Real Dollars and Funny Money


I keep trying to unravel the confusion knotted beneath the surface of our public discourse about money.

For example, it seems evident that most people believe that U.S. Dollars are “created” by business entrepreneurs making profits. Until this happens, the understanding seems to be, the number of dollars available for everyone to try to get some share of is like a big lake of money we’re all drinking from, with the biggest drinker of all being the U.S. government.  What we seem to mean by “economic growth” is this lake growing bigger, and we’re constantly measuring it’s depth and volume in terms of something we call “Gross Domestic Product”. The process that makes the money-lake grow is an entrepreneur investing some of the existing dollars in some venture, and then making a profit on that investment thereby creating new dollars that didn’t exist before, which increases the overall size of the lake. Dollars created in this way are “real” dollars because they are created by private business entrepreneurs competing in a free market. The federal government (for some mysterious and perverse reason that we can’t entirely explain) has the authority to “print” dollars any time it sees the need, but dollars created in this fashion are “funny money”—they simply dilute the value of the “real” dollars and enable the federal government to spend money it doesn’t really have. To protect the “soundness” of our lake of money, we should therefore limit at all costs the federal government’s “printing” of dollars, and the most effective way to achieve this goal is to require the federal government to BORROW dollars from the bond market if, in fact, it has to spend more dollars than it collects in taxes. Having imposed this requirement, we must then carefully track the number of dollars the federal government borrows because if that number exceeds a certain percentage of our Gross Domestic Product, we can assume the government will never be able to repay the debt (because the taxes available from GDP are mathematically inadequate) at which point the federal government will be insolvent. When we reach the point that the federal government is borrowing too many dollars (and, therefore, approaching insolvency) we have to either raise taxes or reduce government spending. If we raise taxes—especially on the entrepreneurs and businessmen—that will reduce the incentive to invest and create jobs, and will slow the process by which new “real” money is created, causing economic growth to falter. The best course of action to reduce an overly large federal debt, therefore, is to reduce federal spending. On its surface, this seems a perfectly reasonable narrative, even though it is politically difficult to translate into action (as we are currently observing.)

Beneath the surface, however, if you feel around down there, you’ll discover some knotty problems with the underlying logic. The first is the basic premise that “new” money is created when a businessman sells goods or services for a profit. By simple accounting, this CANNOT be true because the businessman’s profit is a debit on the balance sheet of whoever bought his goods and services. No “new” money is created at all, it’s just moved from one place to another. So if we achieve the “economic growth” we’re always talking about, how DOES the “new” money get created that corresponds to that growth?

One answer that often pops out in the confusion of our national dialog is that “new” money gets created when an entrepreneur takes out a bank loan to finance a business venture. When the loan is executed, the bank deposits, say, $1000 in the entrepreneur’s bank account. Where did those dollars come from? Once upon a time we imagined those were depositor’s dollars the bank was lending, but now we’ve gotten sophisticated and allowed ourselves to accept the odd reality that banks loan out way MORE dollars than they have on deposit. So when the bank executes the loan to the entrepreneur, it doesn’t deduct dollars from its depositor’s accounts and deposit them in the entrepreneur’s account—instead it simply makes an electronic deposit in the entrepreneur’s account by using computer keystrokes. THESE dollars, then, created by the bank’s computer keystrokes, must be the “new” dollars that get poured into the lake. Before the loan was issued, they didn’t exist, and in the issuing of them, they are not subtracted from someone else’s account or balance sheet. They are completely NEW! The entrepreneur then spends them, buying goods and services to implement his business venture; he might even hire some new employees and pay their wages and salaries using the new dollars—and by this process the new “real” dollars are pushed into the economy.

Except there’s a problem with this explanation as well. Again, it’s a simple balance sheet issue: When the entrepreneur REPAYS the $1000 loan to the bank, the “new” money the loan created is erased. The number of dollars in the money-lake is now exactly the same as before the loan was made and repaid. We assume the entrepreneur made a profit with his venture, and part of this profit he will have paid to the bank as interest on the loan—but since we now understand that the profit is a debit on the balance sheet of the customer who bought the entrepreneur’s goods or services, we can see that interest dollars the bank earns comes from the customer as well, and are not “new” money either.

In fact, no matter how many transactions we can imagine between banks and entrepreneurs and customers, we CANNOT create any “new” NET dollars, but only move existing dollars from place to place, from one side of some balance sheet over here to the other side of another balance sheet over there. While this process doesn’t add to the NET financial assets in the private economy, it very usefully does create a whole LOT of something else: it creates the REAL goods and services the entrepreneurs and businesses and working people PRODUCE by virtue of that money being exchanged from one balance sheet to another: cars and bridges and pizzas and roof-repairs and medicines and high-school educations (the complete list is quite long.)

But this just brings us back to the original knot we were trying to untangle, namely:  It’s pretty obvious that as we create more and more of these REAL goods and services, we’re going to need more and more dollars in our money-lake—otherwise, one of two things will occur: (a) the dollar value of everything we own will begin to fall precipitously (deflation) because the same number of dollars has to be allocated to more and more stuff; or (b) we’ll have to begin producing FEWER real goods and services to keep prices aligned with the amount of money in the lake. This is called “shooting yourself in the foot,” although it would be more accurate to infer the aim is directed considerably higher.

Where in the world DO the “new” dollars come from then? The answer everyone is just going to have to grit their teeth and accept is, unfortunately, “funny money”. There’s only ONE place that U.S. Dollars—new or old—originate from: the sovereign U.S. government “prints” them, either on paper or, more often than not today, electronically with computer keystrokes. Wait a minute, you are saying, that sounds a lot like what the bank was doing when it made a loan, right? Keystroke a deposit into some entrepreneur’s account. Except there’s a very fundamental DIFFERENCE between the U.S. government’s keystrokes and the bank’s keystrokes. (I can feel the knot starting to loosen here….)

The bank’s keystrokes created dollars that had to be REPAID to the bank—which, when that occurred, effectively erased the keystrokes. The U.S. government’s keystrokes, in contrast, create dollars that DON’T have to be repaid—ever. For example, let’s imagine Marble Monument Repair sends the U.S. government a bill for $1000 for services it provided patching up the Lincoln Memorial. Someone in the U.S. government makes some keystrokes and $1000 appears in Marble Monument Repair’s bank account. Does Marble Monument Repair have to REPAY those dollars? Obviously not. Are those then completely NEW dollars that have been inserted into the private sector economy?  I believe they are. Should we be calling them “funny money”? Will they dilute the value of the “real” dollars in our money-lake? I believe that as long as there are real resources available to put those Dollars to work (in this case, marble repair materials, tools, and labor) our money lake will not be diluted but, instead, will be expanded—undoing exactly the knot we were struggling with.

What is “funny”, though, is the peculiar fact that it is likely this $1000 payment to Marble Monument Repair will be added to what we call our nation’s “deficit”—and that we feel obligated, for some fearful reason, to require our sovereign government to BORROW $1000 to make up for that “deficit”. By this convoluted logic, we take a useful instance of sovereign spending (Lincoln is patched and the economy grown) and transform it into national DEBT—which we then flail ourselves with until the blood flows. This is the biggest knot of all.

76 responses to “Real Dollars and Funny Money

  1. Very clear and relevant post J.D. I have one question. When an entrepreneur borrows $1000 from a bank, doesn’t his/her promissory note become an asset of the bank and a liability of the borrower immediately, thus offsetting the banks liability and the entrepreneur’s asset? In other words, the bank’s liability is offset immediately and not when the loan is repaid. Repaying the loan cancels the borrowers liability (note) and destroys the banks asset (note), but leaves the bank a new asset (money). This can occur all at once or over a time period if the loan is repaid in installments. If this is correct, then the lake’s level doesn’t change at all even when the bank creates “new” money.

    • Sunflower,
      When you borrow money the banking system ends up with an increase in assets (loans) as well as an increase in deposits (liabilities). That “borrowed” money ends up as someone’s deposit. It’s that new deposit which is the new money. When the loan gets paid off, it comes at the expense expense of someone’s deposit – hence deposits rise and fall EQUALLY as loans are made and repaid.

      • But aren’t you ignoring, or forgetting, the interest that has to be paid in addition to the “funny money” borrowed. It is this interest money that has to come from somewhere, and that somewhere is from someone else’s pocket. While it is argued that the interest comes out of the profit made by the entrepreneur, that profit comes from the consumer. Unfortunately, the vast bulk of consumers are wage/salary earners and it is easily proven that that ‘income’ only accounts for 25% to 35% of the cost of any product or service created by the entrepreneur/manufacturer. Thus, this vast bulk of consumers can never have sufficient ‘income’ to pay for the product they buy without going into perpetual debt to the banking industry or using up whatever savings they have been able to put aside.
        It is these additional loans to cover the perpetually compounding interest payments that must lead to an increase in the size and volume of “the lake”.

        • the interest payments come out of either A. a person’s salary or B. the company’s profits. This is the way the accounting stays balanced

      • Adam, read this, which goes through the mechanics when a bank creates a loan.

      • Adam1, I don’t disagree that “deposits rise and fall EQUALLY as loans are made and repaid”. What I am asking is, aren’t the assets and liabilities balanced (double entered) when the loan is made, and then balanced again (double entered) when the loan is repaid, either in one payment or in installments? The “borrowed” money that is someone’s deposit is balanced by that someone’s IOU (promissory note) held by the bank as an asset. When the loan is repaid, the borrower’s asset (cash) is used to cancel his liability (note) and the bank’s asset (the note) is destroyed by the repayment which becomes the bank’s asset. I think this double entry happens when the loan is made and then again when it is repaid, so there is never a time when more money enters the lake than leaves.

  2. This is a lovely exposition. What it ignores is the Republican strategy, authored by “economist” (actually a journalist) Jude Wanniski, called “Two Santa Clauses.” Essentially it advises Republicans to run up as big a “debt” as possible when they are in power, funding their constituents, and then when they lose power, complain bitterly about the “debt” as though it’s a problem. This article’s understanding of the “debt” problem is an important antidote to this bit of political misdirection, but not everyone is hip to the whole MMT concept, and unless you take a moment to reflect about it, it sounds nuts. Sort of like Quantum Mechanics — crazy sounding, but accurate.

