itself with the exact same results.

Take John Kenneth Galbraith’s The Great Crash, change the dates and some of the names and you’ve got the post mortem for our current calamity.

Why do economists get it so wrong? They misunderstand not only the nature of money but also the nature of the market.

It is commonplace to link Neoclassical economics to 18th or 19th century physics with its notion of equilibrium, of a pendulum once disturbed eventually coming to rest. Likewise, an economy subjected to an exogenous shock seeks equilibrium through the stabilizing market forces unleashed by the invisible hand.

The metaphor can be applied to virtually every sphere of economics: from micro markets for fish that are traded spot, to macro markets for something called labor, and on to complex financial markets in synthetic CDOs.

Guided by invisible hands, supplies balance demands and all markets clear.

Armed with metaphors from physics, the economist has no problem at all extending the analysis across international borders to traded commodities, to what are euphemistically called capital flows, and on to currencies, themselves.

Certainly there is a price, somewhere, someplace, somehow, that will balance supply and demand—for the stuff we can drop on our feet to break a toe, and on to the mental and physical efforts of our brethren, and finally to notional derivatives that occupy neither time nor space.

It all must balance, and if it does not, invisible but powerful forces will accomplish the inevitable.

The orthodox economist is sure that if we just get the government out of the way, the market will do the dirty work. Balance. The market will restore it and all will be right with the world.

The heterodox economist? Well, she is less sure. The market might not work. It needs a bit of coaxing. Imbalances can persist. Market forces can be rather impotent. The visible hand of government can hasten the move to balance.

Balance is nice; it’s intuitively appealing. In truth, it was not invented by physics. All cultures view it as natural. It is the universal condition—both in nature and in human society. It reflects an inner yearning for fairness.

As Margret Atwood (Payback) explains, all human and ape societies have recognized the law of reciprocity—you will pay back in this life or the next.

There is an innate notion of equivalent values, and therefore of balances. Animals can tell “bigger than” and they revolt when they are shorted. Even the rat knows it’s not fair. She goes on strike if you try to reduce the reward for running a maze. That violates the rat notion of balance.

There is a right way to do things. Failure to follow tradition upsets the balance. Who knows what wrath imbalance might invoke among the gods.

Gabriel, the Angel of records, keeps God’s ledger book—to be produced in the Last Judgment. Too much imbalance in your life and you go to hell.

And, as we know, Lucifer records the debts—of the souls he will collect. He’ll sell you a good time now, but your soul lies in the balance. You buy now, you pay forever. Sort of like Student Loans in America. 

The only things in life you cannot escape are death and taxes. The Devil has a lock on both of those. He’s the tax collector who calls at death. Once your soul is sold, there is no balance. It’s the roach motel—you’ve checked in and you will never get out.

But Christ is the redeemer—he’s a sin eater, repaying your debts to restore balance, to let you sinners get to heaven.

Muslims refer to the scales of justice—your good deeds are weighed against the bad ones. There is a balancing out—if lucky and good, you might just tip the scales.

Much earlier, the God of Time was a Scribe as well as the God of Measurement and Engineering—how would you like that job description? He kept the records, measured worth, and built the scales. At death, he weighed your heart to assess your value.

I suppose you all know that the Pope or Pontiff came out of the engineering gens of one of the Tribes of Rome—that built all the bridges, or ponte, over the Tiber river and followed the example set by the engineers of the Nile by becoming the priestly upper class.

Time. Measurement. Writing. Balance. Everything you need for money and accounting.

And of course none of you is debt-free—original sin ensures that from birth. Can you redeem yourself? Not likely. You need help.

So from time immemorial debts would be periodically cancelled—the Year of Jubilee. With every change of ruler (who of course, was an earthly God of Measurement) or every 7 years or 30 years depending on sinfulness, all debts were cancelled.

Babylonia chose 30 as the likely reign of a ruler; the Bible chose 7—the lucky number, a 7 year ever-normal granary would get you through a drought.

Debt cancellation.

Why? These were no bleeding heart liberals. No, debt cancellation was to restore balance. If all your subjects are in hock to creditors, you cannot rule them. So you eat their sins, redeem their debts, free them and their wives and kids from debt bondage.


Now why do we need periodic debt cancellation? The Sotty principle. Compound interest trumps compound growth. As Michael Hudson says, humans recognized this even before they invented writing. The earliest textbooks showed how to calculate compound interest.

It was our first imbalance—our first violation of natural law.

It would inevitably lead to concentration of wealth—like the game of Monopoly, the last player standing would take all. So from Babylonia to Rome, balance was restored by cancelling debts.

Time was circular: time and accounts would reset at zero when the slate was wiped clean.

Time and debt are inherently related. Time compounds the debts at the rate of interest. In Heaven there are no debts and no time; in Hell all debts are compounded forever.

Redemption allows time and debt to start over from balance.

But with Roman Law we abolished circular time, in favor of property law.

Henceforth time moved in one direction only—from a largely known past to what Paul Davidson would call a fundamentally uncertain future. No more debt cancellations.

Just debtor’s prisons—where the debtor would be held until family could redeem him. Later we used prisons and execution simply for retribution—an eye for an eye, a life for a life, so that the scales would balance.

But debtor’s prisons destroyed the balance between creditors and sovereign—just as debt bondage had several thousand years earlier. With the family head in prison, it was impossible to repay. Again, bankruptcy was invented not out of compassion but to restore the balance between the rights of rulers and of creditors.

Yet bankruptcy only allowed a partial reset. It was a poor substitute for Jubilee and Hallelujah. And the creditors ran the show. They liked inequality; they liked imbalance.

As Kenneth Boulding used to say, surveys of the rich consistently show that you cannot imagine how incredibly greedy they are, and how monumentally stupid they are, too. They will gleefully roast the goose that lays the golden egg.

If you do not believe that, you have not been watching Wall Street over the past decade. Or what Germany is doing to Greece and Ireland. When creditors have too much power, they destroy the balance.

So let’s bring this to the present, which is to Modern Money.

Credit and debt are two sides of the same coin. Both creditor and debtor are sinful. They balance. Exactly. The sinful balance is ensured by double-entry book-keeping.

Redemption frees both creditor and debtor. It results in a different balance—one without sin. Bankruptcy also results in balance, but one that maintains the power of creditor over debtor—at least within the limits of law.

But the point is, debts and credits are always in balance. In the private sector, as we always say, inside debts net to zero. Balance.

When we include a government, its IOUs are balanced by credits held by the nongovernment sector. The nongovernment sector’s net credits are claims on government. The government’s deficit means a nongovernment surplus. It balances.

