How Fiat Money Works

By Chris Mayer*

Warren Mosler tells a good story that shows how our economy works at its most basic level.

Imagine parents create coupons they use to pay their kids for doing chores around the house. They “tax” the kids 10 coupons per week. If the kids don’t have 10 coupons, the parents punish them. “This closely replicates taxation in the real economy, where we have to pay our taxes or face penalties,” Mosler writes.

So now our household has its own currency. This is much like the U.S. government, which issues dollars, a fiat currency. (Meaning Uncle Sam doesn’t have to give you something else for it. Say, like a certain weight in gold.) If you think through this simple analogy, all kinds of interesting insights emerge.

For example, do the parents have to get coupons from their kids before they can pay them to do any chores? Obviously not. In fact, the parents have to spend their coupons first by paying their children to do chores before they can collect the tax. “How else can the children get the coupons they owe to the parents?” Mosler writes.

“Likewise,” he continues, “in the real economy, the federal government, just like this household with its own coupons, doesn’t have to get the dollars it spends from taxing or borrowing or anywhere else to be able to spend them.”

The government creates dollars. It doesn’t even have to print them. The vast majority of spending is simply done by adding electronic dollars to bank accounts. Therefore, the U.S. government can’t go bankrupt. It pays all its bills in U.S. dollars, of which it is the sole issuer.

This sounds really obvious, but it is amazing how many people — even very smart people — forget this simple fact. They get hysterical about the fiscal deficit or the national debt. (This is not to say there aren’t bad consequences from issuing too many coupons, or from government spending in general.) The only way the U.S. government can default is if it chooses to do so.

Going back to Mosler’s example, let’s ask another question: How can the kids “save” coupons in excess of the weekly tax? Well, they can only do that if the parents spend more than they tax. There is no other way to hoard coupons. In the real economy, the same is true. The private sector can save dollars only if the government spends more than it taxes. Spending pours fiat money into an economy; tax payments drain it away.

Another question: Do the parents have fewer coupons if they spend more than they tax? No. The parents make the coupons. They don’t even need physical coupons. They can simply track them on a piece of paper or in a spreadsheet. Likewise, the U.S. government doesn’t have any fewer dollars after running deficits. It can’t run out. (There are real-world restraints on how much government spends.) To borrow from another Mosler analogy, the U.S. government can no more run out of dollars than a scorekeeper can run out of points.

You don’t have to like this. (I don’t.) It’s merely a description of how a fiat currency system works. That’s the world we live in. Too many people tackle economic questions ideologically. I can be as guilty of this as anyone. My own view of the state is that it is, at best, bumbling and incompetent and wasteful. At worst, it is an evil force on society. (My sympathies lie with those old American radicals, such as Lysander Spooner [1808–87]. If you don’t know who he is, look him up. He was a great American. I have his six-volume collected works here on my bookshelf.)

Nonetheless, after much reading and thought, I agree with Mosler: The state’s ability to enforce tax liabilities, fines and fees drives the demand for money. Or as Mosler says, “Taxes drive money.” This is a view of money called “chartalism” and it is one I subscribe to. It has been around a long time. And it forms one of the building blocks of a school of thought Mosler helped to found, called Modern Monetary Theory (MMT).

It’s hard to talk about MMT with people, because they are often quick to draw hasty cartoonish conclusions about what MMT is or represents. (I have to admit, I choked on MMT a bit at first, too.) Over the last several months, I’ve read a handful of books and perhaps a dozen academic papers on MMT. So I believe I can speak by the card.

On one level, MMT is simply a description of how a fiat currency system works. On another level, there are policy prescriptions that flow from this understanding. My only advice on the latter is this: Don’t let your politics deter you from making sense of MMT. (MMT itself is politically agnostic.)

I’d recommend both of Mosler’s books. Start with The 7 Deadly Innocent Frauds of Economic Policy. It’s a short book, just over 100 pages and written in plain English. Mosler has a gift for making complex things simpler. If you try to think through the issues in an honest way, you’ll come away with some “Ah-a!” moments.

Then you can move on to Soft Currency Economics. Believe me, these books will challenge your long-held views on money. (Always a good thing, in my mind. What’s the point of only reading things you know you’ll agree with? Challenge yourself… or ossify.) If you want more, pick up Randall Wray’s primer Modern Money Theory.