  3. J. D. Alt,
    Thanks for another well written and appealing analysis. As a retired philosophy prof, I’m sensitive to the need for expressing difficult ideas very clearly, and in ways that engage the audience. “Eschew obfuscation” was on my desk. (That’s a joke!) As a newcomer to MMT and NEP, I’m very aware of how hard it is to express these hugely important ‘new’ economic ideas, without sounding too technical or too partisan, or both.
    As an architect, and a fiction writer, you seem able to avoid the language problems that some econ profs may have (but not Randall Wray, although I’m having a few problems with the Primer). I appreciate the efforts on NEP to find new ‘memes,’ to ‘reframe the questions,’ and to discover useful metaphors. I don’t think the principles of MMT are arcane, but they need to be sold to the broader public, as has been often said in these blogs and comments. I wish Stephanie Kelton would write more. Her contributions here are usually by video.
    Matthew Berg’s “The Spinning Top Economy” at this site, Feb 25, is another nice job.
    I haven’t seen your work here for a while. I hope you have time to do more of this.
    Thanks again.

  4. It might be interesting to substitute the government deficit in terms of assets, liabilities and net worth comprising that deficit rather than using the term deficit. What goods the government purchases appear as assets, its assurances and borrowings as liabilities and its roads, bridges, buildings, lands and other capitalized assets carried under net worth. Those assets will either be consumed or accumulated and transferred to net worth; its assurances will be consummated or not and interest paid on its borrowings; and collect the income from use of net worth. As is, the government deficit is made up of the government’s balance sheet of its annual expenditures that the term deficit fails to describe or describes in an incomplete manner. Applying depreciation accounting will adjust the applicable sums to reflect use or loss over time. The actual deficit becomes a small fraction of the annual budget. Just a thought.

  5. Great piece
    Here’s an illustrative example of the deflation J.D. is talking about. Lets take two separate time frames: 2010 and 2020 and assume a perfectly balanced federal budget every year and absolutely zero dollars in new money printing by the Fed combined with perfectly balanced trade and by definition flat domestic private savings.
    GDP = G + C + I + NX
    (Not real data) in 2010: GDP = $15Trillion, Population = 300 million, GDP\Cap = $50,000
    10 years of balanced budgets later
    in 2020: GDP = $15 Trillion, Population = 350 million, GDP\Cap = $42,857

  6. The question now JD, is what do we do with that quite brilliant exposition of the general public’s concept of money creation? Is it proper to promote MMT as a “theory” when it is really a fact of how the fiat money system works?
    If it is a “theory” what policies need to be developed to transform it into practice?
    Education, obviously, is high on the list of policies, but are there other concepts that need to be looked at?
    Government borrowing and Government “debt” are major concerns as you point out so, what options are there to address these concerns? I suppose clarifying the facts of Government “debt” might be a good start.
    Who holds the majority of U.S government debt? The US does, not China or Japan. What percentage of products consumed in the U.S. are produced in the U.S.? According to the statistics, 88,5% – and what percentage of products consumed in the U.S. are produced in China? Again, the reported statistic is a surprising 2.7%.
    So, what options are there to reduce Government borrowing apart from the traditional gold standard solutions of raising taxes and cutting spending?
    One idea is to reverse the current fractional reserve scheme and have the Government sell access to credit creation to the private banking system. While the fractional reserve system is essentially a ‘ponzi’ scheme, if modified and properly controlled, it can be made to serve for the benefit of the society. Instead of allowing the private banks to create ‘new’ money as they currently do, by advancing interest bearing credit out of thin air, the Government, on behalf of the people, should create this ‘new money’ and sell it to the private banks. Obviously, the creation of this ‘new money’ would be a simple bookkeeping, or computer spreadsheet activity, exactly as it currently applies. The private banks would be set up in the same manner as presently in place, by obtaining capital from investors through the issuing of shares, debentures or bonds. As legitimate registered businesses, they would be eligible to apply for, and purchase, ‘new money’ from the government at a low rate of interest. The amount of ‘new money’ they request would be set as a ratio of their capital, plus money they hold in deposit from their customers. If the ratio is set at the current rate of 12.5:1, as used by the Bank of International Settlements, this would provide the banks with an adequate level of funds to use in supplying credit to their customers. As the economy grows so would the customer’s deposits, thus allowing the banks to apply for additional ‘new money’ to support the continued growth. The necessary controlling regulations would be related to the nation’s productivity and consumption factors, which the Government would monitor as the primary determination for the creation of ‘new money’. A loan is merely a legal agreement, and in the case of advancing credit, it is simply the ‘monetisation’ of future effort. The borrower promises to repay the loan at a later date from the fruits emanating from the advance. In this respect, all credit is really public property because only people are capable of producing products and services that will create the ability to repay the advance. The creation of credit should never have been handed over to the private banks in the carte blanch manner which applies today.
    Under the current system, Governments borrow money from private sources and pay interest on the bonds they issue. This revised system would operate through modifying the role of the Reserve Bank. Specifically, their role would be to monitor the nation’s productivity factors and handle the sale of ‘new money’ on behalf of the people. Provided the Government is constitutionally constrained from creating ‘new money’ in excess of the constraining parameters, a controlled fractional reserve ‘ponzi’ system is a way of increasing the money supply in keeping with the needs of a growing economy. Effective constraints would need to be by way of constitutional restrictions on the level of ‘new money’ allowed by the Government and relating the increase in the money supply to calculated and properly defined productivity measures. This would effectively control inflation as the volume of money would keep pace with the volume of goods and services available.

    • “is a way of increasing the money supply in keeping with the needs of a growing economy. Effective constraints would need to be by way of constitutional restrictions on the level of ‘new money’ allowed by the Government and relating the increase in the money supply to calculated and properly defined productivity measures. This would effectively control inflation as the volume of money would keep pace with the volume of goods and services available.”

      The way new money enters the US dollar ecosystem is through govt deficit spending, this is what expands the money supply. The govt creates=spends more money than it taxes=destroys. The govt doesn’t “borrow” money in any sense that we USERS of the currency do. UST’s = financial liabilities for the Govt and UST’s = financial assets for the non-govt. The govt doesn’t owe money, the govt has money that its citizens (and foreigners) have deposited into the Fed in the form of UST’s. Why would we need to revolutionize the system, eliminate the law that dictates the treasury can’t have an overnight overdraft at the Fed, allow the fed to buy UST’s directly when appropriate and focus on Inflation, sectoral balances and private debt to GDP levels to manage the economy. Separate gambling from commercial banks and cap their size so they can fail without causing systemic risk and encourage union membership with “free” higher education…..DONE

      • I have to disagree with you Auburn. The vast majority of ‘new money’ enters the system through credit provided by the private banking system as interest bearing debt, which they create out of thin air and only constrained by the supposed limitations set by the fractional reserve ratio. What I’ve suggested is that the government can set and control the creation of this type of credit on behalf of the people, who ultimately, are the real owners of the credit anyway. The government could do this by selling this credit access to the private banking system at a low rate that would allow the banks to make an operational profit by on-selling the amount of credit they have ‘bought’ from the Government. If this is coupled with the condition that there is no lender of last resort and the Banks had to take out their own insurance to cover customer’s deposits, this would prevent orgies of sub-prime lending and massive gambling on dubious financial products. The Banks’ shareholders, knowing they are ultimately responsible for the way the bank is run, would ensure a more prudent approach to their bank;s operations.

        • Ironically, I happened to just get a reply from Warren Mosler today with a bit about just this subject, this is the exchange:
          (ME) However, how does this static nature of US dollars comply with the increasing private debt to GDP levels? Is it because all private debt essentially cancels itself out from an accounting POV?

          (WM) “bank loans create bank deposits. but the ‘net’ is 0”

          (ME) “In other words, Prof. Steve Keen has repeatedly commented that MMT is overlooking the role of private credit or money creation by claiming the federal govt is the source of all NEW US dollars, is he missing something….”

          (WM) Yes, he is missing that I have been discussing and writing about the role of private credit creation for over 20 years, including direct discussion with him many years ago.”

          You’re not really disagreeing with me here, its more or less an accounting identity from a double entry ledger POV. If a bank creates a loan for $100 to person A…..Person A has $100 in his checking account and a loan liability of $100. The bank has a $100 liability (person A deposit) and the $100 loan contract as an asset. Everything must = 0 The person pays back that $100 over time, cancelling the original debt and paying off the banks loan asset plus interest which would have came out of person A’s future earnings (relative to when the loan was taken out)

          • The failure of MMT to distinguish between money and monetary assets is the source of much confusion.
            What is really explained and understood about ‘money’ from Warren’s observation:
            ” “bank loans create bank deposits. but the ‘net’ is 0″” ??
            What did that say to your question of squaring(complying) the growth of debt-to-GDP with banks extinguishing their loans upon repayment?
            Warren’s observation does provide reference to the transitory nature of debt-based money.
            But it ignores much deeper accounting realities that are also present.
            Banks create a (P+I) debt (monetary asset) when creating ‘purchasing power’ money that is greater than the amount of money(P) created. Warren says the ‘net’ of private money-creation is zero, but it is not zero. The net financial result of the private-money loan transaction is the creation of unfundable debt – the transaction sums to a net minus.
            One problem is that no explanation exists within MMT for the lack of permanence of the ‘purchasing power’ in the debt-based money system – and this is essential to understand the pro-cyclicality of this system.
            Another problem is that compounding interest on all ‘debt-money’ in existence is a cause for the regressive return of wealth to wage earning citizens. More and more of the real wealth goes from the payers of the interest to the issuers of the monetary assets.

            If you’re a monetary-asset junkie, then MMT might provide double-entry bookkeeping answers to why endogenous money makes any ‘net-zero’ sense.
            But if you are a money system junkie, then MMT never really gets out of the starting gate.
            For the Money System Common.

            • “What did that say to your question of squaring(complying) the growth of debt-to-GDP with banks extinguishing their loans upon repayment?”
              – it says that the private debt-to-GDP growth is due to folks not paying the banks back and federal debt-to-GDP because the feds don’t have to (they just “roll it over”).

              “…the lack of permanence of the ‘purchasing power’ in the debt-based money system”
              – its there, in the hands of the butcher, the baker or the candle stick maker, either moving to the next pair of hands or ‘drained’ into savings (foreign or domestic) for future purchasing power. Even the banker either spends or saves his purchasing power, but eventually he gives it to someone else to do the same. Even if he takes it to the grave, someone could dig it up – just another form of saving; very much like what we do with most gold, i.e. shiny bricks in a tomb waiting someday to be picked up (the Germans are getting theirs out of the NY Fed’s basement).

              • Bob,
                “”- it says that the private debt-to-GDP growth is due to folks not paying the banks back”
                I’ll pretend you’re kidding. But I know you just missed the debt-based money point being made.
                Private debtors NOT paying back their debts (deleveraging) results in a decrease of the private-debt amount. Therefore a decrease in the money supply (as ALL money is debt – and vice-versa). Therefore also, a decrease in the ratio of private debt to GDP. All other things being equal.