And when we include an external sector, a domestic deficit must be balanced by a foreign surplus. It, too, balances.

There is always financial balance. Imbalance can arise only due to arithmetic errors. Looking at our global mess as a financial imbalance—as almost everyone does—is a mistake.

Our mess is not due to excess liquidity sloshing around the world in the mid 2000s. It is not due to excessive borrowing by America from the Chinese. And it is not due to profligate spending by Mediterraneans with too little self-control.

We need to look at this the way Babylonia’s rulers saw it. The problem is a balance of power, not an imbalance of finance. And to understand this, we’ve got to understand what money is. We need to return to Keynes’s Treatise on Money.

I know I’ve used up more than half my time. But that is OK because many of you have heard me talking about Keynes’s State Theory of Money for the past 20 years. I’ve got nothing new to say about it.

To greatly simplify, money is a measuring unit, originally created by rulers to value the fees, fines, and taxes owed. By putting the subjects or citizens into debt—original sin—real resources could be moved to serve the public purpose. Taxes drive money. This is why money is always linked to sovereign power—the power to command resources.

That power is rarely absolute. It is contested, with other sovereigns but often more important is the contest with domestic creditors. Too much debt to private creditors reduces sovereign power—it destroys the balance of power needed to govern.

Money is not a commodity or a thing. It is an institution, perhaps the most important institution of the capitalist economy. The money of account is social, the unit in which social obligations are denominated.

I trace money to the wergild tradition—that is to say, money came out of the penal system rather than from markets, which is why the words for monetary debts or liabilities are associated with transgressions against individuals and society. A transgressor had to pay a fine to the injured; this prevented “eye for eye” blood feuds.

Eventually, authorities managed to subvert the wergild system so that the fines were paid to the authorities, themselves. And eventually they came up with a measure of the fines, a unit of account in which to compare the incomparable.

And why wait for a transgression before the authority can collect? Enter original sin. We owe taxes for the mere act of being born.

And finally the authority learned it could issue its own IOUs, to purchase what it wanted, while accepting those IOUs in the tax payments. The IOUs of course were denominated in the unit of account—money. 

Only the sovereign can impose tax liabilities to ensure its money things will be accepted. Others can issue money things denominated in the sovereign’s money of account—but as they are not sovereign they cannot impose liabilities to ensure their money things are demanded.

But power is always a continuum and we should not imagine that acceptance of non-sovereign money things is necessarily voluntary. We are admonished to be neither a creditor nor a debtor, but all of us are always simultaneously debtors and creditors. It is hard to avoid being simultaneously a creditor and a debtor of a bank! I’m sure that description fits everyone in this room.

Maybe that is what makes us Human—or at least cousins of Chimpanzees, who apparently keep careful mental records of liabilities, and refuse to cooperate with those who don’t pay off debts—what is called reciprocal altruism: if I help you to beat Chimp A senseless, you had better repay your debt when Chimp B attacks me.

Our only advance over Chimps was the development of writing—so we don’t need Elephantine memories to keep track of the credits and debts.

Money predates markets, and so does government. As Karl Polanyi argued, markets never sprang from the minds of higglers and hagglers, but rather were created by authorities.

The monetary system, itself, was invented to mobilize resources to serve what government perceived to be the public purpose.

Of course, it is only in a democracy that the public’s purpose and the government’s purpose have much chance of alignment. In any case, the point is that we cannot imagine a separation of the economic from the political—and any attempt to separate money from politics is, itself, political.

We can think of money as the currency of taxation, with the money of account denominating one’s social liability. I have to deliver a dollar’s worth of commodities—including labor power–to satisfy the public interest.

Often, it is the tax that monetizes an activity—that puts a money value on it for the purpose of determining the share to render unto Caesar.

The sovereign government names what money-denominated thing can be delivered in redemption against one’s social obligation or duty to pay taxes. It can then issue the money thing in its own payments.

That government money thing is, like all money things, a liability denominated in the state’s money of account. And like all money things, it must be redeemed, that is, accepted by its issuer.

It’s not money that the sovereign wants—she wants real resources. Money receipts is the tool, not the goal. If private creditors run the economy there just isn’t enough power to produce left for the sovereign—for the public purpose.

If government emits more in its payments than it redeems in taxes, currency is accumulated by the nongovernment sector as financial wealth.

We need not go into all the reasons (rational, irrational, productive, fetishistic) that one would want to hoard currency, except to note that a lot of the nonsovereign money denominated liabilities are made convertible (on demand or under specified circumstances) to currency. So, many economic units need currency because they’ve agreed to redeem their IOUs for it.

Since government is the only issuer of currency, like any monopoly government can set the terms on which it is willing to supply it. If you have something to sell that the government would like to have—an hour of labor, a bomb, a vote—government offers a price that you can accept or refuse.

Your power to refuse, however, is not that great. When you are dying of thirst, the monopoly water supplier has substantial pricing power.

The government that imposes a head tax can set the price of whatever it is you will sell to government to obtain the means of tax payment so that you can keep your head on your shoulders. Since government is the only source of the currency required to pay taxes, and at least some people do have to pay taxes, government has pricing power.

Of course, it usually does not recognize this, believing that it must pay “market determined” prices—whatever that might mean.

But just as a water monopolist cannot let the market determine an equilibrium price for water, the money monopolist cannot really let the market determine the conditions on which money is supplied.

Rather, the best way to operate a money monopoly is to set the “price” and let the “quantity” float—just like the water monopolist does.

My favorite example is Bill’s buffer stock job guarantee program in which the national government offers to pay a basic wage and benefit package (say $15 per hour plus usual benefits), and then hires all who are ready and willing to work for that compensation.

The “price” (labor compensation) is fixed, and the “quantity” (number employed) floats in a countercyclical manner.

With JG, we achieve full employment (as normally defined) with greater stability of wages, and as government spending on the program moves countercyclically, we also get greater stability of income (and thus of consumption and production).

As Minsky said, anyone can create money (things). I can issue IOUs denominated in the dollar, and perhaps I can make my IOUs acceptable by agreeing to redeem them on demand for US government currency.

The conventional fear is that I will issue so much money that it will cause inflation, hence orthodox economists advocate a money growth rate rule. But it is far more likely that if I issue too many IOUs they will be presented for redemption. Soon I run out of currency and am forced to default on my promise, ruining my creditors.

That is the nutshell history of most private money creation. If you’ve heard of Bear or Lehman or Northern Rock, you know what I mean.

But we have always anointed some institutions with a special relationship, allowing them to act as intermediaries between the government and the nongovernment. Most importantly, government makes and receives payments through them.

