Letter to My Brother

By J. D. Alt

My brother, Jeff, is a very smart guy who went to West Point, got a masters degree at Purdue, had a successful career as a business man and now, in his retirement, can sometimes beat his wife at golf. I sent him the NEP link to Playing Monopolis Monopoly and the other two essays I wrote as well, Men on a Wall and New Sense Common Sense. Since then we’ve been corresponding about MMT—with me trying to get him to “see” it, and he, to his credit, actually doing his best to “see” it while also collecting a lot of other opinions on the topic. Recently he sent me one of these other opinions, which included a textbook circular flow diagram that seemed to prove that MMT was impossible.

The dialog I’m having with my brother might well be representative of other inter-family debates going on in the MMT community. It occurred to me, therefore, that it might be useful to submit my latest brotherly correspondence for comments and suggestions. Here it is:

10-2-12

Jeff,

Thanks very much for sending me Tom’s response to my essay, and the other articles. I’m pleased you are so interested in this—as I am—and want to understand the truth of it, as I do as well, even though it’s not easy to do. I appreciate the time Tom has taken to give such a considered response. His comments have been very helpful.

What I’m coming to realize is that MMT has three parts: the first is very basic logic and quite simple; the second is extremely complex banking procedures; the third is a political policy conundrum that MMT doesn’t have a silver bullet for. The last is the part I am ultimately trying to get to (because it intersects the architectural ideas I’m pursuing) but I can’t really go there until I get over the basic logic component.

The basic logic is where my NEP essays have been focused. If you don’t “see” and accept the basic MMT logic, then making “sense” out of everything else is futile. The basic logic has to do with a fundamental shift in the dynamics of money that began in 1971 when Nixon took the U.S. (and the rest of the world) off the gold standard.

Until then, you could understand money—paper currency and coins and various I.O.U’s denominated in them (bonds etc.)—as being representative of a relatively fixed amount of financial wealth (the gold and/or silver the paper was convertible to “on demand”, and which was stored around the country in vaults―most in Fort Knox, I suppose.) This relatively fixed pot of money—for convenience let’s just call it “dollars”—was shared by everyone who needed to make financial transactions:  households, businesses, state and local governments, and the federal government. The banking industry essentially managed the distribution of these dollars amongst the people and entities who earned them and spent them and borrowed them. Households and businesses earned dollars by working and providing services in exchange for those dollars. Governments—state, local and federal—“earned” their dollars by levying taxes on the businesses and households. Everyone (including the federal government), if they didn’t have enough dollars to pay for what they needed at a given moment, could (if they were credit worthy) borrow dollars from somebody who was willing to lend them.

This state of affairs is illustrated in the textbook circular flow diagram that Tom provided. (Here it is).

circular flow

To be honest, I’m not sure I understand the diagram entirely, but I assume from Tom’s comments it describes the flow of money within the economy and, as he suggests, the Federal Government should be considered simply another box in the loop. For my purposes, that’s all that’s important. So here I’ve modified the diagram as he instructs, adding the Federal Government box. I’ve also added something else: the outline of a “pot” filled with blue “dollars”, representing the idea that all these boxes—including the Federal Government—are sharing the dollars within the pot.

The dollars in this pot were printed or coined by the federal government (others who printed dollars were called counterfeiters and put in jail.) The danger was that the federal government would print too much paper currency relative to the amount of gold backing it up—which would cause the value of the dollars to collapse (everyone running to the bank to convert their dollars and there wouldn’t be enough gold, so the remaining dollars would be worthless.) To prevent this Congress passed laws controlling how the federal government could print dollars.

Even so, the pot of dollars shared by the system fluctuated because the banks were allowed—by law—to loan out more money than they had in deposits. So, for example, if a bank had $1000 in deposits, it was allowed to make loans worth $10,000. In effect, the bank “created” $9,000 out of thin air. There was, of course, some danger in doing this, because the banks were promising to convert those “created” dollars to “real” dollars on demand—which, in turn, were convertible, on demand again, to some portion of the real gold that was stored at Fort Knox. Folks being folks, if they began to get a whiff that the bank couldn’t make good on the promise, they’d all run to the bank to withdraw their dollars—even worse, try to convert them to gold. This happened over and again throughout the course of history: it was the inevitable result of everyone—including sovereign governments—sharing (and leveraging through the banking system of loans) a relatively fixed pot of financial wealth.

Everything Tom says in his letter—and the main points in the other articles you sent—assumes that the world described (and illustrated) above still exists. And, in fact, most of the “rules” that were put in place to control that world—to keep it from collapsing, so to speak—are still with us, still guiding the Fed (central bank), the Treasury and the private banking industry.

What MMT is saying is that the fundamental logic of this monetary system changed in 1971—even though the “rules” stayed the same. What changed is basically twofold: First, the federal government is no longer “sharing” the pot of dollars, but is now purely the issuer of the dollars that go in the pot. Fiat currency (which is what the US Dollar converted to when Nixon decoupled it from gold) is created by the sovereign government, and that is the ONLY way it can come into existence. (If you found a gold nugget in your back yard, you could convert it to a fiat dollar by selling it to a neighbor; but the only way that neighbor was able to have the fiat dollar to spend was because the federal government had created it.) Second, because the fiat dollars are no longer representative of a fixed amount of gold or silver, the sovereign government can, theoretically, create an infinite amount of them.

The analogy that L. Randall Wray—the leading U.S. author about MMT—uses to visualize this transformation is that the old pot of gold-backed dollars became a “bathtub” of fiat dollars with the plumbing spontaneously evolving to reflect the new reality. The first plumbing change was that the federal government stepped OUT of the bathtub and became the spigot that, when turned on, poured dollars into the tub. Still IN the tub, sharing the dollars—earning them, spending them, borrowing them—are the U.S. households, businesses, state and local governments (in essence, everyone except the sovereign government, which is now the spigot.) The second plumbing change is that the tub got a drain which could be closed or opened, a little or a lot, to let dollars drain out of the tub.