                “and federal debt-to-GDP because the feds don’t have to (they just “roll it over”).””
                Federal debt creation is at the option of the government. It does not create any new money. It has zero effect on the money supply. It should be abolished.

                “”(purchasing power) its there, in the hands of the butcher, the baker or the candle stick maker”” .
                Again, you appear to not grasp the very real fact that with debt-based money, the quantity of national purchasing power expands with each loan created and is extinguished with repayment of each loan of the merchants.
                This is the basic reason why Fisher proposed reforms to the monetary system – “to end the lawless variations in the quantity of our national circulating media”. (See “purpose and Intent” 1939 Program for Monetary Reform: Fisher, Douglas, Graham, et al)
                The same is true with Milton Friedman’s call for ending debt-based money, which includes the admonition to “end the creation and destruction of capital”. (See his Fiscal and Monetary Framework for Economic Stability – “The proposal..”)
                Google Atlanta Fed Credit Officer, economist Robert Hemphill, for a quote on the lack of a permanent money system. It’s not as simple a matter as you may think.

                • reserveporto

                  “”- it says that the private debt-to-GDP growth is due to folks not paying the banks back”
                  I’ll pretend you’re kidding. ”

                  He’s not kidding. He’s just saying that the amount of debt the private sector is maintaining relative to its income has increased. The debt just shifts around so that different people hold it at different times. For this to be possible, lenders have to have become more willing to lend on the basis lower levels of collateral, and borrowers have to have become more willing to take on greater leverage. These developments are possible due to a reduced perception of or a greater tolerance for risk. I’m not sure how one would prove it, but I’d argue that the greater risk tolerance is a consequence of a greater perceived understanding from economic studies of the sources of risk and of better tools, like hedging, to manage risk. It almost seems as if being better able to understand and manage normal expected risk has increased the likelihood of catastrophic unexpected risk due to the greater tolerance for the high levels of leverage endemic to catastrophic financial situations.

                  • I’ll pretend you’re kidding as well.
                    The metric we were discussing was the growth in private debt-to-GDP .
                    It has nothing at all to do with private sector income.
                    The rest of what you said is a hypothetical around loan-risk preferences.
                    You could well be right about that.
                    Again, it has nothing to do with how the private sector’s debt-retrenchments (balance-sheet recession) can result in higher private sector debt-to-GDP metrics.
                    Only a fall in GDP at a rate more rapid than private debt-retrenchment could produce such a result.

        • See my comment below. The prevalent meme that banks “create” money from thin air is misleading to say the least. A bank deposit balance is a legally binding debt of the bank. Yes, banks can create these debts from thin air. That’s no different from the fact that you and I can create and issue legally binding IOUs from thin air. Once created, we are on the hook. Same with the bank.

          • Derryl Hermanutz

            Dan, The liabilities that banks create against themselves function as money. Your IOUs do not. Bank deposits, which are the bank’s liabilities and the customer’s money, can be converted into currency (cash) at the ATM or teller window, and banks have virtually unlimited access to cash from the Fed. You cannot convert your IOUs into cash. You are not a bank. You cannot create credit money. Banks are banks. Banks can create credit money every time they make a loan or purchase a government security. Almost all of the money in existence, including the money the government borrowed from primary dealer banks and spent into the economy, was directly created as a bank loan of credit money. Banks purchase assets, including private borrowers’ promissory notes, and government’s bills, notes and bonds, and banks “pay” for those asset purchases by creating new credit money in the form of new bank deposits. Banking “is” money creation. This is not “misleading”. This is how our money system works.

            The banks’ assets are our debts. Banks buy our promises to repay money, and they fund those purchases by creating the money and lending it to us. Borrowers spend the money into the economy where it becomes the economy’s money supply. The private sector maintains a far larger stock of outstanding bank debt than the government, which means private debtors have provided far more of the economy’s money supply than government debtors. What is “misleading” is MMT’s claim that government debt creates permanent “vertical” money whereas private sector debt does not. This is just wrong. Both kinds of debt are identical.

            The government routinely pays out old debt (maturing bills, notes, bonds) and takes on new debt, maintaining and increasing its total stock of debt by continuously rolling it over rather than paying it out. The private sector as a whole does the exact same thing on a larger scale. Some borrowers pay off loans, other borrowers take out and spend new loans, but the private sector as a whole maintains and increases its stock of debt just like the government does. As long as the loans remain “outstanding”, the money that was created by those loans and spent into the economy remains outstanding in the economy. Sometimes the government runs a surplus and reduces its total debt, and sometimes private sector debt growth flattens or reverses. The reversal of debt growth means a reduction of the economy’s money supply, because more money is being taken out of the economy and returned to the banking system and extinguished as loan repayments, than is being added as new debt-spending. The flattening or reversing of money supply growth is called recession and depression, so net debt paydown reduces the real economy. So once the Ponzi arithmetic of our bank-debt money system becomes clear, and debt growth stops because it is recognized that debtors cannot repay their bank debts, we either allow price deflation to render creditors and debtors insolvent, or we find some way to get debt growing again, because in our money system debt to the banking system creates the economy’s money.

            Or we could grab a brain and have the government issue some of its own non-debt money, via platinum coins or otherwise. Because unless we do that, our choices are deflationary collapse, or infinite debt. Right now the government is adding a trillion per year of new debt growth to keep the economy from deflating and the Fed is bailing out the bankers so they have a few more years to earn fraudulent profits and loot their banks before extend and pretend gives way to recognition of loan losses and abject insolvency. But ultimately government debt is still “debt”, and even if it is technically possible for the government to ‘issue’ money to pay its debts, the government in fact “borrows” money to pay its debts, and as the recent coin debate demonstrated it may well be politically impossible for the government to EVER issue any money of its own. The technical possibility of government money issuance is completely moot if the government cannot or does not in fact issue money into existence outside of the bank-debt money creation process. Adair Turner recently covered this ground in his advocacy of Overt Money Financing (i.e. government money issuance) in his speech and paper, “Debt, Money and Mephistopheles: How do we get out of this Mess?”

            In the world as it now exists, banks issue our money. Non-banks, including the government and private sector, get money by borrowing it from banks. That’s the bottom line fact of our money system. Our money “is” credit money that is issued by banks. It is not some mystical vertical money that governments somehow conjure into existence outside of the banking system. The government “borrows” the money that it deficit spends. The government does not spend money into existence. Banks lend money into existence, and borrowers spend the money into circulation in the economy. The government does not issue or create that money. Banks do.

            All of our money, including the money that was borrowed and spent by government, is owed as debt to the banking system that issued that money as newly created bank deposits. The creation of new bank deposit money is how banks “fund” 100% of their loans to government and private borrowers. Banks don’t loan out “government issued money”. Banks issue the money that they lend. The government issues coins, but that’s the only money the government issues, and coins comprise one ten thousandth of the money supply. 9999/10000ths of all money is issued as bank deposit money, not government coins. Government is an insignificant issuer of money. Bank deposit money can be converted into the Fed’s banknotes (currency), but the banks have to buy that currency from the Fed with money they earned from their loans to us. So ultimately currency merely converts some of the bank deposit money to cash money. Cash doesn’t “add” to the money supply, it merely converts some of the money supply from one form to another. So for all practical purposes, the truest statement that can be made is that banks create all the money, which means that the term “money” effectively means bank credit money, and all money is owed as debt to the banks.

            The government is the sovereign issuer of the banking legislation that institutionalized our bank-debt money system. But that legislation formally transferred the money issuing function to the private banking system, making the banks the sovereign issuers of money, and making the government a sovereign debtor to its banks. In the eurozone only the commercial banks and the ECB can issue euros, so the euro nations are not monetarily sovereign, but the euro-issuing banking system is monetarily sovereign. Contrary to popular belief that the eurozone is different than the US$ zone, this is actually a copy of the American system where the government gave up its monetary sovereignty to its banking system. The eurozone is currently adopting something like the US practice of “requiring” commercial banks (like the primary dealers in the US system) to purchase government debt, and having the ECB backstop this with practically unlimited support for euro banks via ongoing loans to the bankrupt sovereign debtors who owe all those euros to those banks.

            But the bottom line is that the banks, not the governments, own and operate the money systems. You can’t just imagine the legislation away. If you want the government to be the sovereign issuer of the national money, then you have to CHANGE the current money system. This is technically a piece of cake. But the piece of cake is on the other side of a Grand Canyon of political opposition by the bankers and their plutocrat allies who would lose their monopoly of money and visions of neofeudalist splendor if such a change was ever made. So far no government has managed to bridge that canyon. Maybe it can’t be done. It certainly won’t be done by imagining the bridge is already in place and dreaming that the government is already issuing money.

            • Debts come in many forms, so it’s said.
              I owe one to you for this clear-sighted perspective that you have so well put forward. My thanks.
              I owe one to NEP for maintaining the discussion in the presence of this fork in the road. Thanks also for that.
              The evolution of the science and knowledge of money is again coming into the light. We are fortunate to meet here at the NEP corner of modern money thinking.

              We’re sort of like sailors who have a chart that can obviously get them to safety, but there is no understanding of where they are on the chart. It’s a good time to get your bearings right, or the course you set might not get you where you want to go.

              A discussion of so-called modern money is really a discussion of two things. One is what sovereign fiat money can be, and that can be pretty much be anything made legal. Another is what fiat money is, now, in its present form. This is just as you described it, and my only enhancement would be adding the terms autonomy and independence to sovereign money operations.

              MMT has the most advanced grasp among all economists of the potential for the monetary system to be used to achieve all kids of equity and justice for our society and for our planet. But in order to get to that point of comfort and safety you really need to know where you’re at on the ‘Sovereign , fiat monetary systems’ chart. And MMT hasn’t done that yet. I hope you have contributed to its progressive change, to that which many of its intelligent advocates now believe – the Money System Common.

            • Just a couple notes for completeness:
              – the primary dealers (“the banks”) have no choice but to buy the feds’ debt, but if for some reason they don’t, then the FED can buy the feds’ debt (as they are doing now, see QE).
              – the FED’s board is appointed by the President – he’s part of the govt.
              – once operating expenses are covered and the FED pays the member banks for their services,, all FED ‘profit’ is turned over to the US Treasury
              – yes, the feds’ debt is eventually paid by rolling it over, but the end result is the feds’ debt is always there and mostly growing except for those rare and short-loved periods of running surpluses – it can, and has, grown indefinitely – basically a score board for the growing wealth of the country.
              -yes, the banks make money but they’re not taking over the world; they do F it up on occasion but that has more to do with certain types of folks coming into govt and de-regulating the banks – in the end, that’s the voters’ fault.