Mosler himself is an interesting character. Unlike most economists, he is no armchair theorist. Mosler made a lot of money in markets. And in markets, you get paid to be right, which is where all too many economists fail.

Warren Mosler is, like me, a former banker. He began his career in banking in 1973, working to collect on bad loans. After a year of that, he became a lender. And I can tell you: This is great training for an investor. As Mosler recounts, he had ongoing discussions with his boss about the “logic of banking” and the “theory of lending.” As every lender learns, you want to make loans where the odds are heavily in your favor so that profits easily make up for small (but expected) losses. Investing is not much different.

Anyway, Mosler was a good banker with a head for the odds and the payoffs. Eventually, he would move on to manage the bank’s $10 million investment portfolio. He came up with a bunch of good, if unconventional, ideas. He made the bank a lot of money pursuing no-risk trades. Mosler had a knack for smoking out mispricing in the market for things like bonds and CDs.

He went on to join the Wall Street broker Bache & Co., followed by Bankers Trust and then the investment-banking firm of William Blair & Co. in Chicago. (In his books, he recounts his adventures at these places.) He made each firm a bunch of money with his “free lunch” trades, just as he did in his banking days.

In 1982, he co-founded his own fund, Illinois Income Investors (III). Over the next 15 years, III would rack up a remarkable record with only one losing month — and that was a 0.1% loss due to a timing issue that reversed the next month. Managed Account Reports ranked III No. 1 in the world through 1997, when Mosler left the firm.

One great story Mosler tells in both books is how he cleaned up on another free lunch in lira-denominated bonds in the early ’90s. This was before the euro and back when there was worry over a default by Italy’s government. Italy’s national debt was 110% of GDP and interest rates were high on its bonds.

But Mosler knew that it was the sole issuer of lira. Italy could not default unless it wanted to. Mosler actually met with senior officials in Rome to let them in on the “secret.” Long story short, Italy didn’t default. Mosler’s fund made over $100 million.

For an investor, macroeconomics has limited uses most of the time. Mosler’s career shows this can be otherwise. But then again, you have to study economics that actually describe the real world. And Mosler’s economics, or MMT, does that rather well.


Chris Mayer is the editor and founder of Capital & Crisis, a financial newsletter published by Agora Financial. This piece appeared in the February 2014 issue of Capital & Crisis, published on January 7. 

Chris, a former banker, comes to MMT from the Austrian camp. (He used to write for the Mises Institute). “I read Mosler’s books on a plane and the proverbial light bulb went on,” he writes. “Since then I’ve read Wray’s books and various MMT papers, all of which forced a major change in my thinking. But I’m convinced MMT is the right approach.”

50 responses to “How Fiat Money Works

  1. Although the state can be, ” at best, bumbling and incompetent and wasteful” it does not follow that it has to be or that the private sector is necessarily immune from the same ills. Social Security is a good example of an efficiently run program, and I am sure Chris Mayer could cite many examples of private enterprises that have been wasteful and bumbling, especially in large corporations where only the “company’s money” is at stake. I think this problem is especially acute in today’s plutocracy where lobbyists and politicians work hand in hand to direct spending into the right “channels”.

    • The private sector can be just as wasteful as the public; however, if an investment does not work out, it has to be liquidated along with the respective financial claims. In the public sector losses due to wasteful use of resources are never recognized, nor are the respective financial claims ever liquidated. If the government borrows or prints $2 billion to build a bridge to nowhere, the productive capacity of the economy is not improved in any way; however, the $2 billion financial claim persists basically in perpetuity (unless, of course, the government ran a $2 billion surplus in order to liquidate such claim). As a result, active fiscal policy tends to suppress productive capacity while increasing financial claims, which is the perfect recipe for inflation. The stagflation in the 1970’s was a direct result of active fiscal policy in the prior decades. Also, I agree with your point about the lobbyists. Unless a government program is designed as a self-funded insurance pool (such as the FHA Insurance fund), government spending (including tax expenditures) tends to benefit one group over another. This shifts incentives away from productive investment and toward government cronyism. Rather than investing in the real economy, corporations hire armies of lobbyists and tax attorneys.