Here is Tom’s diagram modified to illustrate this new reality.

So now, instead of the “old” way, with the gold-backed dollars essentially being recycled over and over within the pot―with the federal government taxing and borrowing them so it could subsequently spend them to get the things and services it needed―the plumbing works in a new (modern) way: The federal government turns on the spigot and fiat dollars flow into the tub until the tub fills up to the “right” amount. When the tub gets filled up too much (too many dollars chasing a fixed amount of goods and services, as Tom pointed out) the Fed opens the bathtub drain. The bathtub drain is federal taxes. The relationship between the dollars flowing out of the spigot (federal spending), and the dollars draining out of the tub (federal taxes) is what controls the amount of dollars in the tub (and hence, inflationary or deflationary pressure on the currency.)

There are two critical things to make note of here. The first is that the MMT economists are not proposing that this is the way things ought to be; they are saying this is way things actually are happening right now.

The second thing to notice is that the only thing that can activate the spigot―adding dollars to the tub―is federal spending. The federal government can’t just “put” the dollars in the tub; there is no mechanism for doing that. To turn on the spigot, the federal government has to spend the dollars on something. It can buy services (like medical services for people on Medicare), or it can pay to build something useful or necessary (the Hoover Dam, for example), or it can purchase an asset from someone (like a Treasury or mortgage bond.) Each one of these transactions adds dollars to the tub―specifically, it adds dollars to the Private Sector bank account of the person providing the Medicare services, or the persons building the Dam, or the person or bank selling the bond.

What is called the federal “deficit” is the difference, at some particular point in time, between the number of dollars the federal government has spent INTO the tub, and the number of dollars it has drained OUT of the tub with taxes. (It is running a “deficit” when it is spending more IN than it is taking OUT.) That, by definition, is the federal “deficit”. But we can immediately see, by simple logic, three important things:

First, what we are calling the federal “deficit” are the dollars left in the tub!―in other words, the financial wealth of the households and businesses of the Private Sector. We can reduce the federal “deficit” either by turning down the spigot (reduce federal spending), or by opening the drain wider (increasing taxes), or by some combination of the two. In either case, reducing the “deficit” will, by definition, reduce the number of dollars in the tub―which directly translates to fewer dollars in the bank accounts of households and businesses. Now the ONLY reason you’d want to do this, that I can think of, is if the tub was too full of dollars (which means the currency is experiencing major signs of inflation.) This is why the debate going on now in Congress about how to reduce the federal “deficit” is political insanity!

Second, we can see that what we are calling the federal “deficit” is NOT a “deficit” at all in the same way the word would apply to me or you, or any business, or state or local government in the tub (the Private Sector.) If any of us in the Private Sector spends more dollars than we earn,  we have to come up with a way to earn (or borrow) dollars to make up the difference―or, we go bankrupt. The federal government, in contrast, doesn’t HAVE to “come up with a way” to earn (or borrow) dollars to make up its “deficit” because, of all the players at the table, it is the ONLY one who can simply create dollars as needed. In fact, you could reasonably argue that the job of the federal government is to deficit spend. If it doesn’t, the Private Sector economy will slowly grind to a halt.

Finally, we can see that, by logic, the federal “deficit” is NOT a debt that the federal government is obligated to repay to anybody, at any time―now or in the future. It is, by definition, the simple balance sheet accounting of the difference between the number of dollars the federal government has spent into the tub, and the number of dollars it has drained out of the tub with taxes. The federal government doesn’t need those tax dollars to spend from the spigot. There is no “bucket brigade” that catches those dollars coming out the drain and carries them up to dump into the spigot. The draining dollars are just “cancelled”, so to speak, and new fiat dollars are created in the spigot as needed. Nor does the federal government need to borrow dollars to spend from the spigot. The Fed’s “borrowing” (selling bonds) has nothing whatsoever to do with the need to acquire dollars so it can spend them. The Fed’s bond sales are, instead, a mechanism for managing the banking and monetary system….But this is where we get into the extremely complex banking procedures which I referred to in the beginning. To see and believe the basic logic and truth of MMT, I don’t think it is necessary to go there.

So this brings me finally to the political policy conundrum for which MMT has no silver bullet. An article yesterday in The Wall Street Journal attributed to the president of the German Bundesbank, Jen Weidmann, the following sentiment: “Central banks exist to defend a currency against politicians’ cravings for easy money.” This pretty much sums up the conundrum from both perspectives: If we thought pork-barrel politics and Congressional earmarks for “bridges to nowhere” were out of control before, what do we imagine will happen if Congress (and the K-Street lobbyists) get a whiff of the idea there is an infinite supply of dollars available for their pet projects? How could we possibly control the ensuing chaos? At the same time, however, Mr. Weidmann’s position (and, indeed, his actions in the Eurozone financial crisis) ensures that some major sector of society will suffer, or at least be unable to generate and take advantage of the full economic energy of which it is capable—and which, in fact, is available to it, except for the first part of the conundrum.

I personally believe that MMT is a crucial turning point in the evolution of human society. It is the critical dynamic that will enable us to create the enormous technological and infrastructural solutions that our survival and prosperity are going to depend on as the human population approaches ten billion souls on a finite planet. It is therefore essential that we not only acknowledge MMT as the new economic reality that it is, but we also figure out an effective way to manage and control it.

55 Responses to Letter to My Brother

  1. Finally, we can see that, by logic, the federal “deficit” is NOT a debt that the federal government is obligated to repay to anybody, at any time―now or in the future. It is, by definition, the simple balance sheet accounting of the difference between the number of dollars the federal government has spent into the tub, and the number of dollars it has drained out of the tub with taxes.