              • Sunflowerbio

                As I understand it, the Federal Reserve cannot buy Treasury bonds directly, but it creates temporary reserves that the primary dealers use to buy Treasuries on the “open market”. If the primary dealers don’t want to hold the Treasuries, the Federal Reserve will buy them (if no other entity wants them) to hold. So, in a sense the primary dealers may not have a choice to buy, but they do have a choice of whether or not to hold Treasuries. Please let me know if this is incorrect.

    • The question now JD, is what do we do with that quite brilliant exposition of the general public’s concept of money creation? Is it proper to promote MMT as a “theory” when it is really a fact of how the fiat money system works?

      I agree. It should be called Modern Monetary Science, not Theory.

      In fact, Robert L Owen, Former Chairman, Committee on Banking and Currency, United States Senate wrote a paper in 1939 in an attempt to explain the new fiat currency to Congress. He called it Modern Monetary Science.

      There are differences between his description and MMT. And he was pushing for changes in the Federal Reserve, and was a proponent of Irving Fisher.

      • I have been pushing for MME or MMEconomics. But as Mosler and Wray have pointed out, its probably too late, as the name has kind of taken on a life of its own. Nothing from the USA even comes up on google when you type in MME\conomics. So we have to have new articles or retitle the old ones, then have those get linked to enough times, etc. etc.

    • This points out another misunderstanding of the general public. They do not understand the definition of a theory.

      A theory is the highest point on the scientific pyramid. Hypotheses can be promoted to a theory but once you reach the level of theory you are at the top. Nowhere else to go. The theory is either true in that all the facts support it or it is thrown out.

  7. Thanks for this interesting explanation and attempt to clear up what Dr. Bernd Senf calls ‘the fog around the money’.
    I think the major gaps that exists in really understanding the system of money and banking has to do with originating money as debt.
    The first gap that exists has to do with the amount of new debt created when the loan creates the ‘new money’. All money, actually, but in expanding quantities.
    Debts are things that are repaid with money.
    The amount of the debt to be collected from the borrower’s promissory note is the sum of principal and interest payments.
    So we create a future need for an amount of money beyond what is being provided by the loan. And that would have to be real M-1 money. This is the essential reason why fractional-reserved and debt-based money is pro-cyclical. And why it doesn’t work in reverse, in the sense that is pretty well explained in Fisher’s deflation theory.

    An understanding of the effect of compounding interest on debt-based money would show that this is not a mater to be left un-addressed. We are creating more demands for money units than we are creating money units. It cannot end happily. Unless you are the debt-issuer to the debt-issuer.

    And there is also this:
    “The U.S. government’s keystrokes, in contrast, create dollars that DON’T have to be repaid—ever.”
    No, they don’t.
    Government keystrokes are plain vanilla when it comes to the control and management of both financial accounts and the money supply.
    On the financial accounting side, government ‘keystrokers’ cannot make any payments out of its accounts unless there are credits in those accounts – that’s the plain and simple truth.
    On the money supply side, the government’s spending is merely a pass through of already existing money either as tax or debt proceeds from one M1 bank account to another.
    Here’s the thing, of course it is true that the government could create new money when it spends, as Lincoln did with Greenbacks.
    But it cannot be done without a major reform to the money system.
    That’s the issue.
    The monetary system needs reform.

    • “…debt proceeds from one M1 bank account to another.”

      Nope, the govt creates the debt instrument out of thin air. Moreover, like death, da dealers (i.e. da banks) have no choice but to take it- otherwise, the govt will anoint new dealers.

      Compounding interest as well as compounding inflation is not a problem if compounding growth is bigger. Inequale income off of the system eventually impacts compounded growth; that’s why it is a macro problem that has to be dealt with – not because its unfair and morally wrong (which it is).

      • Bob,
        To be clear, the government does issue the Treasury’s Certificates of Indebtedness, borrowing its proceeds from private hands. My point is that nobody can buy a government security unless the private bankers have already issued sufficient M1 money for the government to receive that existing M1 money(the proceeds) from someones bank account, and that after borrowing, the only thing the government CAN do is to pay that already existing money into someone else’s M1 bank account.
        The government creates the debt instrument and the banks create the money – both out of thin air.
        If you do understand that this is what I am saying and you have any problem with that, then please explain.Thanks.

        For an explanation of the wealth-concentrating effects of compounding interest on all monetary assets created over time, please Google up Dr, Bernd Senf’s “The Deeper Roots of the World Financial Crisis”.

        It’s not that the accounts don’t balance. It is that the growth in the amount of assets are accomplished by transfers of real wealth rights from the payers to the receivers of the interest on the assets loaned.
        That so-called ‘growth’ merely defines nominal debt.

        • Dan Kervick

          The primary dealers are large financial institutions, so my understanding is that they purchase securities directly from their reserve accounts.

          • Dan,
            I believe you are responding to this point –
            “…. nobody can buy a government security unless the private bankers have already issued sufficient M1 money for the government to receive that existing M1 money(the proceeds) from someones bank account…….””

            Primary dealers are not buyers of government securities, they are dealers in government securities. These dealers purchase that which is already backed by a ‘buyer’ – one who actually places an ‘order’ for the security. Or they do not make a purchase.
            That ‘buyer’ already has the ‘M1 money’ in his or her bank account – money created ONLY by the private bankers – to exchange for the government security.
            The fact the the PDs can deal with reserve balances would change absolutely nothing about the point being made here.
            That point was, and remains, that government spending NEVER creates new money, and is merely a pass-through of existing bank-created money from one taxpayers M1 account to another taxpayers M1 account.
            Because that’s the way it is.

            • “These dealers purchase that which is already backed by a ‘buyer’ ”

              Not correct… and I believe that would be check mate

              • joe bongiovanni

                That would be check-mate only if the whole weight of the discussion hinged on that one observation being correct or not.
                Clarifying first that I am not speaking of normal FOMC transactions of buying/selling all forms of T-securities daily – only the new Tsy issuances which COULD in theory result in an increase of the money supply. And I could be wrong about that point, having read both on Tsy site and in Ritter’s Money-And-Banking that the role of PDs in new issuances is as market-maker between the issuer and the buyer. I apologize and admit I can be wrong about that.
                Having said that – this is NOT the point of the discussion and not any emphasis at all. The point is that the issuance of the GUVsecurity is made possible by the existence of already-created and issued private bank money.

            • Dan Kervick

              We’re going in circles. The fact is that when people buy a Treasury security, it necessitates a transfer of some Fed-issued reserve balances to a Treasury account. Even if the purchaser is an ordinary person with an ordinary bank account using Treasury Direct, when the payment is cleared, the purchaser’s bank will have to make a transfer of reserves to settle its debt to the Treasury.

              When the Fed makes a purchase from the private sector – say to purchase a Treasury security, to pay interest on a reserve account or to purchase some other financial asset – it doesn’t have to get the money from anywhere. It just credits the appropriate account. This increment to a private sector account balance at the Fed is a nominal increase in the US government’s “liabilities”. But the fact is that those liabilities cannot be redeemed for anything other than liabilities of the same kind. So the debt is only pro forma.

              Commercial banks do not simply issue money in the very same way the Fed issues . What the banks issue are genuine IOUs. They are liabilities of the bank for which the account holders have the right to demand payment in some form other than the liabilities the bank itself issues. So this is a completely different matter from what the Fed is doing. If it makes people a thrill to say that those liabilities are created “from thin air”, OK. But IOUs are always created from thin air. When someone makes a promise, they don’t have to get the promise from somewhere else in order to make it.

              What really needs to be understood is that bank deposit balances are not a kind of fiat money. The banks don’t have a “printing press” . The deposit balances they create are genuine financial liabilities, not just some kind of self-sufficient and free-standing private sector currency of the kind free-bankers dream.

              • joe bongiovanni

                I would rather avoid that reserves-clearing-in-the-payment-system-are-money circle discussion. I agree with Cullen Roche’s observation below.
                I thought we were discussing whether government creates money when it spends and whether the Fed, by increases of bank reserves for any purpose whatsoever, ITSELF increases, the supply of money. It does not.

                True, private bank balances are not money – they are an ACCOUNT of legal purchasing power (money) that is owed between the depositor and the bank. When there is a transaction in the account and the balances change in order to provide for a real wealth exchange, THEN they become legal purchasing power – money. But those account balances do COUNT as part of the supply of money

                Without permission, I include here Cullen Roche’s recent comment from MR discussing Richard Werner’s postulations on the nature of money.
                Cullen Roche March 7, 2013 at 10:30 am
                Pretty crucial distinction though and it’s where I think MMT goes wrong. MMT will describe the reserve settlement via TGA as “destruction” and then “creation” of money. Ie, they imply that the system they want is the one we already have. But that totally ignores the actual flow of funds through the system. The actual flow shows that the govt can only settle in TGA after it has obtained bank deposits. And that bank deposit exists as a result of the creation of the loan. That loan doesn’t get “destroyed” when the govt taxes you. The govt necessarily spends the deposit back into the system.
                When you view the world through the MMT lens you get the impression that the govt creates all of our money when the reality is that the govt is a mere redistributor of money. The money system is built around banks and the reserve system supports this system based around banks. As Werner says in this video, the money supply has been “outsourced” to the pvt sector.
                Of course, Werner, (and all the MRists) understand that the MMT world is a very real option. But it would require a change in the system with the focus becoming the govt and not the banks.


                • Dan Kervick

                  I thought we were discussing whether government creates money when it spends and whether the Fed, by increases of bank reserves for any purpose whatsoever, ITSELF increases, the supply of money.

                  Fed purchases from the private sector obviously increase MB, which is one measure of the so-called “money supply”.

                  The idea that the government must obtain commercial bank deposit balances in order to spend or do anything else fiscally is manifestly wrong. That the government even maintains deposits at commercial banks at all is a matter of sheer policy convenience. It’s just a way of keeping reserve balances within the banking system to help the Fed with liquidity management. Those deposit balances are simply bank liabilities to the depositor – in this case the government – for reserve balances that the government itself issued.

                  I really think you need to read more about the legal status of commercial bank deposit balances. I don’t know how much clearer I can make it. Those deposit balances are debts of the bank, and they are redeemable only in the form of money that is issued by the government and that banks in the aggregate can only obtain from the government.

                  • joe bongiovanni


                    Whenever the MMT discussion gets around to the real issue of whether the government creates money AT ALL, so that we might further compare its theory of public purpose money – you know to have MONEY to spend and to create jobs and do all these good things that we all want to do – we are inevitably directed into that which Dr. Senf so correctly describes as “the fog around the money”.
                    Into reserve accounting.
                    Into the monetary base(MB), where ‘reserves’ rule, and where NOTHING of the real economy ever happens. Why is that?
                    Why is MMT incapable of discussing REAL money creation for the REAL economy without resort to reserve nuances?
                    Monetary Base (MB) today includes about $2.8 TRILLION – most of it in excess reserves. What value does ANY of that bring to our discussion of socio-economic progress, or of real government spending?
                    Can’t spend it, nor see it.