      I also have an issue with how the parent/children story simplifies the origin of fiat money. Think for a second – why would parents give coupons to kids to do chores, tax them later and punish them if they don’t pay the tax? Parents will simply make the kids do the chores and punish them if they don’t – no coupons needed. Neither do governments need to pay people to conscript their time and labor. Think of the military draft during the Vietnam war. To illustrate the true origin of fiat money, you have to change the story a little bit. The kids are required to do 5 chores a week. Suppose the father has to go on a business trip and doesn’t have time to mow the lawn. He offers two coupons to the child who is willing to cut the grass for him (in addition to the 5 chores for the week). The coupons can be redeemed in the future for two of the weekly chores (the extra coupon serving as incentive or interest on the borrowed resources). This is the true origin of fiat money. The coupons represent borrowing by the parents and the interest is what compels the kids to lend those additional resources. Government debt came first, and fiat money came later. This is the reason why the US Treasury does not have the legal authority to print money but has to borrow it first and pay interest. US dollar bills or T-bonds represent one and the same – borrowing of real resources by the government.

      I agree with MMT that technically government can print as much money as they want, and many have. But the real question is whether people are willing to hold that money at 0% interest – in other words, are people willing to lend real resources in exchange for those paper bills. If the answer is yes, as has been the case in the US since the 2008 financial collapse, governments can print as much money as they want. But as soon as that demand for money changes, the bill will come due. If the Fed does not withdraw those balances and continues to keep interest rates low, we will have inflation. If the Fed begins to tighten the money supply, we will have higher interest rates. MMT often says that governments are not financially constrained. I have to disagree. The demand for money is what imposes limitations on both fiscal and monetary policy.

      • I also have an issue with how the parent/children story simplifies the origin of fiat money. Think for a second – why would parents give coupons to kids to do chores, tax them later and punish them if they don’t pay the tax? Parents will simply make the kids do the chores and punish them if they don’t – no coupons needed.

        I don’t think anyone in MMT has implied that states can’t and haven’t also imposed real (non-financial) obligations on its residents, especially on the under classes of society. Although the simple parent/child analogy can’t tease all of them out, there are plenty of good reasons to prefer provisioning the government via taxes rather than by press-ganging labor and taxing natural resources directly. Imposing a tax burden creates a marketplace for government provisioning, which is usually more motivating, more efficient, and easier to manage than the central planners demanding such-and-such from so-and-so. Payment via IOUs also allows measurement of accumulated private credit-wealth, which is a simple way to harness the marketplace to reward some labor (e.g. palace courtesans) more than other (e.g. press-ganged moat diggers). Even in the case of conscripted labor it still makes sense to pay in fiat currency. The best way to provision/reward the army is to impose a tax burden on everyone else (forcing everyone else to “do their part” to feed/reward the soldiers). On top of that, the closer a state represents a democracy, the more people are going to resent being press-ganged into service not of their choosing. So under most circumstances, a tax-credit-based system is also the most just way of provisioning the government.

        This is the true origin of fiat money.

        A citation from researchers in archaeology, history, or anthropology would go much farther than your analogy followed by your assertion. (I’ve left out citations above because the MMT literature is chock-full of them already. But if you need help finding them, I’m sure folks here can point you in the right direction.)

        The coupons represent borrowing by the parents and the interest is what compels the kids to lend those additional resources.

        I don’t know about your dad, but my dad might have simply told me that I need to also mow the lawn that week (i.e. raised the tax obligation). I might have negotiated and gotten out of another less important chore in exchange for doing that one (i.e. same basic tax obligation, but with extra resources expended on negotiation, thus possibly less efficient than the coupon/market-pricing system). The father doesn’t need to provide interest on the coupons in order to get the work done (many kids would be happy to simply have less work to do next week as reward for more this week) and if his goal is to simply get the work done then providing interest might even be counterproductive. Also, what resources are the kids lending other than their hours of labor, which the father is already quite capable of extracting from them (via raising tax-obligation or conscripting the labor)? By your analogy, they are doing extra labor one week, but in aggregate they are providing the same amount of labor (or less if there is an interest payment).

        Government debt came first, and fiat money came later

        Fiat money is IOUs, tax-credits, government liabilities. In the sense that all liabilities are “debt”, then all fiat money is also government debt.

        In your updated analogy the coupons still represent nothing more than credit towards chore obligations, and you haven’t introduced any new (non-fiat) liabilities for the father. The imposed chore obligation is still a tax. So the demand for coupons is still driven entirely by the chore-tax obligation. First, tax obligations are imposed, then comes spending (coupons in exchange for mowing the lawn), then taxing (either you surrender the appropriate mix of chores and chore-credit-coupons, or you get punished).