Hence, when you receive your Social Security payment it takes the form of a credit to your bank account; you pay taxes through a debit to that account.

Banks, in turn, clear accounts with the government and with each other using reserve accounts (currency) at the central bank, which ensures clearing at par. To strengthen that promise, we introduced deposit insurance so that for most purposes, bank money functions like government money.

Here’s the rub. Bank money is privately created when a bank buys an asset—which could be your mortgage IOU backed by your home, or a firm’s IOU backed by commercial real estate, or a local government’s IOU backed by prospective tax revenues.

But it can also be one of those complex sliced and diced and securitized toxic waste assets you’ve been reading about since 2008. A clever and ethically challenged banker (is there another kind?) will buy completely fictitious “assets” and pay himself huge bonuses for nonexistent profits while making uncollectible “loans” to all of his deadbeat relatives.

The bank money he creates while running the bank into the ground is as good as the government money the Treasury creates serving the public interest. And he will happily pay outrageous prices for assets, or lend to his family, friends and fellow frauds so that they can pay outrageous prices, fueling asset price inflation.

This generates nice virtuous cycles in the form of bubbles that attract more money until the inevitable bust.

The amazing thing is that the free marketeers want to “free” the private financial institutions but advocate reigning-in government on the argument that excessive issue of money by government is inflationary.

Yet we have effectively given banks the power to issue government money (in the form of government insured deposits), and if we do not constrain what they purchase they will fuel speculative bubbles. By removing government regulation and supervision, we invite private banks to use the public monetary system to pursue private interests.

Again, we know how that story ends, and it ain’t pretty. Unfortunately, we now have a government of Goldman, by Goldman, and for Goldman that is trying to resurrect the financial system as it existed in 2006—a self-regulated, self-rewarding, bubble-seeking, fraud-loving juggernaut.

To come nearer to a conclusion: the primary purpose of the monetary monopoly is to mobilize resources for the public purpose.

There is no reason why private, for-profit institutions cannot play a role in this endeavor. But there is also no reason to believe that self-regulated private undertakers will pursue the public purpose.

Indeed, we probably can go farther and assert that both theory and experience tell us precisely the opposite: the best strategy for a profit-seeking firm with market power never coincides with the best policy from the public interest perspective.

And in the case of money, it is even worse because private financial institutions compete with one another in a manner that is financially destabilizing: by increasing leverage, lowering underwriting standards, increasing risk, and driving asset price bubbles.

Unlike my JG example, private spending and lending will be strongly pro-cyclical. All of that is in addition to the usual arguments about the characteristics of public goods that make it difficult for the profit-seeker to capture external benefits.

For this reason, we need to analyze money and banking from the perspective of regulating a monopoly—and not just any monopoly but rather the monopoly of the most important institution of our economy. 

Government has an unlimited supply of its own money—but there have to be available productive resources.

In modern economies that is not the usual constraint, however. Government’s sovereign power is constrained in two main ways: arbitrary self-imposed budgetary constraints, and exchange rate constraints.

Many countries happily impose both types—including Euroland. The handcuffs of budget limits were not enough—so they imposed the ball and chain of the Euro. We can observe the fall-out right now.

A sovereign government that issues its own currency faces no inherent financial constraints. It cannot produce a financial imbalance. It can buy any resources that are for sale in terms of its own currency by using keystrokes.

That does not mean it should try to buy all the resources—it can certainly produce inflation and it can leave too little resources to fulfill the private purpose.

Government needs to use its sovereign power to move just the right amount of resources to serve the public purpose while leaving enough for the private purpose. That balance is mostly political. It is hard to find. I admit all that.

But trying to use an arbitrary budget limit or supposed “balance” between tax receipts and monetary spending (over some time period determined by the movement of celestial objects) is the worst possible way I can conceive of trying to find the right balance between the public and private purposes. What it usually does in reality is to leave the resources unused—wasted—rather than to leave them for the private purpose.

Much better is to explicitly decide: what do we want government to do? What do we want our private sector to do? Do we have a sufficient supply of resources domestically plus what we can obtain externally to achieve both? If we don’t how can we expand capacity as needed?

I’m not necessarily arguing for a planned economy as usually defined. But of course, all economies are planned, of necessity. The question is by whom and for whom. Currently, the by and for is Goldman. 

These are the real issues, they are difficult, they are contentious. But they have almost nothing to do with the size of a budget deficit. It is worse than pointless to set a deficit ratio goal of 3% or 6%, and a debt ratio goal of 60%. It is counterproductive.

Let me turn to the other self-imposed constraint: pegged exchange rates. Adopting a gold standard, or a foreign currency standard (“dollarization” or “euroization”), or for that matter a Friedmanian money growth rule, or an inflation target is a political act that serves the interests of some privileged group.

There is no “natural” separation of a government from its money. The gold standard was legislated, just as many countries legislate the separation of Treasury and Central Bank functions, and some require balanced budgets or set arbitrary deficit ratios and debt limits. Nothing natural about that.

Ditto the myth of the supposed independence of the modern central bank—this is but a smokescreen to hide the fact that monetary policy is run for the benefit of Wall Street and London and Frankfurt and Paris.

Wynne Godley taught us about balances—the sectoral balances. If you take a look at US sectoral balances across the three sectors, what do you see? Balance. A mirror image.

In normal times, the private sector surplus plus the current account deficit equals the budget deficit. In the abnormal times of private sector deficits, we still saw balance—the government even ran budget surpluses for a few years to maintain the balance.

Take a look at Euroland’s balances; what do you see? Balance.

Isn’t it amazing? Whenever the private sector surplus rises, the budget deficit rises; the correlation is near 100%, with the current account acting as the balancing item.

Financial balances balance.

If you take the world as a whole, there is no external sector since we don’t trade with Martians. And so the sum of the global government deficits equals the sum of the private sector surpluses. It balances. 

What’s the problem in Euroland? Power. Private creditors in central Europe have too much of it; Sovereigns on the periphery have too little.

The creditors are starving the member states, aided and abetted by the Euro, which usurped sovereign power and handed it over the banking elite.

But even still, the balances balance. You can curse the moon for its travels but it still is going to circumnavigate the globe.

Admonish the Mediterraneans all you like for their budget deficits, but they still will have them compounded by the German export surpluses.

The real imbalance is power.And this isn’t just a European disease. There is a generalized perception of a world out of balance. We’ve got Arab springs, Occupy Wall Street movements, and protests all over Europe.

Why? Imbalances: everywhere I look in the Western world, the public sector is too small; we’ve privatized too many essential public sector functions—our arts, culture, prisons and punishment, military in Iraq, increasingly our education, our motor vehicle departments. All privatized.