                    Here’s a non-fact from Dr. Dan.
                    “”The idea that the government must obtain commercial bank deposit balances in order to spend or do anything else fiscally is manifestly wrong.””

                    If you believe the government can spend one dollar that it does not have, and also that does not come directly from bank-issued ‘money’, please show us all – from where the authority to so spend is derived, and from where the money will come.

                    If you watched Dr. Wray’s Lewis and Clark lecture at 47:15 he says clearly that this exact constraint does exist.
                    “We put in operational constraints, one that says that Treasury can’t spend money unless it has money in its account at the Fed” – so we cannot spend money we do not have.
                    Therefore, Dan, “ that the government must obtain commercial bank deposit balances in order to spend or do anything else fiscally” is actually manifestly correct.

                    FYI, as that Treasury constraint has always existed, the same constraint would exist were the government to abandon the Fed as its banker (which it should do unless it owns the Fed). It’s an operational constraint that demands fiscal propriety.
                    Only IF the Treasury is AUTHORIZED by law to spend more than it obtains in revenues – all as allowed by the Kucinich Bill and the original Greenback legislation – only then can it spend new money into existence for economic purposes.

                    I understand the legal aspects of money, Dan.
                    Reserves are not money. They mean nothing to the Treasury. There is no reason for Treasury transactions to affect reserve balances at the Fed, beyond to maintain account balances between the Fed and its depositories.

                    The significance of Treasury reserves today is equal to what it would be were the Treasury to return to being its own bank. None. Again, reserves with the CB are the real throwback to the gold-standard era that MMT abhors.

                    MMT defends the private debt-based system of money creation and issuance, and it does so through the cloak of nuanced reserve accounting. Show me the money.

  8. Great article !

  9. Somehow the whole tone of this excellent essay suggests that MMT should be renamed as MMLogic.

  10. Nice piece J.D. – a good intuitive discussion.

    One thing I would query, however, is what seems to be your identification of net financial assets with money. I don’t think they are the same thing. Imagine a one-sector economy in which all financial assets, including the most liquid and money-like assets used for discharging most debts, are credit instruments. That is, imagine all money is credit-money. And suppose those assets are all issued by banks. That is, assume every unit of currency exists as a liability on the balance sheet of a bank and an asset on the balance sheet of a depositor at that bank.

    Suppose a depositor at the bank has a deposit account containing 5000 units of the currency:

    Assets: 0
    Liabilities 15,000

    Assets: 15,000
    Liabilities: 0

    Now suppose a bank makes a loan to the depositor for 10,000 units of the currency at 5% interest. It credits an additional 10,000 units to the depositor’s account, which thus becomes a further liability of the bank and asset of the depositor. At the same time, the depositor gives the bank a promissory note for 10,500 units, the amount of the loan plus the interest. That note is an asset of the bank and a liability of the depositor. Here are the new balance sheet positions:

    Assets: 10,500
    Liabilities 25,000

    Assets: 25,000
    Liabilities: 10,500

    Their balance sheets have thus grown. Now let’s assume the depositor pays off the loan out of her existing account balance. The bank no longer has the promissory note for 10,500 on the asset side of its balance sheet. But it cancels out 10,500 on its liability side. Similarly, the depositor’s liabilities decrease by 10,500, but the depositor has 10,500 less in assets. So we then get:

    Assets: 0
    Liabilities 14,500

    Assets: 14,500
    Liabilities: 0

    Now what can we say about the changes in the economy that have occurred as a result of these transactions, and these transactions alone? Well we can say these things at least:

    1. The net assets of the sector consisting of the depositor plus the bank never changed. The net was zero at the outset; it was zero after the first transaction; it was still zero after the second transaction.
    2. The distribution of assets and liabilities did change after each transaction.
    3. The quantity of money changed as well: it grew from 15,000 to 25, 000, and then declined to 14,500. The quantity of money is not the same thing as the net amount of financial assets.
    4. The bank profited as a result of the two exchanges – to the tune of 500 units. This is not surprising, because that’s why banks make loans. (Of course the depositor might have profited elsewhere. And just to keep things simple, we have made the unrealistic assumption that the loaned amount was never spent on consumption or investment. In the real world, investments would have been made with the loaned balance.)

    So, we don’t want to say the amount of money or currency in the economy is the same thing as the net financial assets of the economy. In a closed economy, the combined financial assets and liabilities net to zero. But the deposit liabilities on the liability side of bank balance sheets expand and contract throughout that time, and the depositors as a result have a greater or lesser amount of negotiable financial assets to exchange for real goods and services, or for other financial assets.

    Now where does the government come into the picture? That depends on the nature of the system. In our system it comes into the picture like this: By definition, a liability is something of negative value to its owner. In the case of financial liabilities, that negative value exists in the form of a debt, which is a legal obligation to make a payment. Financial liabilities are always liabilities for something. In some cases, these liabilities of one economic agent are debts for the liabilities issued by some other economic agent. In the US system that is always the case for the deposit liabilities of banks. These liabilities have the legal status of primary obligations of the bank. The bank is legally obligated to make payment with the liabilities that are directly issued by the US government if the depositor (a) demands to convert some of his deposit balance into government-issued physical currency (hence the term “demand deposit”), or (b) issues a draft – e.g. a check – to someone who is not a depositor at the same bank. The draft is a three-party negotiable instrument: It is a payment order issued by the depositor at the bank (the maker) and transferred to some recipient (the drawer) which gives the recipient a claim to payment by the bank (the drawee). In case (b) the bank might be able to make the payment simply by creating another deposit account liability, if the drawer is a depositor at the same bank. But if the drawer is not a depositor at the bank, the bank will have to make payment in some other way: either by providing some government-issued cash, or (if it is a Federal Reserve member bank) by executing a draft of its own on its reserve account and transferring some of its government-issued reserves to another bank.

    So in the above, when we were looking at the creation and destruction of money in the economy, we were only looking at one kind of money the “broad” money typically held as an asset by households and firms in the non-banking portion of the private sector that exists as a deposit liability of a bank. But there are also the money-like liabilities directly issued by the government, and that serve as absolutely final payment in our economy, given the present legal structure of our society. These liabilities come in two main forms: physical currency and account balances at the Fed – especially the reserve account balances of banks. We can then identify at least these four kinds of money:

    1. Reserve account liabilities of the government held by banks;
    2. Physical currency liabilities of the government held by banks;
    3. Deposit account liabilities of banks held by the public;
    4. Physical currency liabilities of the government held by the public.

    While 2 and 4 are the same kind of money in one sense, since they are the same kind of stuff, 3 is classified as part of the monetary base MB, along with 1 – a narrower measure of the amount of money in circulation, while 4 is included in the various “broad money” measures of money in circulation.

    It is important to recognize that bank money – a banks’ deposit account liability – is not just a liability for government-issued money in some functionally insignificant pro forma sense. It is not as though banks are constantly incurring new deposit liabilities that are exchanged freely in the economy without ever being redeemed for the government-issued liabilities. Rather, those redemptions are occurring all the time, since people are constantly both withdrawing government-issued cash and making payments to people who are depositors at other banks. In our little toy example above, the most natural real-world event that would happen after the new deposit balance is created is that the borrower would immediately begin withdrawing cash and making payments to people, maybe using the whole sum, and many of those payees would be depositors at other banks. So the bank would have to draw immediately on its stock of government-issued money, i.e. its vault cash or its reserve account balances, to meet its primary obligations to the depositor.

    In our economy, where there is usually some positive rate of growth, bank deposit liabilities are usually expanding. Apart from whatever is happening with the economy’s net financial assets, bank balance sheets are continually expanding. As a result, if the government didn’t respond to the continual increase in commercial bank deposit liability expansion by expanding its own monetary liabilities to the private sector – i.e, by increasing the private sector holdings of government-issued cash and reserve account balances – the first result would be a sharp increase in the interbank lending interest rate, the Fed Funds rate, as banks scrambled to acquire the increasingly scarce government-issued money they need to meet the additional withdrawal and payment obligations they have incurred by expanding their deposit liabilities. Ultimately, if the government didn’t act, some banks would become insolvent, and all banks would freeze their lending. Of course, behaving in this way would make no sense for the government, and in the system that exists reserve account deficiencies trigger automatic lending and balance sheet expansion by the Fed for banks deemed solvent.

    So that’s why the government’s role is essential. When we say banks “create” money, all that means is that banks are permitted to incur a certain kind of debt. They create deposit accounts and add to the balances in those accounts, which means that they have increased their debt to the depositor. But the government constantly needs to issue its own form of money so that the banks can service that debt, since the money issued by government is the only legally acceptable final means of payment for that debt.

    So far all we are talking about is money. None of this yet explains why the government generally needs to foster an increase the net financial assets of the public. Money in circulation in the private sector is not the same thing as the net financial assets in of the private sector. If we look at the whole economy combined, government and non-government sectors together, the net financial assets of the whole economy will still be zero. But when we divide the economy into two sectors, it is possible for one sector to have more financial assets than liabilities, while the other sector has an equivalent excess of liabilities over assets. Why does it matter whether the sector with the greater assets is the non-governmental sector? Why not the government?

    The reason is that people and businesses save. During a given time, some of the financial assets they have will be circulating as they are transferred from one holder to another. But another portion of those assets will just stay where they are with their current owners. And for various reasons people will seek to accumulate those assets and hold onto them. Although many of these assets – including the monetary ones existing as deposit account balances – are negotiable, they will not all be negotiated. As a result, it is possible that while the deposit account liabilities of banks and reserve account and cash liabilities of government might be increasing, the amount of these liabilities that are circulating by being spent on consumption goods and services and investment goods and services might be declining as savers increase their stocks of held assets. And if while at the same time as the desire to save is increasing the stocks of held assets, the supply of net financial assets of the non-government sector is also decreasing because the obligations of the public to the government are growing faster than the obligations of the government to the public, then the inhibitory effect on the economy will be exacerbated. So if a growing economy is the aim, the government has to increase its liabilities to the public in a way that is sufficient to accommodate the private sector’s prevailing desire to save while allowing for the expansion of spending.

    • Dan, thanks very much for taking the time to write this in-depth explanation.
      I’ve printed it out and will do my best to digest it for future efforts.