    This might be true A.D., but under our current operational arrangements, federal deficits are offset by additional debt issuance. If Treasury spending is X and revenues are Y, and X > Y, then the Treasury issues debt to raise the balance X-Y. And those new securities are legally binding obligations of the federal government. They are obligations a government like the US can always meet, since it is not dependent on an outside source for the final means of payment. But they are obligations nevertheless.

    And even though the federal government therefore never faces a solvency constraint, there might be other serious drawbacks to the issuance of so much debt. For one thing, that debt is effectively welfare for the affluent – free money for those with a financial surplus who are willing to buy securities from the government. Another problem is that the government could end up having such a high volume of debt repayment obligations that paying them requires corresponding monetary asset withdrawals elsewhere – via taxes or more borrowing – in order to be able to inject all of that interest without damaging price stability. I don’t think that is a serious consideration right now, but it could be at other times.

    In an earlier post, I made a distinction between a “pure deficit” and a “financial deficit”. A pure deficit occurs when the government spends more than its revenues and borrowings combined. A financial deficit occurs when it spends more than its revenues, but makes up the full difference with borrowing. A pure deficit is always an option for the government. But it is an option that our current leaders refuse to consider. The system they have created and stubbornly maintained is one in which revenue shortfalls trigger borrowing and debt.

  2. To a layman like me this Modern Money Theory is the same old theory of demand and supply of purchasing power with a fresh phraseology.

    • Javed: Don’t know exactly what you mean by “the same old theory of demand and supply of purchasing power” but in essence, you are right. MMT is just old-fashioned Keynesian / Institutional/ Monetary Analysis economics. The main thing is that it gets rid of useless garbage detail & its illogical non-consequences. Which can happen partly because monetary systems have been simplified since 1971, making them closer to what they always really were. To comment on the main article, nothing absolutely fundamental changed, or could have changed in 1971. The plumbing didn’t “spontaneously evolve to reflect a new reality”. Nixon’s White House plumbers just flushed an ancient clog out the system, so the plumbing could perform the functions it always had, better.

      As Wray says : MMT proudly stands on the shoulders of giants. We never claimed to have created MMT out of whole cloth. Our argument has always been that anyone who treasures the works of our “forefathers and foremothers”—people like Marx, Veblen, Keynes, Commons, Robinson, Minsky, Lerner, Godley, Moore, and Davidson—will immediately recognize their work in MMT. We are synthesizers, in the main. What we added—largely thanks to the insights of Warren Mosler—is a detailed examination of the coordination between the Treasury and the Central Bank, all those operational factors that negate not only the “deposit multiplier” but also the legislated and self-imposed constraints that make it appear that a sovereign currency issuer faces market-imposed constraints. It does not.

      (Wray’s Nostradamus and the Euro Post here , July 29, 2012) For about a week, most of my posts with links are being eaten & never appear.

      • I’d just like to point out that the theoretical understanding of fiat money was established long before the US went off the gold standard.

      • Calgacus: Thank you very much for your comment and in fact you have explained my view point better than me. What I mean to say that the present monetary system has replaced the barter system. Production of goods and services; supply and demand controlled by the market through pricing and the money passes through this piping and at the end of day money remains the same money.

  3. Nice job.

  4. All that has been discussed above — the true benefits of MMT — has been argued solely and very narrowly for only the benefit of America, within her own borders, and certainly not for any notable global benefit. There is a huge lack of explanation in the article above concerning the much wider, negative and very punishing global inflation effects of excessive dollar QE(an MMT innovation) on foreign US Treasury savings of the exporting mercantilists. Of course, the likes of Krugman and his supporters ultimately believe that this is the proper way to “correct global economic imbalances”. But the pure arrogance of this bland and dangerous statement by Krugman is astonishing. To me, under the apparent assumption from Krugman that America must always economically dominate and win no matter what questionable economic policies are enacted(to save the world again?), this is a poor joke explanation which holds no truth and which so sadly corrupts the very notion and belief about how free markets should be run. To me it simply resurrects the old well-known saying, “Do as we ask..not as we do”. Here, Krugman argues, all America has to do is flick on the inflation switch via QE to become, once more, industrially competitive and which also acts as a forced no-option accelerator to increased US Treasury purchases worldwide. A simple enough procedure, while the rest of the world is forced to grovel by the usual route and raise interest rates and find ways to increase productivity the hard way. Ah yes, the easy way to force foreign credit!! Just export dollars and sell US Treasuries to the rest of the world to lock them in to this damaging and corrupt dollar dependency.

    I was, nevertheless, so heartened when Mahadir Mohamed, the then Prime
    Minister of Malaysia during the Asian crisis of 1997, outright disobeyed the IMF ruling on his economy and, instead of raising Malaysia’s interest rates, he gave two fingers to the IMF(a heavily influenced American institution, bye the way) and then proceeded to set punishing currency controls against dollar inflows into his country, amidst howls of protest and derision from the American economists and media. And because of that policy, Malaysia came out of the Asian Crisis on turbo. God bless Mahadir Mohsmed for teaching us that. I’m also sure that many rising mercantilists — such as China — took very careful note of Mahadir’s use of currency controls against the dollar.

    The trouble becomes, as the above article clearly states — as if this is indeed the normal and acceptable monetary status quo for a reserve currency issuer — that the US Fed can now add more money to the pot or even drain money from the pot at will and whenever they deem fit. Isn’t this a form of gross currency manipulation of the worst degree on a global scale? Couldn’t the now MMT weaponized Fed make covert but painful economic war with likes of Russia, China, Brazil, the Middle East or any of the mercantilists who hold Treasury savings? Is this true democracy in action or is this dictatorship and economic empire ? Is this Free Markets in action? I really don’t think so.