Even responsibility for full employment, and supervision of our banks. We let them self – regulate, and even self-prosecute and self-punish.What happens? Fraud, unemployment, inequality, poverty, and inadequate healthcare, retirement, and welfare.

If you think about it we chose the worst of all possible times to embark on the great Neoliberal experiment—downsizing government, privatizing many of its functions, slashing the safety net. In the West we are aging—which creates the twin problems of the need to devote more resources to aged care and at the same time a private desire to accumulate financial resources for individual retirements.

And that in turn led to the accumulation of unprecedented financial wealth under management by professionals.

Current and future retirees demand higher returns to increase their security and what Minsky called Money Manager Capitalism responded by pouring more resources into the financial sector, doubling its share of value added and capturing 40% of all corporate profits.

It’s too much. Finance is at best an intermediate good that might in the best of circumstances contribute to production. At the same time, financial wealth represents a potential claim on output but does not guarantee output will be available as needed.

We need old folks homes but finance is more interested in gambling on CDOs squared and cubed.

But it is worse than that. Modern finance, at least what is practiced at the biggest banks, is about fraud. 

So finance is not even a zero sum game—it largely makes a negative economic contribution.

So the imbalance is one of power. The disease is money manager capitalism. The symptom is the subprime frauds in the US, the austerity imposed on Greece and Ireland, the stagnation of incomes in most developed nations, the rising inequality and poverty in the midst of plenty, the growing despair and feelings of hopelessness.

We are headed into another Global Financial Crisis, and likely into a Great Depression 2.0. We’ve handed the monopoly power over to Wall Street and tied the hands of government.

The Occupy Wall Street protestors have got it right—you’ve got to cut off the head of the beast—the Blood-Sucking Vampire Squid on Wall Street that has completely subverted democracy.

We must have fundamental reform and MMT shines a light on the path we need to take.

When a Country Adopts a Foreign Currency: Responses to MMP Blog #27

By L. Randall Wray 

Apologies to all, I have just finished a Coffee conference in Newcastle and before that a SHE conference in Sydney so this is late and brief. I will deal with many of these topics in MMP blog #28. But let me deal with just a few of the comments here.
Q1: Can a euro-using nation like Greece issue net financial assets to its nation?
A: Ignore for a second the government and foreign sectors. Within the domestic private sector, many economic units issue IOUs that represent their debt; these are held by other economic units as their assets. Clearly for every debt there is an asset. They net to zero. Now add the government sector. It has claims on the domestic private sector, and it issues claims on itself. The private sector meets its obligations to government by delivering the government’s own IOUs (ie: currency broadly defined, although in practice taxes are ultimately paid using reserves—a transaction performed by banks that have accounts at the central bank). As we know from previous blogs, deficit spending by government leads to net credits. So the private sector will have net financial assets in the form of claims on government. And in practice those net claims will be bank reserves at the central bank. Government can then sell treasuries as a higher interest earning alternative—which are bought through debits to reserve accounts.
Now the question is whether these reserves or treasuries are net financial assets for the domestic private sector. Surely they are.
Add the foreign sector. Presume the government is operating with what amounts to a fixed peg—either it makes its currency convertible one-to-one against a foreign currency, or it actually adopts a foreign currency (say, the euro). Its central bank opens a reserve account at the central bank that issues the currency (say, at the ECB). It accumulates claims on foreign central banks (its financial assets) and foreigners accumulate claims on it (its financial liabilities). It clears its accounts using ECB reserves (the ECB debits its reserves and credits reserves of foreign banks that have claims against it). When it is short reserves needed for clearing, it must borrow them from other banks that have accounts at the ECB, or from the ECB itself.
As the Greek domestic private sector plus government sector purchase foreign goods, services, and assets, foreign central banks will accumulate claims on the Greek central bank. And as foreigners purchases Greek goods, services, and assets, the Greek central bank will accumulate claims on foreign central banks. If Greece runs a current account deficit (which it does), there are net claims against Greece—net Greek debt that represents net financial assets held by foreigners. (Technically, a current account deficit is offset by a capital account surplus—plus official transactions.) These can be claims on the Greek private sector and on the Greek government. All of this can go on so long as foreigners are willing to accumulate claims on Greeks (private plus government debtors) and the ECB is willing to lend reserves to the Greek central bank. But Greece is subject to the “whims of the market”—the “market” might require a higher interest rate to induce it to continue to “lend” to Greece.
Q2: Can a fixed exchange rate ever be beneficial?
A: An advantage of a fixed rate is that uncertainty over exchange rate movement can be removed—so long as you really believe the peg can be maintained. Let us say you believe it. Then the disadvantage is that the nation gives up domestic policy space since it will have to ensure policy is consistent with maintaining the peg. That is a big trade-off. It could be possible that desired domestic policy is consistent with maintaining the peg. For example, let us say that you want to run your country in a manner that maximizes net exports—so that your central bank accumulates foreign exchange. In that case, maintaining the peg is facilitated. Now, exports are a cost while imports are a benefit—in real terms: you work hard to produce goods that will be consumed by foreigners. Again, it is possible that such a policy is consistent with domestic goals. Let us say you want to develop your productive capacity and want to ensure high quality products so need to perform to global standards. That is a big reason why China wanted to become an exporter. But China must realize the drawbacks to such policy: workers produce goods and services they do not get to consume. So, I am not arguing that no country should ever adopt a peg—rather, countries should be aware of the relative costs of doing so. Finally, pegs invite speculators—who bet that you cannot maintain the peg. That is why it is foolish to peg unless you have an unassailable foreign currency reserve.
Q3: What are the causes of inflation?
A: Excess demand is clearly not the only cause of inflation—and I never implied that it is. Indeed, inflation in the US, outside major wars, has always coincided with high unemployment. Assorted other reasons include rising prices of imported commodities (oil, food), bottlenecks (shortages of key resources including skilled labor), wage-led or profits-led inflation (either workers or capitalists insist on excessive increases to incomes), government indexing (increasing prices paid on purchases, indexing government salaries and benefits, indexing transfer payments), and so on. It is no secret that Germany held the line on wages while almost all other euro-using nations allowed wages to rise—making labor in many nations non-competitive with German workers. Where should we point the finger: at Germany or at Greece? Germany chose a race to the bottom strategy and if all others had followed that strategy, all wages would have been pushed toward zero so that Euroland could “enjoy” falling living standards that at the extreme would fall to the lowest common denominator.
Q4: Several questions and comments related to private credit creation and Steve Keen’s work. Frankly, I did not follow. Let me phrase it this way: is a private credit-led expansion possible.
A: Yes. We saw that in the US from 1996-2006. As Sarah Pallin might ask: how’s that working out for ya? Not too well. When will such an expansion stop? When private debtors become unwilling to continue to expand borrowing, or private lenders become unwilling to lend. And as soon as growth of debt stops, the expansion is over. It will almost certainly turn downward because much of the borrowing is based on the expectation of growth of incomes or asset prices (since that makes it easier to service the extra debt). These things almost always end in a very ugly manner. Such as a global financial crisis.