  11. Well and good up to the 2nd to last paragraph. The problem with this paragraph is that it is not the Federal government that pushes some buttons to create the $1000. It is the Federal Reserve Bank that pushes the buttons. The money thus created is then used to buy US Treasuries via the Fed’s member banks. This is how the newly-minted money gets to the Federal Government, and also why the amount is added to the National Debt. Is is in every sense a debt like any other, owed by the US Government to an autonomous financial institution.

    • The Fed is not autonomous. Besides the fact that it was created by Congress, and is predominantly run by people appointed by the President, it is also the case that the liabilities it issues are by law liabilities of the US government.

      • While your observations are true in a formal sense, the reality is quite different. A brief review of the state of play: (1) While it is true that the Fed was created by an act of congress, this act was largely written by bankers, who quite naturally had the interests of their own institutions at heart. (2) The Fed is 100% owned by its member banks, whose ownership is is held in the form of dividend-paying stock shares. It therefore has the earmarks of a corporation, although the stocks cannot be traded or used as collateral, for obvious reasons. (3) While theoretically subject to Congressional oversight, the inability of Congress to audit the Fed for nearly 100 years suggests that this oversight is a good deal less compelling than one might suppose. (4) The decisions of the Fed do not have to be approved by any branch of the US Government, and members of the Board of Governors, who serve terms far longer than any elected government officials, cannot be removed from office due to their policy decisions. In other words, once confirmed, they are in reality free from government oversight. Furthermore, key positions in the governance structure are held by private bankers. For example, Jamie Dimon of JP Morgan sits on the board of directors the NY Fed branch.
        Regarding your comment “it is also the case that the liabilities it issues are by law liabilities of the US government.” I think we’re saying the same thing here.

        • True enough. The Fed has too much operational independence right now. But note that Congress has not been “unable” to audit the Fed. They can audit the Fed any time they want by passing a Fed auditing law. Congress has instead chosen not to audit the Fed. The same with oversight and Congressional approval. Congress can choose whatever degree of oversight and hands-on control over monetary policy they want. The Fed system isn’t part of our constitutional structure; it is a policy choice of Congress. Congress created the Fed and delegated a lot of monetary policy to it. But it can un-delegate whenever it wants to. Rather than see these things as an evil conspiracy of banksters who have taken control of the country, I think it is better to see them as the choices of a lazy, plutocratic and corrupt Congress that refuses to do its job.

          • Auburn Parks

            Hey Dan
            How do YOU square the circle with the MMR guys over at the pragmatic capitalism blog. Cullen Roche has made many mentions about the fact that he came up through the MMT camp but then decided that MMT’s insistence on a “Government Centric” (re:source of all new US dollars or maybe FA might be more appropriate) instead of MMR’s “private centric” approach where the US govt is a strategic USER of US dollars that are printed by the quasi private FED and created through private bank balance sheet expanding etc.?
            I don’t know who to believe. It seems to me that even though our corrupt politicians dont control the FED doesn’t mean that Congress couldn’t. So while maybe MMR does describe the statutorily mandated system we have today more accurately, MMT is right about the foundation, meaning that Congress could rewrite the FED’s rules\structure any time they wanted.

            • Dan Kervick

              Auburn, I don’t know what you mean when you say MMR describes the present system accurately. If you read my comment, I think one conclusion would be that it doesn’t. The banks don’t “create” money that the government then uses. Banks create IOUs that, in order to function as a medium of exchange, have to be redeemed routinely for the kind of money that only the US government issues. This redemption of bank IOUs for the government-issued cash and reserve balances is an omnipresent and legally mandated part of our everyday monetary operating system. When the government accepts a check drawn on your deposit account in payment of taxes, it doesn’t just accept some sort of bottomless bank-created “fiat” money. It accepts that check because the clearance of that check requires the required amount of bank reserve balances to be transferred from the bank’s account to a government account. The bank did not “create” those reserve balances.

              So ultimately, the government only accepts its own money in payment of taxes. If you don’t have the cash, and just have a deposit account, you don’t directly handle the government-issued money. But your control of the negotiable instruments that comprise your deposit account give you a kind of remote handle on those bank reserves. By sending the govt an IOU from your bank, the government then gets to collect on that IOU and gets some of its reserve balances back to settle the tax payment.

              What seems to cause a lot of people puzzlement is the idea that if bank money just consists in IOUs for government-issued money, then that means that the loadable funds and money multiplier models must apply. But that doesn’t follow at all. The rules under which banks are permitted to operate permit them to issue the IOUs for government-issued money first by creating deposit accounts, and then to acquire later any additional government-issued money they need to clear drafts written on those accounts. So the Fed permits the banks to drive the process, so to speak. The banks are like a ship’s pilot in a coal-driven ship whose decisions with the rudder and throttle are draws on the power produced by the engines. If the pilot slams down the throttle, the guys in the engine room might have to accommodate by shoveling in more coal, or else the ship will stall. The pilot drives, and his decisions come before the accommodating coal shoveling. But that doesn’t mean pushing down the throttle “creates” power. The power is created in the engine room and the pilot is drawing on it.

              The difference is that the ship has a finite stock of coal available – like a country under a gold standard with a finite stock of accumulated gold. But we’re on the “Fed dollar” standard. The Fed can produce dollars in unbounded quantities at almost zero cost. So the only thing constraining it’s emissions of dollars are its own decisions about monetary policy. What it generally decides to do is set an interest rate and stick to it, which means that banks’ issuance of more IOUs is automatically accommodated so as to keep the rate where it is.

              And the ship doesn’t go faster if the guys in the engine room shovel in mountains of coal but the pilot never accelerates. So bringing the analogy over to money again, the central bank can’t generate new lending and new deposit balances by shoveling dollars into reserve accounts. Nevertheless, when those deposit balances are created, they function as redeemable IOUs for government-issued money. The bank money does not function autonomously as a self-sufficient “basic” kind of money. It functions as IOUs that are handles on the basic money.

              Yes, the Fed has been granted a fairly wide degree of operational independence by Congress in conducting US monetary policy, and making decisions about when and how to emit the class of US government liabilities that consist in non-interest bearing notes and reserve balances: the stuff we use as the final means of payment in our society. But this is obviously a Congressional choice since Congress created the Fed and wrote all the laws under which it operates, and Congress is the constitutional seat of the monetary authority of the United States. Congress can make whatever choices it likes in this regard.

              • Auburn Parks

                Thanks for the expansion Dan.

                First thing to understand. I am all on board as far as understanding the nature of fiat money and the foundational explanations that MMT offers. Learning about all this has totally changed my perception of how the world operates (unfortunately this has caused me to despise the news given its inherent ignorance about monetary & fiscal subject matters). The world of economics has been made much clearer to me now that I can view it through the lens of operational reality. However, I just discovered all this about 3 weeks ago and I have been spending multiple hours everyday devouring any and every bit of video, radio, and many of the articles online, but obviously relative to most of the people here I am the ignorant one.

                With all that said…….

                The MMR folks claim that the MMTers have the foundational truth of money creation wrong.
                The MMT folks claim that the MMRers have the foundational truth of money creation wrong.

                One of these camps must be right. I have no idea which one. Hell, I don’t know enough to even know what to begin to look for to in order to go about adjudicating which side has this aspect correct. I simply made the point that maybe both are correct in their own way, but of course I have no way of knowing this, it was simply a suggestion.

              • My apologies in advance if I do not reply quickly or at all to any replies, and my appreciation to others for lucidly setting out what I believe are mistakes, but enlightening ones.

                Dan: Financial liabilities are always liabilities for something. In some cases, these liabilities of one economic agent are debts for the liabilities issued by some other economic agent.

                No, financial liabilities are not liabilities “for something” this way. In this sense of the word “for”, the only thing a financial liability is “for” – is: another financial liability directed the other way, between the same agents. And that is what happens in the example of the borrower paying off his loan with his pre-existing deposit. Bank money, not government money is used.

                Because currency, government money is money = a negotiable debt, it can be used to measure, to denominate bank liabilities, especially in stable, modern, peaceful situations. That is NOT saying the bank liability is a liability “for” the government-issued dollar, the currency.

                Tom Hickey unfortunately makes the same kind of error (I used to make ’em too, and still find myself making them once in a while). Also in a very lucid, instructive, way, here:
                Bank money is a promise to settle in the government’s money on demand, the fact that many intra and interbank transaction settle by netting notwithstanding.

                This gets things backwards. The right statement is: Bank money is a promise to settle by “netting” through intra and interbank transactions notwithstanding that it sometimes settles in the government’s money “on demand” – (when that is physically possible, which is not always true).

                This way of thinking that I have been annoyingly criticizing many on for some time is IMHO what leads to this flatly erroneous statement:

                They create deposit accounts and add to the balances in those accounts, which means that they have increased their debt to the depositor. But the government constantly needs to issue its own form of money so that the banks can service that debt, since the money issued by government is the only legally acceptable final means of payment for that debt.
                “Money issued by government” is of course NOT the only legally acceptable final means of payment for that debt.
                It is ONE “legally acceptable final means of payment” – and not the most fundamental one.

                A cancelling debt to the bank is – e.g. suppose you have a credit card linked to that account, and you have incurred a debt on the card. When the bank withdraws all the money in the account to pay off your balance, and you close the account, and you stop using the card, you and the bank are quits. Legally acceptably and finally.

                So since government currency is not the only final settlement of such demand deposit debts, or even the commonest one, it is not necessary for the government to continually net inject currency/NFA. Balanced budgets & growing economies are possible, are logically consistent. Bank money can function autonomously as a self-sufficient “basic” kind of money, for a time, because it is logically, structurally able to do so. But economies become more unstable with a diminishing proportion of stable government NFA – even more basic money – at the bottom. But that government money is the most basic is merely an empirical, behavioral fact, not an absolutely fundamental, structural, logical, definitional one.

                Auburn Parks: MMTers and fellow damned hippies in their commune, circuitists like Alain Parguez – are right. MMR is confused and confusing. If I ever have time to do more than carp at the good people who post at MMT sites, I will finish and present a critique. What Dan presents above is too “government-centric” and is a bit vulnerable to confused MMRish critique. But in a way that true 200 proof MMT (Monstrous Moonshine :-)? ) is not! Everything IS up to date in Kansas City. They HAVE gone about as far as you can go. 🙂

                I don’t know enough to even know what to begin to look for …
                The place to start is Mitchell-Innes’s papers. Read ’em repeatedly. And read the papers in the book edited by Kelton and Wray on them.

                MMT is not government-centric the way MMR misunderstands and accuses. It just notices that the 800 pound gorilla in modern economies is called “the government”. It is because government is a gorilla that modern economies’ money is based on it. If there were a bigger gorilla, we’d use that gorilla’s liabilities as the most basic money.