    It further becomes slightly hilarious when certain American economists and politicians forever rant against the cheating of China who ties her currency “so unfairly” to the dollar’s value. Cheating? Manipulating? Really? Hasn’t America and the Fed already set the gold standard for manipulating the dollar already over the last few decades via the global effects of QE and is this not therefore an acceptable economic precedent for other mercantilists countries to use similar monetary mechanisms as they wish in order to help or save their own economies? Isn’t that the democratic and fair way to look at this? If your answer is no — then I again gently redirect you to the saying — “Do as we say…not as we do”, which might hopefully jog some disturbing thoughts of empire, economic dictatorship, corruption etc.

    Let’s not also forget that China will overtake the US as the world’s largest economy soon. So it is also likely that the Chinese Yuan will soon, at the very least, become the regional currency of Asia. If this eventually is the case, then US Treasuries will have their first major global competitor in Chinese Treasuries. So, if China goes further down this route and actually achieves status as perhaps the world’s reserve currency — as Wen Jiao Bao has firmly stated — then what will happen to the dollar? How effective will MMT be without the Debt/Treasury cycle mechanism and manipulated exhange rates by the Fed. Is it to be the Fed printing dollars at white heat forever until America so sadly disappears down the Black Hole of inflation? Without exporting her dollars; without her reserve currency status; with ever reducing foreign Treasury purchases; with a disturbing negative Real GDP, with 23 million unemployed; with all the global mercantilists steadily dumping the dollar now through currency swaps; with the petrodollar now dead; with China buying more gold and all economic prospects in America not improving at all appreciably in the future — with only ever more debt on the horizon, I think the US will have a big economic problem, which will be much greater than now. And also don’t forget that China will be able to manipulate her reserve currency in the same way as America has done for decades and if this is the case — since America has already set this corrupt precedent — then how can America or any truly honest American economist complain lest they be tagged hypocrites ? And how would you like it, as an American, if China then turned around to a complaining America and said, “Do as we say…not as we do” ? That’s why such economic precedents, as already adopted by America for decades, are very dangerous indeed.

    For the rest, Michael Hudson’s “Super Imperialism: The Economic Strategy of American Empire” and Rothbard’s “The Case Against the Fed” are the main influencers on my opinions above — although to certainly give him his due — I also loved Bill Black’s “The Best Way to Rob a Bank is to Own One “. Bill Black never holds back and always tells it like it is. To my mind — the economic tenets that Bill Black expounds should all be applied globally to all banks. I agree Bill, no wriggle room for them should be the policy. Then perhaps — just perhaps !! — America will get the strong and honest Presidential leadership that she deserves.

    So, MMT a globally useful mechanism for the US dollar?

    Well, I guess that really depends on whose side you’re on. And I’m afraid “side” as well as influence should have nothing whatsover to do with the correct functioning of Free Markets or honest government for that matter.

    • MMT applies to any sovereign currency, not just the dollar. There are many sovereign currencies, but the dollar is also the global reserve currency, with the burdens and benefits that entails. No one has shown a serious interest in taking over that job. Not Japan, not the UK, not China. Europe as a whole has gone rather the other direction, abandoning a basket of sovereign currencies for a non-sovereign currency (In most legal ways and every practical way, the EU is not a sovereign. It is a confederation of sovereigns, and that is proving to be the euro’s Achilles heel.), and among other effects, it has left something of a power vacuum in the sovereign currencies club. The US can be attacked for all manner of stupidity and arrogance, but to declare that MMT is just a mechanism for enforcing such attitudes simply doesn’t compute. You’ll find that most of the mechanisms for enforcing those attitudes stem from the denial of MMT.

    • Current situation nicely explained by Bill Jencks. It looks that Chinese Yuan is likely to make a ‘currency attack’ on the currencies of the world and specifically can cause a gradual corrosive effect on the global value of the American dollar. Even if China diverts its economic policy from export led to consumption led, they have enough reserves and will continue to influence the global financial market. The situation may not go that bad but this is what I perceive because of American debt and European economic fragility.

  5. This is great stuff. A couple of points:

    First, the international sector needs to get represented somehow, in order to diagram the sectoral balance relationship and explain the irrationality of all the China-bashing out there.

    Hence, regarding “We can reduce the federal “deficit” either by turning down the spigot (reduce federal spending), or by opening the drain wider (increasing taxes), or by some combination of the two, ” you can also do it by increasing exports or decreasing imports.

    Second, I’m not sure the narrative accounts for the difference between the original or “real” gold standard and the dollar-centric, quasi-gold-standard of Bretton Woods. The on-again / off-again transition from the gold standard to the Bretton Woods standard to the fiat monetary system is chronicled in all its historic complexity in Dr. Michael Hudson’s “Super Imperialism” (1971) . Which I regard as the prescient first text of MMT.

    Cheers

    • Yeah, I was thinking of the same question: how does foreign trade fit in the diagram? Maybe China –per se– is simply another entity/box –albeit a big one– in the tub of blue dollars (I thought dollars were green), and maybe then, trade balance with China is orthogonal to “federal deficit” as defined by MMT.

      Very interesting stuff overall.

  6. JD,
    Well done.
    Do you think your brother is ready to add the savings drain and import/export two way valve? Or Congress creating all the sloshing around the tub? Or the QE drain of interest income? The tub needs to be expandable to accommodate the hidden spigot that added liquid to the TBTF banks.
    See if you can get him up to speed by Thanksgiving. Turn the sound down on the football games and have at it. If Romney wins, you can tell him how Congress will let him spend and cut taxes. If Obama wins, you can tell him how Congress will pronounce the dire need to cut the deficit and balance the budget. (Assuming Rs keep the House)

  7. chuck martel

    No doubt there’s an MMT explanation for the near hyper-inflation of the Iranian rial, which is, after all, a sovereign currency. What would that explanation be?