Financial Sovereignty

By Fadhel Kaboub
(Cross-posted from Al-Ahram)

I read Niveen Wahish’s article ‘Less is more’ (Al-Ahram Weekly, 3-9 November) with a great sense of frustration about the prevalence of the conventional wisdom that tax revenues finance government spending and that “borrowing” is inherently destabilising. If Egypt is going to lead the way in a new era in the Middle East, it must abandon the “sound finance” mythology, which is a relic of the gold standard, and embrace a model of true financial sovereignty. A financially sovereign country prints its own currency, collects taxes in that same currency, and most importantly issues government bonds that are only denominated in that same sovereign currency. As such, Egypt can finance all the national priorities that its people demand. A national debt is always manageable under a flexible exchange rate system and an adequate agricultural and industrial policy. Egypt’s most valuable assets are its people and their ingenuity. The country must also harness support from and cooperation with like-minded nations that are interested in fair trade amongst equals rather than neo-colonialist subjugation. The real burden on Egypt’s economy is the odious debt that was incurred under the Mubarak regime. This debt must be repudiated in the same way that Iraq’s and Ecuador’s debt were. Debt cancellation (not forgiveness) is the least that the West can do today to make up for the ills that Mubarak and his Western supporters have done to the people of Egypt.

Europe’s Transition From Social Democracy to Oligarchy

By Michael Hudson
This article was first published by Frankfurter Allgemeine Zeitung, Dec. 3, 2011, as “Der Krieg der Banken gegen das Volk.