                The banks, the 1% are just little chimps, who bamboozle the gorilla into giving them cardboard cutouts of gorillas that look bigger than the gorilla, and then swagger around inside them in order to convince him he ain’t the biggest gorilla. But he is.

                • Thanks for the comments Calcagus,

                  I don’t think interbank netting systems alter anything fundamental in the picture I gave. They just influence the frequency, efficiency and size of the daily settlements between banks. They don’t alter the fact that when payments between Federal Reserve depositors have to be made, they are made with government-issued reserve balances.

                  Just for people who don’t know what we’re talking about, in a system without netting if during the course of a business day Bank A has to make one payment to Bank B of $100,000 and Bank B has to pay Bank C $100,000, and Bank C has to pay Bank A $200,000, then there would three separate payments totaling $400,000. But the net result of those payments is that Bank A has $100,000 more and Bank C has $100,000 less – while Bank B is unaffected. So if they are using a netting system like CHIPS, Bank C will just pay the netting system $100,000 and the netting system will pay Bank A $100,000. In practice with CHIPS, the the bank will prefund CHIPS at the beginning of the day and at the end of the day if the bank’s closing position is negative, and CHIPS will release the net payment due to each bank at the end of the day for banks whose closing position is positive. So in our little example, the total net payments made will only be $200,000 instead of $400,000. The banks can settle among themselves with a single daily net adjustment on the books of CHIPS, rather than a multitude of redundant and offsetting intraday payments. This holds down the total volume of daily payments.

                  But the payments to CHIPS and from CHIPS are made via Fedwire. CHIPS has its own account at the Fed, and so the payments from banks to CHIPS and from CHIPS to banks are settled with government-issued reserve account balances. Because of the netting efficiency, the volume of final payments is smaller. But the medium of making final payments is the same.

                  The same considerations apply to the different kinds of netting that can settle the obligations between a bank and its depositor, or between any two agents who each owe a debt to the other. If the bank has a debt to me and I have a debt to the bank, then the bank might discharge part of its debt to me by canceling my debt to the bank. So if I have a deposit account for $50,000 and owe the bank $2000 as a result of a loan (or a credit card balance), then the bank has a net debt of $48,000 to me. I can pay the $2000 I owe by having $2000 of my deposit account credited to my credit account, thus clearing the credit account balance and leaving me with $48,000 in the deposit account. If I only had $2000 in my deposit account, then the two debts simply offset.

                  But a financial liability is always a liability for something else, even if liabilities can sometimes be offset when two parties owe mutual debts to one another that can be measured in the same unit of account. Debt is a legal institution consisting of legally binding payment obligations determined in most cases by contract. And there is always some kind of thing that constitutes the final payment of that debt. If a bank has a net debt to the depositor in the form of a deposit account balance, then the depositor can demand final payment. The depositor can demand either physical cash, or order a payment from that account to another bank, and net payment obligations between Federal Reserve member banks have to be settled in government-issued money of some form. What will constitute final payment depends on the contract between the parties that created the debt relation.

                  It is not true that all financial liabilities between two parties are for liabilities directed the other way, between the same agents. For one thing, it is possible for only one of the two agents to have a debt, so their can be no debt discharge that consists of reduction of a debt directed in the opposite direction. If I have a bank deposit and don’t owe the bank money, then the bank can’t settle its debt to me by reducing my debt to the bank. In can only settle by making final payment, and that payment must take the form of conveying to me (or to somebody I designate) the liability of some third party – typically the government’s liability. Many financial liabilities involve debts for third-party liabilities of other kinds. For example, I could make a contract with someone to purchase corporate bonds for me. Suppose the deal is that I pay the agent up front on Monday, and that the bonds will be purchased by the agent and delivered to me on Friday. After I make the contract and make my payment on Monday, the agent is in my debt. He owes me something; he has a liability to me. But what he owes me are corporate bonds, which are liabilities of some corporation to whomever is a bearer in due course of the bond. So the debtor has a liability to the creditor, and that liability is the liability for the liability of another party.

                  As one part discharges its net liabilities by making final payment, that final payment triggers the creation of other liabilities between other parties. For example, the corporation might discharge its liability to me by writing me a check on its bank account. The business between the corporation and me is settled. But now the corporation’s bank has a liability to me. I deposit the check and receive a demand deposit balance from my bank, and now the business between my bank and me is closed. But the corporations bank now has a liability to my bank. At the top of this whole system are the monetary liabilities of the government. I call those liabilities “loopy liabilities” for the following reason. The government’s liability to me represented by some form of government issued money I hold might be discharged by netting, when I use it to discharge my tax debt to the government. But if the government has a “net liability” to me of $X after I have paid all of my taxes, there is nothing I can demand for payment of this liability other than another government liability (I can exchange my reserve balances for cash, cash for other forms of cash, etc.). So the the hierarchical structure of liabilities terminates in a loop, where the most fundamental kind of liability is a liability for a liability of the same kind.

            • Dan Kervick

              “loanable funds”, not “loadable funds”

          • Actually, I don’t see the Fed as an evil conspiracy. One can hardly blame banks for looking after their own interests first. I don’t think the Federal Reserve is a good system, but then again, I don’t know if anyone has come with one that works all that much better. So we must resign ourselves to working within a system created and operated by humans, and which will therefore reflect human qualities, both good and bad. And I could not agree more about the behavior of Congress in this area. The one place where we may not agree here is the influence of the Fed’s member banks (and their owners) over members of Congress, which makes Congress’ kid-gloves approach to Fed oversight a lot easier to understand.

            But I digress. In my original post, what I was trying to get at was the reason why the freshly-minted dollars add to the Federal debt. The reason is that those dollars were in fact issued by the Fed, not by the US Treasury. They made their way to the US Treasury in return for Treasury bonds, through the somewhat circuitous route through the Fed’s member banks. So in all senses of the word, the dollars so created are balanced by debt instruments, and so must contribute to the Federal debt.

  12. Pingback: Real Dollars and Funny Money | Fifth Estate

  13. Thanks for a that brilliant post JD.

    The oft repeated dismissive references to ‘funny money’ (vs supposedly ‘sound money’) needs to be robustly challenged to show up the people that utter these phrases don’t know what they are talking about.

    One quibble, perhaps due to deliberate simplification, is your statement that “The U.S. government’s keystrokes, in contrast, create dollars that DON’T have to be repaid—ever”. But doesn’t that break the MMT cycle that, apart from money that ends up in savings, the dollars all ends up going back to the government as tax?

    Again, thanks for an excellent piece, which is right up there with Warren Mosler’s best.

  14. @JD — I noted a comment by Matthew Berg ( that seemed to conflict with your clear presentation here. Would you care to clarify further in the discussion there?

  15. Great post, JD; and great comments, Dan!

  16. You used lucidity and lucid within the same post…

  17. Dan Kervick

    I’m in an airport so no chance to respond at length. But a few points:

    A bank deposit is a debt of the bank. When you draw on your bank deposit to withdraw cash, it is obvious that the bank did not issue that cash. The cash was issued by the Fed. When you withdraw the cash, the bank is making good on its debt to you. Just as in the case if other debts, the debtor can pay off the debt by conveying to the creditor the debt of a third party that the creditor is willing to accept. In this case the third party debt is the rather unusual “liability” of the us government. You agreed to accept that liability from the bank in payment of the bank’s debt when you made your deposit agreement with them.

    Legally, the status of the banks IOU and an IOU you issue yourself is not very different. It’s just that the bank’s debt is more generally acceptable than a personal IOU, and almost everyone will accept it for payment of debt. The bank even operates machines for paying its debts. Those machines don’t dispense more bank debt. They dispense Fed-issued liabilities.

    Unlike the government a bank cannot pay off its debt to you just by issuing more bank debt and conveying it to you. The bank is required to pay off the debt with the money issued by government. If it doesn’t then it is in default.

    Banks can’t pay for merchandise simply by issuing some sort of pure medium of exchange and paying with its own issued money. It can create a deposit account for the seller of the merchandise and put a balance in it. But that balance is a debt to the seller. And when that seller either withdraws cash or issues a draft ion the account to a depositor at another bank, the bank then has to pay its debt by drawing on its reserve assets, which consist of government issued money that the bank had to obtain and did not create.

  18. John Hermann

    The answer is very simple actually. The bank asset (the loan) is a security, but it is not money. The deposit created (the bank’s liability) is of course money.

  19. Sorry but without that your points have not foundation.

    It may come as a shock but there is no way around it.

    • joe bongiovanni

      I realize you must be busy, but please take the time to say which points that I have made about anything are influenced at all by whether primary dealers purchase initial GUV security offerings on buyers’ orders.
      Unless, of course, I missed the memo that made DAB ‘the decider’.

  20. Of course reserved are money. If they weren’t banks would never be able to pay one another. The dollars that the treasury has in its account at the Fed are the same status – they are direct liabilities of the Fed, which makes them liabilities of the US govt.

    You say that you understand the legal structure of the system, but you are not getting it. The govt imposes tax onligations that its citizens settle with their bank’ s deposit balances, but that just means the bank then has an obligation to the government that it can only settle with its reserve balances – and that form of money is not issued by the banks themselves

    • joe bongiovanni

      I know you think you’re right about this, Dan.
      Sorry, but reserves are not money and the fact that you cannot distinguish between an account-balancing identity and the national, legal tender, exchange media is an example of the failures of MMT to square its corners with legal, historic facts. Money DOES have a legal definition and I assure you that reserves are not even close. Please read through the federal statutes on the money system and tell me where reserves are legally defined as money. They cannot be.

      Banks don’t PAY one another with reserves, they use reserves to settle account balances that must be ‘squared’ with real money. But that’s ALL the banks do with them and that’s all that the national economy does with them. They settle central bank account payment balances so they don’t have to carry bags of money around. They do have a relationship with money, like the poker chips discussed elsewhere. But you can’t buy a beer with a poker chip, and you can’t buy or sell a good or service anywhere in our national economy with reserves.

      As CB reserves replaced the gold-relationship with money in circulation, non-money reserves can be anything, and anything can be reserves. Cash money is MB reserves. If that cash comes to circulation in my pocket, it is still money, but it is no longer reserves.
      If reserves were money, then we the people would work for reserves, we would get paid and pay with reserves, we would borrow reserves and banks would lend us reserves. Rather, we do all that with money.