        This is the reason why the US Treasury does not have the legal authority to print money but has to borrow it first and pay interest.

        The US Treasury doesn’t have that legal authority because the laws were written with the gold standard in mind, dollars were convertible into gold at a fixed exchange rate, and the government needed to manage its promises of convertibility. But access to gold is a silly thing to base an economy on, and the laws are out-dated.

        • I agree with everything you are saying. I used a poor example to make my point. In 1971, when the US fully closed the gold window and the US dollar truly became a fiat currency, the federal debt stood at around $425 billion or 36% of GDP. What I am trying to say is that the US borrowed and spend money into existence; not tax and spend money into existence as the parent/child story in the article suggests. There is a very interesting historical account of how the Bank of England and the British pound got its start. In 1694, the English king borrowed $1,2 million of gold bullion from a group of merchants, who incorporated into the Bank of England and received a monopoly on bank note issuance. The king chose to borrow even though he could have chosen to tax.

          Could governments have created money by taxing and spending it into existence. Absolutely! But that’s not what happened. Borrowing is a much more palatable way for governments to requisition resources, because unlike taxation, borrowing involves a voluntary transaction between the state and its citizens. And it is precisely for that reason that governments have to pay interest as to compel the public to engage in this voluntary transaction. It is the balance between the supply and demand for money that determines the interest that governments have to pay. As a result, governments are financially constrained because they do not control the demand for money. Interest rates, CPI and unemployment are the measures of that constraint. For that reason control over money supply is vested with independent central banks with a mandate to keep those measures within acceptable range.

    • Certainly agree.

  2. “My own view of the state is that it is, at best, bumbling and incompetent and wasteful. At worst, it is an evil force on society. ”

    Wow, MMT is a big tent.

    • Well, yeah, and it ought to be. There’s nothing in MMT that can’t appeal to anyone, regardless of their views of government. It’s not just for Progressives.

      If there’s going to be government, and government is going to define the unit of account, issue a sovereign currency and demand taxes in that currency, then it is the only one that can be held responsible for managing the currency and the economy. Not by micro-managing or central planning, but only by taxing the right amount so as not to cause excessive inflation or unemployment. They do control those things, whether they want to or not – that’s what MMT shows us. How much to spend and what to spend it on are political questions, and different cultures and countries will have different answers. They can all use MMT.

      • I know what you mean and don’t mean to re-litigate the issue here. Lots of folks want to draw a bright line between the descriptive elements of MMT and its policy implications. But I don’t think that’s particularly helpful — except maybe as a pedagogical device. The policy implications of MMT are what interests me the most and, to me, they are clearly progressive — in a really fundamental moral and philosophical sense.

        I think this is particularly true in communicating MMT and winning over converts. Start with the big policy questions, then move to the policy implications of MMT, and finally emphasize values and preferred outcomes.

        BUT YMMV.

        • I guess I don’t read all the writings of all the MMTers, but all the ones I read except Mosler are openly Progressive. They see the expanded “policy space” as an opportunity to fund their pet projects without causing the inflation predicted by other macroeconomic theories. Conservatives would see the same thing as an opportunity for tax cuts that don’t have to be “paid for”. There is nothing inherently Progressive about the desire for full employment and prosperity, and the different paths to that common goal satisfy a variety of political desires.

          • Auburn Parks

            Full employment may not be antithetical to some vague notion of “conservatism” but it is absolutely antithetical to 99.9% of the republican party and far too much of the dem party.

            • I don’t think so. Republicans were for quite a while, and conservatives are still, loudly critical of Obama economics on the grounds that the recovery has been the slowest on record, and unemployment still, after 5 years, unacceptably high.

              Not being MMTers, they don’t think 0% unemployment is possible without massive inflation, but they do believe in trying to be as close as possible to NAIRU.

              • And this is the party that got together the night after his election and decided their strategy would be to oppose everything Obama wanted to do whether it be good or bad and to be relentlessly negative about him. You are taking something seriously they are saying about Obama?
                Come on Golfer, I think you know better. They are out to destroy Obama regardless of the harm they do to the country and they’ve made it clear that that is their strategy.
                They represent the rich people of the country and haven’t cared about the rest of us. They just denied much needed long term unemployment to the people. They want to destroy social security which has been our most successful anti-poverty program. Roosevelt had it right, they want economic slavery. They want our workers competing against the workers of China, Vietnam, India and anywhere they don’t pay a livable wage.
                It’s an old book but you should read ‘The Revolt of the Conservatives, a History of The American Liberty League 1934-1940’. The rich haven’t changed, they just hide their motives better.