    • Clonal Antibody

      Chuck Martel,

      Iran is dependent upon exporting oil and importing “things” for its basic survival. If the purchasers of oil can make do with a shortfall of oil, then the value of the Rial falls. There is economic warfare being conducted, and the results are not much different than bombs being dropped on Iranian cities.

      If the embargo was not a unified act, and was broken, say by the actions of the BRICS countries, the Rial would not have collapsed. However, the BRICS are not equal in power to the North American-Europe coalition, and find it to be in their benefit to throw in their lot with the US.

    • Chuck: At least you said “near”. Iran’s inflation, which as others have explained, has exterior causes, is definitely not hyperinflation. It is easily in the territory of old-fashioned Latin American chronic inflation, which could go on for decades, with no gigantic damage to economies. I suspect a bit of a propaganda campaign to make it sound worse than it so far is.

      Of course, it does represent real problems, represent a reconciliation of real, incompatible claims. If sanctions and war continue to do their malign work, it could become hyperinflation. That’s just saying that MMT or any other sort of economics is not magic.

    • bubbleRefuge

      Supply shock. The embargo limits aggregate supply in the Iranian Economy. Without a commensurate decline in demand, prices increase.

  8. JD
    This is brilliant. You are so right to break the ramifications of MMT into three categories. You are also right to concentrate on the basic fundamentals of the bathtub. The Monetary and political legerdemain around the fundamentals is where everyone gets lost in the quest to make sense of the basic truths in our monetary system. But without a fundamental understanding, that quest can be very offsetting for those just trying to understand what is going on and are new to the theory. For those who worry about the rest of the world and their relation to the US dollar tub, the rest of the world is nothing more than a user in the tub at a fundamental level.

    Thanks again. Your clear analysis is very helpful in getting inquisitive minds over the gold standard bump that is now plaguing the world, big time.

  9. “No doubt there’s an MMT explanation for the near hyper-inflation of the Iranian rial, which is, after all, a sovereign currency. What would that explanation be?”

    Well it’s being reported that Iran is struggling to sell approximately a quarter of its oil output because of international sanctions effects, particularly hard-hitting being the global insurance ban for oil super-tanker ships. This obviously has had a devaluation effect on the rial which has plunged since the fall of 2011 making imports a lot more expensive and imports are an important part of the standard of living in Iran.

  10. I liked the article, good job. I think though you should consider doing a re-worked version which includes the international sector’s effect on the balance sheet and the role of taxation reduction to throttle down the drain spigot.

  11. @chuck martel

    Is Iranian inflation really a monetary system effect? Sanctions function like a blockade. The currency of the blockaded economy looses credibility, initially, because it can’t purchase imports. Then it looses the ability to express liquidity-preference because no one can foretell how long the blockade will go on. There must occur a flight to real goods and hard foreign currencies as stores of value. The competition between individuals to acquire the highly limited available quantities quickly leads to a collapse of the blockaded currency. How is the rial’s fate materially different from that of the Confederate dollar during the Civil War?

  12. This is very good, but I believe you are confusing your stocks and your flows. You say:

    What is called the federal “deficit” is the difference, at some particular point in time, between the number of dollars the federal government has spent INTO the tub, and the number of dollars it has drained OUT of the tub with taxes. (It is running a “deficit” when it is spending more IN than it is taking OUT.)

    Then you say:

    First, what we are calling the federal “deficit” are the dollars left in the tub!―in other words, the financial wealth of the households and businesses of the Private Sector.

    The initial statement is correct, the second is not. The deficit is a flow that measures the difference between what is going into the tub and coming out of the tub. This is a different in rate of flow, and is the deficit. The total debt is what is left in the tub, and is the stock measured at a single point in time. In this manner, it is not the deficit, but the total debt that is available for private sector use (one sector’s debt is another’s surplus).

    Overall, I thought it was very good, but you need to make sure you keep your stocks and flows straight. Deficits measure flows while debt’s measure stocks. The amount sitting in the tub at any point in time is the stock (debt), the difference in the rate at which water enters and exits the tub is the flow (deficit).

  13. Upon a review, I realized that the first statement I quoted in my comment above is not correct. You are still referring to a debt, not a deficit, in that statement, as you are talking about a specific point in time (such as the difference on June 15th). If you were to talk about it over a period of time (say, the difference between what went in and what came out over the course of a year), it would be a deficit.

  14. So this brings me finally to the political policy conundrum for which MMT has no silver bullet. J. D. Alt

    No, but the Bible does. Matthew 22:16-22 (“Render to Caesar …”) implies that we should have coexisting government and private money supplies. If that were the case, then overspending by the monetary sovereign relative to taxation would only hurt the monetary sovereign and its payees, not the private sector.

  15. To turn on the spigot, the federal government has to spend the dollars on something. It can buy services (like medical services for people on Medicare), or it can pay to build something useful or necessary (the Hoover Dam, for example), or it can purchase an asset from someone (like a Treasury or mortgage bond.) J. D. Alt

    Wrong! Remember G.W. Bush’s “Stimulus Checks”? And what about Social Security payments? What is the government “buying” there?

    Also, borrowing by the monetary sovereign is “corporate welfare” according to Bill Mitchell since the monetary sovereign has NO need to borrow. As for buying private debt, that is a form of “corporate welfare” too since it transfers private risk to the general population.

  16. “Even so, the pot of dollars shared by the system fluctuated because the banks were allowed—by law—to loan out more money than they had in deposits. So, for example, if a bank had $1000 in deposits, it was allowed to make loans worth $10,000. In effect, the bank “created” $9,000 out of thin air.”