      Finally, on the ‘taxing’ matter. It’s really too bad that MMT is born from a double-entry accounting identity. Were it not so, it would be free from these accounting excesses.
      “”The govt imposes tax obligations that its citizens settle with their bank’ s deposit balances,..”” Period. What has happened is that a financial obligation between two economic players has been settled. It is done. The players here are the taxpayer and the government. When the ‘transaction’ between the taxpayer’s bank and the Treasury TGA takes places, there is a concurrent adjustment of both banks’ balances and reserves. There are not two ‘forms’ of money that transact. Rather there is one monetary transaction and one accounting ‘adjustment’ of bank reserves.
      Again, Dan, my request is to prove otherwise. Not by anecdote, or hyperbole or metaphor or stylized reality. But by cold, hard facts.
      If a notion about money is incapable of fixing all that is wrong with the economy, then that notion is not money, and it is of no use to discuss it.

  21. Dan Kervick

    Reserves are obviously money. What in the world are you talking about? Reserves are the greatest part of MB which is one of the two principle types of monetary aggregates the Fed measures. Reserves provide the clearing balances for interbank payments, and are routinely borrowed and loaned in the interbank market. Government-issued cash and commercial bank deposit balances are the form of money that us used by most households and businesses to make payments, and reserve balances are the form of money used by banks to make payments.

    • joe bongiovanni

      Dan, your statements are in contradiction to reality and confirm exactly what I have written about the difference between reserves and money.
      First, we need a legal definition of money in order to square the corners of CB ‘reserves’ with that definition.
      F.A. Mann’s “The Legal Aspects of Money” Ch. 1 which includes both private and public law on money.
      “In law, the quality of money is to be attributed to all chattels, which, issued by the authority of the law and denominated with reference to a unit of account, are meant to serve as a universal means of exchange in the state of issue.”

      You see, right there Dan is where we have the problem of MMT’s penchant for, first, considering that reserves are money, and second, in deadly macro-economic heresy, claim that the issuance by the private CB of these account-balancing norms is all the proof we need that the government creates the nation’s money.

      The three problems with that belief are that the CB is not the government, that the accounting balances the private CB issues remain within the banking payments-settlement system, and that these private CB reserves are never meant to serve as a universal means of exchange. Thus, reserves are not money.

      So, if reserves are not money as a matter of legal fact, then what is to be gained in discussing them at all within our great social transition, to be achieved by using the powers inherent in a sovereign, fiat money system? We should forget about them and talk about the real money that matters in real commerce and real economy.

      Having come this far, Dan, I’m going to give this to you straight. As in AMI’s evaluation of MMT, it includes 3 throwaways. These are ‘truths’ that have crept into MMTs understanding of modern money systems, truths that just ain’t so.

      The first is a stand-alone from Dr. Wray’s research. Money is not debt. Mitchell-Innes traditional, and self-perpetuating, banker’s view of money-as-debt is deeply enriching for our modern aristocrats – and wrong.

      The second and third tie together Warren Mosler’s and Stephanie Kelton’s contributions.
      MMTs belief system around reserves stems from Warren’s intricate understanding of the workings of the FOMC’s trading system and the CB’s payments system, which is correct, but which should never come to the conclusion that reserves are money. If he has done so, I have not seen that he has.
      And then there is Dr. Kelton’s integration of the deepest machinations of reserve accounting to prove that the government creates and destroys money through taxing and spending – because when you debit a negative, you positive.
      Positive or negative accounting outcome, the government’s USE of the money system does not result in creating a dollar($US).

      Dr. Kelton’s research really shows that you can’t have two governments running the money system, one at the Fed and one at the Treasury. Take the Treasury out of the private Fed banking/payments system and see what happens – the Treasury is a USER of the private money system.

      So, what needs to be asked about this reserves-are-money belief is this. How are you going to use reserves to achieve full employment?

      • Dan Kervick

        Joe, as I am sure you are aware, you can find numerous documents issued by the US government in which reserves are classified as one component of the money supply. But you can hold that those documents are all legally invalid and rely on your one solitary old mid 20th century jurist if you wish.

        You’re making mountains out of molehills here. Like the Austrians with their hysterical denunciations of “funny money” and the like, you seem to want to insist there is one true and proper money, and all of the. You also seem to think there is some important difference between “settling” and “paying”. There isn’t. Banks use their reserve balances at the Fed to settle their debts to other banks just as you and I can use our commercial bank deposit balances to settle our debts to the restaurant where we just bought our lunch. It’s exactly the same thing.

        You refuse to attend to the legal structure of the liabilities issued by bank liabilities. You don’t seem to understand that the ability of people to use their bank deposit balances to pay one another in an economy filled with a multitude of private banks depends on the fact that banks can use their reserve balances to pay one another. When you write a check to a contractor that the contractor then deposits in his bank, the debt your bank had to you is first converted via your authorized payment order into a debt the bank has to the contractor and then via your contractors indorsement of that payment order into a debt your bank has to your contractor’s bank. The only reason the contractor’s bank is willing to accept that check and give the contractor an additional deposit account balance in exchange for it is because the bank is confident it will get paid by your bank. Getting paid in this case usually means that your bank’s reserve account is debited by a given amount and the contractor’s bank’s reserve account is credited by that amount. This is exactly the same thing that happens between your account and the contractor’s account when there is only one bank involved. The crediting and debiting of accounts; the conveyance of debt from one creditor to another, is how payment usually happens.

        How and in what way bank reserves could be involved in generating full employment via a government employment program depends on the means the government chooses to employ. If it relies on the most conventional methods, it would work something like this: The US government could first issue and sell $100 billion in treasury bonds. Most of that $100 billion would as a result be drained from bank reserve accounts in completing the bond transactions, and credited to treasury accounts, while the bonds would be deposited in securities accounts owned by the purchasers. The government would then write checks to purchase $100 billion in goods and services. The recipients of those checks would deposit them at their banks, and the settlement and clearance of the checks would result in $100 billion flowing out of the Treasury account back into bank reserve accounts. What else happens depends on other factors, such as how much of the newly issued debt is purchased from the public sector by the Fed.

        None of the bond transactions are really necessary, however. Congress could pass a law directing the Fed to credit the Treasury account directly. Then when the Treasury spent, the money would move from the Treasury account to bank reserve accounts. The result would be the same as if the Fed had created those reserves directly.

        • joe bongiovanni

          Let’s just leave it at that, Dan.
          There is obviously some questioning to be done by someone else.
          Some day MMT is going to have to come to grips with reality.
          I try to show why and how this is true.
          Because its heart is in the right place.
          Hanging on a thread of accounting quasi-reality may suffice at this stage of development of the theory, but when we get to the real world, the laws that will be passed to facilitate a full-employment, living wage, egalitarian and truly democratic economy will not be about the private Fed directly buying government bonds.
          They will be about restoring the power of money creation and issuance to the people where it belongs.
          The issuance of government bonds will be history..
          And reserve accounting will go the way of the dinosaurs.

  22. Well then you have just admitted that the government can create money. Now that that is done…

    • joe bongiovanni

      “”……. you have just admitted that the government can create money…””
      In case you’ve missed the point of my advocacy for real public money administration here, it is that, of course the government can not only CREATE money, but also issue and regulate the value thereof.
      The problem, DAB, is that our government(U.S. Treasury) does not create-and-issue the nation’s money (coins excepted)c.e..
      The sovereignty of a nation includes monetary sovereignty, which is all that is needed to show that a government CAN create-and-issue its currency.
      But government’s can, and do, lose the autonomy and independence that sovereignty provides over its money system. Countries never really lose their sovereignty over money.
      The Euro is an example of participating nations losing their monetary(currency) autonomy, and here we have the sovereign’s abdication to private debt-based money creation and issuance as an example of losing monetary independence.
      I gladly admit, and rather loudly proclaim, that the government CAN create and issue the money – and equally loudly proclaim that it doesn’t.
      And that’s the problem that MMT does not get.
      For the Money System Common.

  23. And yet you admitted that it does right now through bonds that are bought without preexisting money.

    You’re going to have to do some serious squirming to get out of that one.

    • joe bongiovanni

      Squirming master here, DAB.

      Please consider….

      The purchase by the the private central bank of existing open-marketable Treasury obligations never creates any new money – in and of itself. It’s strictly a balance-sheet transaction of assets and liabilities.

      When these Treasuries were ORIGINALLY issued, the government borrowed already-existing, bank-created monies for use by the government to pay its expenses. That’s the essential reality. The U.S. government is a user, and not an issuer, of the currency. The money was previously created by the banking system, and later, in using that same money to buy the Treasury security, the banking system lent that money to the government.

      Now, when those same Treasuries came onto the market last week or month, and the private CB took them out of the private market(for whatever purpose) – again, what took place was a balance sheet transaction. The Fed took the Treasuries on to its balance sheet and the banker(s) took reserves onto its balance sheet.
      The Fed didn’t create any money.

      Just for discussion, and possible edification, did the money supply change?
      And, pray tell, with One Point Seven TRILLION dollars in excess reserves already on the CB-depository balance sheet, what actually changed in the world of money by adding another $60 Billion in excess reserves to the Fed’s bankers?? Nothing.

      The possession of reserve balances by the Fed’s depositories creates credit-creation space – that’s all it does. Now those banks have even MORE lending space. But they’re not lending. As my Dad always said, fractional-reserve banking does not work in reverse.

      Banks need to have reserve balances at some points in time and in the old days (’50s and ’60s esp.), reserves mattered somewhat. But today, reserves are completely meaningless. Most banks meet their reserve requirements with cash balances.

      The most significant thing about reserves today is the fact that the CB pays interest on reserves. While negating the bankers complaints about lost potential revenues, the main CB operational gain from the move is to completely obviate OMC activities in order to manage interest rates. They are all managed by the reserve interest rate.
      Quantitative easing was originally called – quantitative monetary easing. But, that’s a lie.
      Easing (or expanding) the quantity of reserves has zero effect on the money supply, unless the money supply is already at reserve capacity.

      So, there it is, DAB.
      Straight Up.
      No squirming necessary.
      Only understanding.
      If we want the government to issue the money, then we NEED to change the system.
      For the Money System Common.

  24. Banks are capital constrained not reserve constrained… Now stop it.. You’re just talking in circles because you hate that the would doesn’t operate the way you want.

    • joe bongiovanni

      That would be funny if you were not serious.
      I just said that reserve requirements are meaningless, the result being that banks are no longer reserve constrained as they once were. I never said banks weren’t capital constrained. That never came up. Banks are regulated in multi-faceted ways. But many commercial banks today still must meet reserve requirements every other Wednesday – as I said they are automatic due to to QE flooding the reserve market, and because currency provides about all the reserves that are needed. But I seem to have lost your point. I thought we were discussing whether the government creates the money.
      I don’t hate the fact that the world doesn’t work the way I want it to.
      I don’t hate anything.
      Not even hate.

  25. Sorry for the tone… I engaged you. I agree with the end you advocate.