The easiest way to understandEurope’s financial crisis is to look at the solutions being proposed to resolveit. They are a banker’s dream, a grab bag of giveaways that few voters would belikely to approve in a democratic referendum. Bank strategists learned not torisk submitting their plans to democratic vote after Icelanders twice refusedin 2010-11 to approve their government’s capitulation to pay Britain and theNetherlands for losses run up by badly regulated Icelandic banks operatingabroad. Lacking such a referendum, mass demonstrations were the only way forGreek voters to register their opposition to the €50 billion in privatizationsell-offs demanded by the European Central Bank (ECB) in autumn 2011.
The problemis that Greece lacks the ready money to redeem its debts and pay the interestcharges. The ECB is demanding that it sell off public assets – land, water andsewer systems, ports and other assets in the public domain, and also cut backpensions and other payments to its population. The “bottom 99%” understandablyare angry to be informed that the wealthiest layer of the population  is largely responsible for the budgetshortfall by stashing away a reported €45 billion of funds stashed away inSwiss banks alone. The idea of normal wage-earners being obliged to forfeittheir pensions to pay for tax evaders – and for the general un-taxing of wealthsince the regime of the colonels – makes most people understandably angry. Forthe ECB, EU and IMF “troika” to say that whatever the wealthy take, steal orevade paying must be made up by the population at large is not a politicallyneutral position. It comes down hard on the side of wealth that has beenunfairly taken.
A democratictax policy would reinstate progressive taxation on income and property, andwould enforce its collection – with penalties for evasion. Ever since the 19thcentury, democratic reformers have sought to free economies from waste,corruption and “unearned income.” But the ECB “troika” is imposing a regressivetax – one that can be imposed only by turning government policy-making over toa set of unelected “technocrats.”
Tocall the administrators of so anti-democratic a policy “technocrats” seems tobe a cynical scientific-sounding euphemism for financial lobbyists orbureaucrats deemed suitably tunnel-visioned to act as useful idiots on behalfof their sponsors. Theirideology is the same austerity philosophy that the IMF imposed on Third Worlddebtors from the 1960s through the 1980s. Claiming to stabilize the balance ofpayments while introducing free markets, these officials sold off exportsectors and basic infrastructure to creditor-nation buyers. The effect was todrive austerity-ridden economies even deeper into debt – to foreign bankers andtheir own domestic oligarchies.
Thisis the treadmill on which Eurozone social democracies are now being placed.Under the political umbrella of financial emergency, wages and living standardsare to be scaled back and political power shifted from elected government totechnocrats governing on behalf of large banks and financial institutions.Public-sector labor is to be privatized – and de-unionized, while SocialSecurity, pension plans and health insurance are scaled back.
Thisis the basic playbook that corporate raiders follow when they empty outcorporate pension plans to pay their financial backers in leveraged buyouts. Italso is how the former Soviet Union’s economy was privatized after 1991, transferringpublic assets into the hands of kleptocrats, who worked with Western investmentbankers to make the Russian and other stock exchanges the darlings of theglobal financial markets. Property taxes were scaled back while flat taxes wereimposed on wages (a cumulative 59 percent in Latvia). Industry was dismantledas land and mineral rights were transferred to foreigners, economies driveninto debt and skilled and unskilled labor alike was obliged to emigrate to findwork.
Pretendingto be committed to price stability and free markets, bankers inflated a realestate bubble on credit. Rental income was capitalized into bank loans and paidout as interest. This was enormously profitable for bankers, but it left theBaltics and much of Central Europe debt strapped and in negative equity by2008. Neoliberals applaud their plunging wage levels and shrinking GDP as asuccess story, because these countries shifted the tax burden onto employmentrather than property or finance. Governments bailed out banks at taxpayerexpense.
Itis axiomatic that the solution to any major social problem tends to create evenlarger problems – not always unintended! From the financial sector’s vantagepoint, the “solution” to the Eurozone crisis is to reverse the aims of theProgressive Era a century ago – what John Maynard Keynes gently termed“euthanasia of the rentier” in 1936.The idea was to subordinate the banking system to serve the economy rather thanthe other way around. Instead, finance has become the new mode of warfare –less ostensibly bloody, but with the same objectives as the Viking invasionsover a thousand years ago, and Europe’s subsequent colonial conquests:appropriation of land and natural resources, infrastructure and whatever otherassets can provide a revenue stream. It was to capitalize and estimate suchvalues, for instance, that William the Conqueror compiled the Domesday Bookafter 1066, a model of ECB and IMF-style calculations today.
Thisappropriation of the economic surplus to pay bankers is turning the traditionalvalues of most Europeans upside down. Imposition of economic austerity,dismantling social spending, sell-offs of public assets, de-unionization oflabor, falling wage levels, scaled-back pension plans and health care incountries subject to democratic rules requires convincing voters that there isno alternative. It is claimed that without a profitable banking sector (nomatter how predatory) the economy will break down as bank losses on bad loansand gambles pull down the payments system. No regulatory agencies can help, nobetter tax policy, nothing except to turn over control to lobbyists to savebanks from losing the financial claims they have built up.
What banks wantis for the economic surplus to be paid out as interest, not used for risingliving standards, public social spending or even for new capital investment.Research and development takes too long. Finance lives in the short run. Thisshort-termism is self-defeating, yet it is presented as science. Thealternative, voters are told, is the road to serfdom: interfering with the“free market” by financial regulation and even progressive taxation.
Thereis an alternative, of course. It is what European civilization from the 13th-centurySchoolmen through the Enlightenment and the flowering of classical politicaleconomy sought to create: an economy free of unearned income, free of vestedinterests using special privileges for “rent extraction.” At the hands of theneoliberals, by contrast, a free market is one free for a tax-favored rentierclass to extract interest, economic rent and monopoly prices.
Rentier interests present their behavioras efficient “wealth creation.” Business schools teach privatizers how toarrange bank loans and bond financing by pledging whatever they can charge forthe public infrastructure services being sold by governments. The idea is topay this revenue to banks and bondholders as interest, and then make a capitalgain by raising access fees for roads and ports, water and sewer usage andother basic services. Governments are told that economies can be run moreefficiently by dismantling public programs and selling off assets.
Neverhas the gap between pretended aim and actual effect been more hypocritical.Making interest payments (and even capital gains) tax-exempt deprives governmentsof revenue from the user fees they are relinquishing, increasing their budgetdeficits. And instead of promoting price stability (the ECB’s ostensiblepriority), privatization increases prices for infrastructure, housing and othercosts of living and doing business by building in interest charges and otherfinancial overhead – and much higher salaries for management. So it is merely aknee-jerk ideological claim that this policy is more efficient simply becauseprivatizers do the borrowing rather than government.
Thereis no technological or economic need for Europe’s financial managers to imposedepression on much of its population. But there is a great opportunity to gainfor the banks that have gained control of ECB economic policy. Since the 1960s,balance-of-payments crises have provided opportunities for bankers and liquidinvestors to seize control of fiscal policy – to shift the tax burden ontolabor and dismantle social spending in favor of subsidizing foreign investorsand the financial sector. They gain from austerity policies that lower livingstandards and scale back social spending. A debt crisis enables the domesticfinancial elite and foreign bankers to indebt the rest of society, using theirprivilege of credit (or savings built up as a result of less progressive taxpolicies) as a lever to grab assets and reduce populations to a state of debtdependency.
Thekind of warfare now engulfing Europe is thus more than just economic in scope.It threatens to become a historic dividing line between the past half-century’sepoch of hope and technological potential to a new era of polarization as afinancial oligarchy replaces democratic governments and reduces populations todebt peonage.
For so boldan asset and power grab to succeed, it needs a crisis to suspend the normalpolitical and democratic legislative processes that would oppose it. Politicalpanic and anarchy create a vacuum into which grabbers can move quickly, usingthe rhetoric of financial deception and a junk economics to rationalizeself-serving solutions by a false view of economic history – and in the case oftoday’s ECB, German history in particular.
A central bank that is blocked from acing like one