    I don’t know if this holds. The bank cannot just loan out infinite money, they have capital requirements and can only loan based on the amount of deposits they have on the books, from what I understand of banking, which is admittedly still on the amateur level. I think you may be confusing the ability of banks to create money through multiplier effects and receiving interest payments with them actually just being able to make infinite loans. When a bank receives payments on loans, the interest paid, in theory, is money created because thew borrower created a product with that loan that added value into the economy (GDP). Yes that money had to come from somewhere, but, and this is where it all fits in and fundamentally I agree with your writing here, it generally came from the government. But this wealth creation from the bank is dependent on the slow and steady production of GDP, so it is contained, and does not lead to runaway inflation. So although you admittedly recognize that you have left banking out of this part of the discussion, I believe it is too fundamental to ignore, too relative to the creation of money and wealth, and too inaccurate to say a bank can just loan out $10k when it only has $1k in deposits.

    • I believe it is too fundamental to ignore, too relative to the creation of money and wealth, and too inaccurate to say a bank can just loan out $10k when it only has $1k in deposits. Matt Sirigu

      The banks get away with this because the money they create stays in the banking system because it is insured by the monetary sovereign and because a legal tender lender of last resort stands ready to provide reserves as needed. Otherwise and especially if the monetary sovereign itself furnished a risk-free fiat storage and transaction service like it should, the banks would be very careful about the amount of liabilities they create. But now they are only limited by so-called “creditworthy” borrowers and perhaps a small capital requirement.

    • Deposits are liabilities of banks, not assets. You are right that there are capital constraints on bank lending, but the bank is less constrained if it has fewer deposits.

  17. I like your second diagram with the spigot and drain. Would the private banking sector (horizontal money) be represented by another box at the top with a spigot into the tub and a pump sucking money back into the bank?
    In other words, the debt money cancels out (asset and liability) in the long run, but temporarily it can lift the level of the money in the tub, adding to the economy, so the level is only partially controlled by government.

  18. It is therefore essential that we not only acknowledge MMT as the new economic reality that it is, but we also figure out an effective way to manage and control it. J. D. Alt

    That’s simple enough if ethics are applied:

    1) Fiat should ONLY* be legal tender for government debts, not private ones.
    2) Genuine private currencies for private debts only should be allowed.
    3) All government privileges for the banks should be abolished.

    We can have a healthy government and private sector if we stop insisting on a single money supply for both.

    *after a universal bailout of the population with new, full legal tender fiat so that the banks are forced to accept the new money.

  19. 1) Fiat should ONLY* be legal tender for government debts, not private ones.

    This makes zero sense. Of what value would the government’s fiat currency be to anyone in payment of a government debt if they couldn’t use that currency to pay off their own debts?

    Your thinking is all over the map – a crazy hodepodge of Austrian free banking, Ron Paul, Dennis Kucinich and other cranks.

    • Of what value would the government’s fiat currency be to anyone in payment of a government debt if they couldn’t use that currency to pay off their own debts? Dan Kervick

      Legal tender for private debts means one MUST accept fiat for private debt if it is offered. However, one can always VOLUNTARILY accept fiat for private debts.

      Your thinking is all over the map – a crazy hodepodge of Austrian free banking, Ron Paul, Dennis Kucinich and other cranks. Dan Kervick

      You don’t even understand what “legal tender” means and you accuse me of crankery?

      But I do notice you are capable of learning so I won’t dismiss you as a crank or worse a bank defender yet.

      • and other cranks. DK

        Don’t be shy, name them. Maybe Steve Keen is someone you consider a crank?

      • Are you saying that Steve Keen is a defender of free banking?

        I say again that your thinking is incredibly mixed up double-think. On the one hand, you think banks are guilty of “counterfeiting” for issuing credit money that only the public should have the right to issue, and that should be issued credit free. On the other hand, you want everyone to be permitted to issue their own money, and want to strip away the legal and institutional foundations of the public monetary system. The crazy cult of anarcho-libertarian voluntariness which lives in half your brain is manifestly incompatible with with the institutionalized legal order of state currency system.

        The government cannot use its monetary system to provision the public sector and produce public goods and services if the acceptance of that money depends entirely on whether or not people happen to feel like accepting it.

        You really don’t know what side you’re on, and all you come up with is knee-jerk bible-thumping moralism detached from any realistic understanding of economic existence.

        • Are you saying that Steve Keen is a defender of free banking? Dan Kervick

          Steve Keen is for a universal and equal bailout of the population, including non-debtors, with new reserves and restrictions on new credit creation to prevent this problem from reoccurring.

          I say again that your thinking is incredibly mixed up double-think. Dan Kervick

          Yet if appears consistent to me. The banks are counterfeiters; the counterfeiting should cease or at least all government privileges for it removed; and the entire population should receive restitution.

          On the one hand, you think banks are guilty of “counterfeiting” for issuing credit money Dan Kervick

          Yes they are and they rely on government deposit insurance and a legal tender of last resort to get away with it and then only partially since their counterfeiting recurrently wrecks the economy they depend on.

          that only the public should have the right to issue, and that should be issued credit free. Dan Kervick

          Government should not be in the lending business since lending is inherently discriminatory especially when new money is created thereby.

          On the other hand, you want everyone to be permitted to issue their own money, Dan Kervick

          Their own private money, good for private debts only assuming they can find someone willing to accept it. OTOH, government should have a legal monopoly on the creation of money for government debts and that money should be inexpensive fiat.

          and want to strip away the legal and institutional foundations of the public monetary system. Dan Kervick

          I wish to strip away government privileges for usury and counterfeiting. If banks can’t survive as purely private businesses (and history says they can’t for long) then what does that say about the nature of their business?

          The crazy cult of anarcho-libertarian voluntariness which lives in half your brain … Dan Kervick

          On the other half, I believe in a free spending monetary sovereign.

          is manifestly incompatible with with the institutionalized legal order of state currency system. Dan Kervick

          That fascist order killed 50-86 million in WW II alone. We should reconsider it since it threatens world peace again?

          The government cannot use its monetary system to provision the public sector and produce public goods and services if the acceptance of that money depends entirely on whether or not people happen to feel like accepting it. Dan Kervick

          People will still need fiat to pay their taxes and ordinarily will prefer to use a single money supply unless that money supply is being debased to, say, support usurers and counterfeiters.

          You really don’t know what side you’re on, and all you come up with is knee-jerk bible-thumping moralism detached from any realistic understanding of economic existence. Dan Kervick

          I’m on the side of peace, prosperity and justice and I dare not (because of the Bible) be otherwise.

          As for “moralism”, economics used to be called “moral philosophy” or at least was closely associated with it. To whose benefit is it that economics must now be amoral? To the banks?

      • Samuel Conner

        I don’t think that it is right to think that banks counterfeit the sovereign’s currency.

        Rather, they promise to make payments on behalf of borrowers in units of the sovereign’s currency. And they have to get this currency from somewhere in order to make these payments. So they borrow it from depositors or from other banks or, at a pinch, from the Central Bank. (I am ignoring liquid capital, which is a small fraction of present banks’ balance sheets).

        Since the banks have to get the sovereign’s currency from somewhere in order to make the payments-on-behalf-of-borrowers they have promised to make, they aren’t counterfeiting at all.

        And since they want to make a profit on this business of making payments-on-behalf-of-borrowers, they have to charge the borrowers more than it costs them to get the sovereign’s currency that they use to make the payments they have promised to make. And in addition to covering their interest costs for borrowing the sovereign’s currency that they use to make these payments, they have to recover the principal that they have borrowed to make these payments (borrowed from depositors, from other banks, or from the Central Bank).

        There is no counterfeiting.

        There can, however, be theft, as when crooked bankers extend credit that they know will not be repaid.

        • So they borrow it from depositors Samuel Conner

          Which would be very few except for government deposit insurance and the lack of a risk-free, government provided fiat storage and transaction service.

          or from other banks Samuel Conner

          Who would also be short of reserves except for government deposit insurance.

          or, at a pinch, from the Central Bank. Samuel Conner

          No one is entitled to stolen purchasing power even if they are in a pinch (of their own making btw).

          There is no counterfeiting. Samuel Conner

          Indeed there is counterfeiting else renters would not have been priced out of the housing market as they have been. Now those whose purchasing power has been stolen are often lusting for a deflationary Depression to get that purchasing power back.

          There can, however, be theft, as when crooked bankers extend credit that they know will not be repaid. Samuel Conner

          The theft occurs when the deposit is loaned into existence since it dilutes other deposits and physical cash. “Prudent” theft is still theft.

          But keep defending banking. It’s only some of the most famous men in history who have condemned it.

  20. Please excuse a novice struggling to understand our monetary system. My understanding is that money is created currently by the Fed and by the banks both through fractional reserve lending and by simply creating the money themselves for loans. Shouldn’t this have a place in your model? What is the impact of this money to the tub, taxing etc. Shouldn’t all this money-making have been inflationary well before now? Seems like what the Fed is printing is trivial comparatively speaking.

    • bubbleRefuge

      The fed is not creating any new money per say via its QE efforts. The fed is changing asset composition by removing longer dated time deposits ( via purchase of treasury securities) and replacing those with non interest bearing reserves. This lowers longer term interest rates.

    • Samuel Conner

      I think that it is not accurate to say that banks “create” money when they make a loan to a borrower. They do create the loan (in exchange for the borrowers promise to pay — the note — and the borrower’s pledge of collateral that protects the bank in the event that the borrower defaults on the promise to pay). But the loan is not “new money from nothing”. Rather, it is the bank’s promise to make payments, up to the amount of the loan, to whatever parties the borrower designates. These parties could be (the recipients of checks drawn against a deposit account created by the bank when it makes the loan, or it could be the borrower himself who takes the loan as cash.

      But where does the money (the Sovereign’s currency) with which the bank makes these payments come from? It is not created by the bank out of nothing. Rather, the bank has to get it from somewhere. Typically, the bank borrows it from private citizens and corporations (deposits owned by these persons and held at the bank) or from other banks (the interbank overnight lending market) or at last resort, from the Central Bank (the Fed “discount window”). Banks also can issue bonds, but that is an expensive source of funds, and has capital contributed by its owners or retained out of earnings.

      So where does this money come from? Operationally on a day to day basis, it is added to or subtracted from the banking system by the Central Bank (the Fed) which buys or sells bonds to add or subtract reserves in keeping with its desire to control the interest rate in the overnight interbank lending market. Ultimately, these reserves are spent into existence by the sovereign fiscal authority (US Congress).

      Bank lending allows borrowers to move future expenditures into the present, and so does increase demand, which could be inflationary if there is insufficient capacity to meet the demand. But, provided that the loans are repaid, bank lending today correspondingly reduces expenditure over the future term of repayment of the loan (the future expenditure that is advanced into the present is no longer in the future). This touches on Steve Keen’s insight that in any period, the component of national income that is attributable to expenditure funded by increased indebtedness is not a durable, long term increase. It will be given up when the increased indebtedness is repaid.

      • I think that it is not accurate to say that banks “create” money when they make a loan to a borrower.
        It is creating money. There are different kinds of money. It’s not creating government money, currency, but it is creating bank money, bank liabilities. And most of the money in our economy is not government money, but bank money. It’s not printing FR notes, government liabilities, which only the government can create, but it is printing private banknotes.
        But where does the money (the Sovereign’s currency) with which the bank makes these payments come from? It doesn’t always need to get currency to make these payments. If you write a check to someone with an account at the same bank, etc, it need not acquire more reserves.

      • It will be given up when the increased indebtedness is repaid. Samuel Conner

        So what? Do you think the evils of inflation are balanced by the evils of deflation? Do two wrongs make a right?