Governmentsdo not need to borrow from commercial bankers or other lenders. Ever since theBank of England was founded in 1694, central banks have printed money tofinance public spending. Bankers also create credit feely – when they make aloan and credit the customer’s account, in exchange for a promissory notebearing interest. Today, these banks can borrow reserves from the governmentcentral bank at a low annual interest rate (0.25% in the United States) andlend it out at a higher rate. So banks are glad to see the government’s centralbank create credit to lend to them. But when it comes to governments creatingmoney to finance their budget deficits for spending in the rest of the economy,banks would prefer to have this market and its interest return for themselves.
Europeancommercial banks are especially adamant that the European Central Bank shouldnot finance government budget deficits. But private credit creation is notnecessarily less inflationary than governments monetizing their deficits(simply by printing the money needed). Most commercial bank loans are madeagainst real estate, stocks and bonds – providing credit that is used to bid uphousing prices, and prices for financial securities (as in loans for leveragedbuyouts).
Itis mainly government that spends credit on the “real” economy, to the extentthat public budget deficits employ labor or are spent on goods and services. Ifgovernments avoid paying interest by having their central banks printing moneyon their own computer keyboards rather than borrowing from banks that do thesame thing on their own keyboards. (Abraham Lincoln simply printed currencywhen he financed the U.S. Civil War with “greenbacks.”)
Bankswould like to use their credit-creating privilege to obtain interest forlending to governments to finance public budget deficits. So they have aself-interest in limiting the government’s “public option” to monetize itsbudget deficits. To secure a monopoly on their credit-creating privilege, bankshave mounted a vast character assassination on government spending, and indeedon government authority in general – which happens to be the only authoritywith sufficient power to control their power or provide an alternative publicfinancial option, as Post Office savings banks do in Japan, Russia and othercountries. This competition between banks and government explains the falseaccusations made that government credit creation is more inflationary than whencommercial banks do it.
Thereality is made clear by comparing the ways in which the United States, Britainand Europe handle their public financing. The U.S. Treasury is by far theworld’s largest debtor, and its largest banks seem to be in negative equity,liable to their depositors and to other financial institutions for much largersums that can be paid by their portfolio of loans, investments and assortedfinancial gambles. Yet as global financial turmoil escalates, institutionalinvestors are putting their money into U.S. Treasury bonds – so much that thesebonds now yield less than 1%. By contrast, a quarter of U.S. real estate is innegative equity, American states and cities are facing insolvency and mustscale back spending. Large companies are going bankrupt, pension plans arefalling deeper into arrears, yet the U.S. economy remains a magnet for globalsavings.
Britain’seconomy also is staggering, yet its government is paying just 2% interest. ButEuropean governments are now paying over 7%. The reason for this disparity isthat they lack a “public option” in money creation. Having a Federal Reserve Bankor Bank of England that can print the money to pay interest or roll overexisting debts is what makes the United States and Britain different fromEurope. Nobody expects these two nations to be forced to sell off their publiclands and other assets to raise the money to pay (although they may do this asa policy choice). Given that the U.S. Treasury and Federal Reserve can createnew money, it follows that as long as government debts are denominated indollars, they can print enough IOUs on their computer keyboards so that theonly risk that holders of Treasury bonds bear is the dollar’s exchange ratevis-à-vis other currencies.
Bycontrast, the Eurozone has a central bank, but Article 123 of the Lisbon treatyforbids the ECB from doing what central banks were created to do: create themoney to finance government budget deficits or roll over their debt fallingdue. Future historians no doubt will find it remarkable that there actually isa rationale behind this policy – or at least the pretense of a cover story. Itis so flimsy that any student of history can see how distorted it is. The claimis that if a central bank creates credit, this threatens price stability. Onlygovernment spending is deemed to be inflationary, not private credit!
TheClinton Administration balanced the U.S. Government budget in the late 1990s,yet the Bubble Economy was exploding. On the other hand, the Federal Reserveand Treasury flooded the economy with $13 trillion in credit to the bankingsystem credit after September 2008, and $800 billion more last summer in theFederal Reserve’s Quantitative Easing program (QE2). Yet consumer and commodityprices are not rising. Not even real estate or stock market prices are beingbid up. So the idea that more money will bid up prices (MV=PT) is not operatingtoday.
Commercialbanks create debt. That is their product. This debt leveraging was used formore than a decade to bid up prices – making housing and buying a retirementincome more expensive for Americans – but today’s economy is suffering fromdebt deflation as personal income, business and tax revenue is diverted to paydebt service rather than to spend on goods or invest or hire labor.
Muchmore striking is the travesty of German history that is being repeated againand again, as if repetition somehow will stop people from remembering whatactually happened in the 20th century. To hear ECB officials tellthe story, it would be reckless for a central bank to lend to government,because of the danger of hyperinflation. Memories are conjured up of the Weimarinflation in Germany in the 1920s. But upon examination, this turns out to bewhat psychiatrists call an implanted memory – a condition in which a patient isconvinced that they have suffered a trauma that seems real, but which did notexist in reality.
Whathappened back in 1921 was not a case of governments borrowing from centralbanks to finance domestic spending such as social programs, pensions or healthcare as today. Rather, Germany’s obligation to pay reparations led theReichsbank to flood the foreign exchange markets with deutsche marks to obtainthe currency to buy pounds sterling, French francs and other currency to paythe Allies – which used the money to pay their Inter-Ally arms debts to theUnited States. The nation’s hyperinflation stemmed from its obligation to payreparations in foreign currency. No amount of domestic taxation could haveraised the foreign exchange that was scheduled to be paid.
Bythe 1930s this was a well-understood phenomenon, explained by Keynes and otherswho analyzed the structural limits on the ability to pay foreign debt imposed without regard for the ability to pay out ofcurrent domestic-currency budgets. From Salomon Flink’s The Reichsbank and Economic Germany (1931) to studies of theChilean and other Third World hyperinflations, economists have found a commoncausality at work, based on the balance of payments. First comes a fall in theexchange rate. This raises the price of imports, and hence the domestic pricelevel. More money is then needed to transact purchases at the higher pricelevel. The statistical sequence and lineof causation leads from balance-of-payments deficits to currency depreciationraising import costs, and from these price increases to the money supply, not the other way around.
Today’s“free marketers” writing in the Chicago monetarist tradition (basically that ofDavid Ricardo) leaves the foreign and domestic debt dimensions out of account.It is as if “money” and “credit” are assets to be bartered against goods. But abank account or other form of credit means debt on the opposite side of thebalance sheet. One party’s debt is another party’s saving – and most savingstoday are lent out at interest, absorbing money from the non-financial sectors of the economy. The discussion isstripped down to a simplistic relationship between the money supply and pricelevel – and indeed, only consumer prices, not asset prices. In their eagernessto oppose government spending – and indeed to dismantle government and replaceit with financial planners – neoliberal monetarists neglect the debt burdenbeing imposed today from Latvia and Iceland to Ireland and Greece, Italy, Spainand Portugal.
Ifthe euro breaks up, it is because of the obligation of governments to pay bankersin money that must be borrowed rather than created through their own centralbank. Unlike the United States and Britain which can create central bank crediton their own computer keyboards to keep their economy from shrinking orbecoming insolvent, the German constitution and the Lisbon Treaty prevent thecentral bank from doing this.
Theeffect is to oblige governments to borrow from commercial banks at interest.This gives bankers the ability to create a crisis – threatening to driveeconomies out of the Eurozone if they do not submit to “conditionalities” beingimposed in what quickly is becoming a new class war of finance against labor.
Disabling Europe’s central bank to deprive governments of the power tocreate money
Oneof the three defining characteristics of a nation-state is the power to createmoney. A second characteristic is the power to levy taxes. Both of these powersare being transferred out of the hands of democratically electedrepresentatives to the financial sector, as a result of tying the hands ofgovernment.
Thethird characteristic of a nation-state is the power to declare war. What ishappening today is the equivalent of warfare – but against the power of government! It is above all a financial modeof warfare – and the aims of this financial appropriation are the same as thoseof military conquest: first, the land and subsoil riches on which to chargerents as tribute; second, public infrastructure to extract rent as access fees;and third, any other enterprises or assets in the public domain.