  21. @infinite54

    When banks “create” money by lending, they simultaneously create “anti-money” on the asset side of their balance sheet – the loan. The *horizontal* money banks create nets to zero against the loans they hold, as do all such private-sector financial contracts. New or “vertical” money is created only by the government.

    The conundrum of very low inflation in the context of greatly expanded Fed and other-central-bank balance sheets is a major tip-off to the fact that the Quantity Theory of money was bogus all along. But for a comprehensive treatment of MMT, find the MMT Primer Tab and dig in.

    Cheers

  22. The fact that most countries around the world now opt to have a single currency within their economy rather than multiple ones has much to do with the negative effects of historical bank runs using multiple currencies but also that at time of major internal and external threat economic mobilization for defense is much easier and effective with a single currency. Little point in debating the respective merits of single or multiple currencies when your country is about to be over-run by a character like Hitler!

  23. casino implosion

    Thanks for this illustration. This is what is needed for the layman.

    The penultimate paragraph on the conundrum is critical here I think. This worry is what causes people to be so resistant to understanding MMT.

    “If everyone believed this, all hell would break loose” is the basic fear behind it.

    I always say, right now we’ve got MMT for the banking elites and Austrian gold standard economics for the rest of us.

  24. Right in the center of the last diagram there’s a box missing labeled “Financial Industry: Sells Junk, Buys Politics” with some sort of icon depicting a one-way pump between one edge of the box and the tub (pumping into the box), labeled “extraction”. Oh, and perhaps additionally a safeguarding pipeline directly connecting this box to the spigot, labeled “Bailouts, QE, etc.pp.”. Well, I know, that’s not the point here, but thats what immediately came to my mind. Anyways, good post.

  25. All of these diagrams are unsuitable because they are incomplete. To model the macroeconomy one must include the 3 factors of production, land, labour and durable capital, and the 3 returns on them, rent, wages and interest (or dividends). None of these models achioeve and consequently the MMT is also incorrect since it misses out a significant amount of what is REALLY goin on in the system.

    You can see the full system which omits these faults on Wikipedia, Commons, under DiagFuncMacroSyst.pdf

  26. Jack Parsons

    Another implication of MMT is that the federal debt is a massive scam- there is no reason for the Feds to pay anyone for the right to create money. The federal debt is a rent.

  27. roger erickson

    This is off topic but related to the cause.

    please, please, please comment at this military website discussing the “foolishness of nat’l debt” – this is a community worth converting – and refer them to diverse entries at NEP; the more the better

    America’s strength is an illusion created by foolish borrowing
    http://fabiusmaximus.com/2012/10/10/america-debt-43894/

    and please be polite; the audience is mostly retired military officers; a very useful community to recruit

    the author is a respected military historian; he’s clearly out of his comfort zone re the details of currency operations, but so is 99.9% of the electorate;
    Please help inform, educate and recruit these people as well as JD’s brother. It may be very useful.

    • Hmm, see it refers to Ed Dolan’s By One Key Budget Indicator, the Structural Primary Balance, Even Greece Is Doing Better Than the United States. Why That Should Worry Us

      Started writing a response at economonitor, but am petering out. There are so many confusions & myths in there. It is so much easier to explain real economics to someone not so educated in fake economics. You can do it without consuming so much time tracking down so many references & urls! A really good illustration of the intellectual destruction wrought merely by changing the nomenclature from “full employment budget” (devised by the redoubtable, rotund Beardsley Ruml to persuade FDR in 1938) to structural balances & whatnot, as billyblog has pointed out many times.

      On that diagram, I disagree, Roger – what is happening in it is even more fundamental than the currency user/ issuer distinction, which could be tacked on. Regarding other comments, if one looks carefully, you can see the foreign sector in the diagram already. And land, labour and capital, & rent, wages and interest are already labelled explicitly in that diagram!

  28. roger erickson

    re the original diagrams, seems to me that the boxes used should be very explicit about illustrating the different statuses of the CURRENCY ISSUER and the CURRENCY USERS, and the implications.

    One is both source & sink, and the other only pass-through users and/or temporary hoarders. (Ignoring as negligible any people who like to shred, burn or otherwise destroy public currency – also illegal, by the way.)

  29. “Another implication of MMT is that the federal debt is a massive scam- there is no reason for the Feds to pay anyone for the right to create money. The federal debt is a rent.”

    Surely you don’t mean another form of institutionalized mooching that those 47% don’t know about?

  30. Dr. Black, I watch you often on The Real News Network with Paul Jay, mostly about financial corruption. But would you make sure to bring up MMT with him? The nonsense about the federal debt needs to be dispense with. I find his economic reporting to be from a liberal point of view, but incorrect. MMT needs more and more media exposure. Thanks!

  31. I am not an economist, just an average person on the outside looking in and reading much. When other countries start trading for oil in something other than dollars, we are toast. Does anyone really think we are concerned about the welfare of indigenous peoples in the middle east? Was Russia concerned about peace in Afgainistan when they killed millions to try and conquer that country? The punishment we are doling out to Iran has nothing to do with Nuclear weapons, it is because they threatened to sell oil to other countries in coin other than the dollar. Pure and simple, when enough oil starts trading by means other than the dollar, we will have nothing to offer the rest of the world except corn, and then they will dictate the price of that.

    • Hey Daniel

      I just dont understand how you think changing the numeraire on a price of oil from $ to something else is going to materially affect the US. Whatever else it is priced in will still have a conversion to dollars and thus a price in dollars. Do people who dont have dollars have no access to oil that is priced in $?? Of course not. Oil is purchased in every country using every currency. What numeraire the oil market chooses to list its prices is irrelevant. I think way too many people are fixated on this.

      Now if the oil producers wont sell to the US thats a different thing. I dont see that happening any time soon and I cant imagine the conditions which would create the scenario.