Inthis new financialized warfare, governments are being directed to act asenforcement agents on behalf of the financial conquerors against their owndomestic populations. This is not new, to be sure. We have seen the IMF andWorld Bank impose austerity on Latin American dictatorships, African militarychiefdoms and other client oligarchies from the 1960s through the 1980s.Ireland and Greece, Spain and Portugal are now to be subjected to similar assetstripping as public policy making is shifted into the hands ofsupra-governmental financial agencies acting on behalf of bankers – and therebyfor the top 1% of the population.
Whendebts cannot be paid or rolled over, foreclosure time arrives. For governments,this means privatization selloffs to pay creditors. In addition to being aproperty grab, privatization aims at replacing public sector labor with anon-union work force having fewer pension rights, health care or voice inworking conditions. The old class war is thus back in business – with afinancial twist. By shrinking the economy, debt deflation helps break the powerof labor to resist.
Italso gives creditors control of fiscal policy. In the absence of a pan-EuropeanParliament empowered to set tax rules, fiscal policy passes to the ECB. Acting onbehalf of banks, the ECB seems to favor reversing the 20th century’sdrive for progressive taxation. And as U.S. financial lobbyists have madeclear, the creditor demand is for governments to re-classify public socialobligations as “user fees,” to be financed by wage withholding turned over tobanks to manage (or mismanage, as the case may be). Shifting the tax burden offreal estate and finance onto labor and the “real” economy thus threatens tobecome a fiscal grab coming on top of the privatization grab.
Thisis self-destructive short-termism. The irony is that the PIIGS budget deficitsstem largely from un-taxing property, and a further tax shift will worsenrather than help stabilize government budgets. But bankers are looking only atwhat they can take in the short run. They know that whatever revenue the taxcollector relinquishes from real estate and business is “free” for buyers topledge to the banks as interest. So Greece and other oligarchic economies aretold to “pay their way” by slashing government social spending (but notmilitary spending for the purchase of German and French arms) and shiftingtaxes onto labor and industry, and onto consumers in the form of higher userfees for public services not yet privatized.
In Britain,Prime Minister Cameron claims that scaling back government even more alongThatcherite-Blairite lines will leave more labor and resources available forprivate business to hire. Fiscal cutbacks will indeed throw labor out of work,or at least oblige it to find lower-paid jobs with fewer rights. But cuttingback public spending will shrink the business sector as well, worsening thefiscal and debt problems by pushing economies deeper into recession.
Ifgovernments cut back their spending to reduce the size of their budget deficits– or if they raise taxes on the economy at large, to run a surplus – then thesesurpluses will suck money out of the economy, leaving less to be spent on goodsand services. The result can only be unemployment, further debt defaults andbankruptcies. We may look to Iceland and Latvia as canaries in this financialcoalmine. Their recent experience shows that debt deflation leads toemigration, shortening life spans, lower birth rates, marriages and familyformation – but provides great opportunities for vulture funds to suck wealthupward to the top of the financial pyramid.
Today’seconomic crisis is a matter of policy choice, not necessity. As PresidentObama’s chief of staff Rahm Emanuel quipped: “A crisis is too good anopportunity to let go to waste.” In such cases the most logical explanation isthat some special interest must be benefiting. Depressions increaseunemployment, helping to break the power of unionized as well as non-unionlabor. The United States is seeing a state and local budget squeeze (asbankruptcies begin to be announced), with the first cutbacks coming in thesphere of pension defaults. High finance is being paid – by not paying theworking population for savings and promises made as part of labor contracts andemployee retirement plans. Big fish are eating little fish.
Thisseems to be the financial sector’s idea of good economic planning. But it isworse than a zero-sum plan, in which one party’s gain is another’s loss.Economies as a whole will shrink – and change their shape, polarizing betweencreditors and debtors. Economic democracy will give way to financial oligarchy,reversing the trend of the past few centuries.
IsEurope really ready to take this step? Do its voters recognize that strippingthe government of the public option of money creation will hand the privilegeover to banks as a monopoly? How many observers have traced the almostinevitable result: shifting economic planning and credit allocation to thebanks?
Even ifgovernments provide a “public option,” creating their own money to financetheir budget deficits and supplying the economy with productive credit torebuild infrastructure, a serious problem remains: how to dispose of theexisting debt overhead now acts as a deadweight on the economy. Bankers and thepoliticians they back are refusing to write down debts to reflect the abilityto pay. Lawmakers have not prepared society with a legal procedure for debtwrite-downs – except for New York State’s Fraudulent Conveyance Law, callingfor debts to be annulled if lenders made loans without first assuringthemselves of the debtor’s ability to pay.
Bankers donot want to take responsibility for bad loans. This poses the financial problemof just what policy-makers should do when banks have been so irresponsible inallocating credit. But somebody has to take a loss. Should it be society atlarge, or the bankers?
It is not aproblem that bankers are prepared to solve. They want to turn the problem overto governments – and define the problem as how governments can “make themwhole.” What they call a “solution” to the bad-debt problem is for thegovernment to give them good bonds for bad loans (“cash for trash”) – to bepaid in full by taxpayers. Having engineered an enormous increase in wealth forthemselves, bankers now want to take the money and run – leaving economies debtridden. The revenue that debtors cannot pay will now be spread over the entireeconomy to pay – vastly increasing everyone’s cost of living and doing business.
Whyshould they be “made whole,” at the cost of shrinking the rest of the economy? Thebankers’ answer is that debts are owed to labor’s pension funds, to consumerswith bank deposits, and the whole system will come crashing down if governmentsmiss a bond payment. When pressed, bankers admit that they have taken out riskinsurance – collateralized debt obligations and other risk swaps. But theinsurers are largely U.S. banks, and the American Government is pressuringEurope not to default and thereby hurt the U.S. banking system. So the debttangle has become politicized internationally.
Sofor bankers, the line of least resistance is to foster an illusion that thereis no need for them to accept defaults on the unpayably high debts they haveencouraged.  Creditors always insist thatthe debt overhead can be maintained – if governments simply will reduce otherexpenditures, while raising taxes on individuals and non-financial business.
The reason whythis won’t work is that trying to collect today’s magnitude of debt will injurethe underlying “real” economy, making it even less able to pay its debts. Whatstarted as a financial problem (bad debts) will now be turned into a fiscalproblem (bad taxes). Taxes are a cost of doing business just as paying debtservice is a cost. Both costs must be reflected in product prices. Whentaxpayers are saddled with taxes and debts, they have less revenue free tospend on consumption. So markets shrink, putting further pressure on theprofitability of domestic enterprises. The combination makes any countryfollowing such policy a high-cost producer and hence less competitive in globalmarkets.
Thiskind of financial planning – and its parallel fiscal tax shift – leads towardde-industrialization. Creating ECB or IMF inter-government fiat money leavesthe debts in place, while preserving wealth and economic control in the handsof the financial sector. Banks can receive debt payments on overly mortgagedproperties only if debtors are relieved of some real estate taxes. Debt-strappedindustrial companies can pay their debts only by scaling back pensionobligations, health care and wages to their employees – or tax payments to thegovernment. In practice, “honoring debts” turns out to mean debt deflation and general economic shrinkage.
Thisis the financiers’ business plan. But to leave tax policy and centralizedplanning in the hands of bankers turns out to be the opposite of what the pastfew centuries of free market economics have been all about. The classicalobjective was to minimize the debt overhead, to tax land and natural resourcerents, and to keep monopoly prices in line with actual costs of production(“value”). Bankers have lent increasingly against the same revenues that freemarket economists believed should be the natural tax base.
Sosomething has to give. Will it be the past few centuries of liberal free-marketeconomic philosophy, relinquishing planning the economic surplus to bankers? Orwill society re-assert classical economic philosophy and Progressive Eraprinciples, and re-assert social shaping of financial markets to promotelong-term growth with minimum costs of living and doing business?


At least in the most badly indebtedcountries, European voters are waking up to an oligarchic coup in which taxationand government budgetary planning and control is passing into the hands ofexecutives nominated by the international bankers’ cartel. This result is theopposite of what the past few centuries of free market economics has been allabout.