                • As a general rule, ” is/does/says/believes ” is false for most values of X and Y. Regardless of their impressive solidarity, modern conservatism is a very strange and heterogeneous coalition. Mosler’s rule of thumb, Hanlon’s razor, “Never attribute to malice that which is adequately explained by stupidity” is not just a good rhetorical technique, in my experience with political debates with normal people (i.e. not-politicians) it is usually the correct assumption.

                  Yeah, yeah, clearly there are many self-described conservative (and liberal!) politicians and lobbyists that are evil and cynical and don’t care about the truth or believe most of what they are saying. They need to be called out, regularly. Yet Elizabeth Warren is still able to find some ultra-conservative Republicans to co-sponsor her bills. There are far more who are better described by Mencken/Sinclair quote: “It is difficult to get a man to understand something, when his salary depends upon his not understanding it!” or who want to justify their behaviors and have (perhaps unconsciously) chosen a worldview that praises them. And there certainly seems to be a conservative tendency to lack empathy for those with experiences outside of theirs. But there’s also a liberal tendency to have empathy for everyone except conservatives.

                  Most of the conservatives I’ve had the pleasure to debate truly are attempting to argue in good faith. If you start the conversation by insulting them with epithets that may fit the fat-cat-rich-tycoons but doesn’t fit middle class religious “patriots” like them, they will (rightfully) discount everything you say afterwards. If you start the conversation by insulting them and the insult does match the target but the target considers themselves basically a good person and isn’t prepared to understand/accept your insult, you might win points from those watching on the sidelines but you won’t be “winning friends and influencing people”.

                  While discussing the Job Guarantee and payroll tax holiday with one of my most politically active and most conservative friends, he was at first dismissive because I compared it to WPA and the New Deal, but after some more discussion he agreed “all of these ideas sound at least palatable and at most very good when explained properly.” If I had started out by claiming that he opposed Obama purely out of spite or that he represents the rich people and doesn’t care about the rest, I would have been wrong and he (rightfully) wouldn’t have stuck around to continue the conversation (and I would have needlessly soured a friendship).

                  There truly is a lot in MMT that the majority of voting conservatives can love, even including some of the most important policy prescriptions. Lower (payroll) taxes and moving people off of welfare and long-term unemployment into JG are easy sells to most conservatives (after you’ve shown that they are economically viable). It’s also easy to convince many conservative voters that our politicians and media use the deficit hysteria and manage our fiat currency like a smoke and mirrors shell game, if you can sit down to discuss it calmly with them.

                  • Thanks nick for making some excellent points. It seems to me that MMTer s are missing an opportunity to sell their understanding and increase their chances of actually seeing their programs enacted by not using the appeal of lower taxes and a JG to recruit converts from more conservative voters. MMTer s understand that taxes do not fund the federal government but that tax policy is really to encourage certain types of behavior and discourage other types. MMT could use the appeal of lowering taxes (the holey grail to many conservatives) to garner support for their programs. Hard core Libertarians wont bite, but a large percent of conservatives are not Libertarians, just working Joe s who want to keep more of their earnings and see that their families have a better life.

                  • Oops. My first line was gobbled up by the HTML tag scrubber. It should have read ”Heterogeneous group X is/does/says/believes assertion Y.”

                  • Thank you, Nick.

                    The dialog here reminds me of another saying: “Conservatives think liberals have bad ideas, liberals think conservatives are bad people”.

                    MMT would make more progress, I think, if its advocates adopted your attitude. They wouldn’t even have to be sincere, just willing to be civil.

                    You know you will be drummed out of the Progressive movement now, right? There is no tolerance for any deviation from the party line.

                  • I ‘m referencing the fact that every republican in the senate agreed to oppose anything Obama proposes and to speak evilly of him every chance they get and they’ve been doing it for over 5 years with almost no breaks in their solidarity. How many votes have we had on Obamacare from the house republicans?
                    None of them cared how much damage they were doing. It’s the process they chose to bring down Obama.
                    I’m aware that one will occasionally break like Coburn and do something with Warren but it’s rare.
                    You should read Lewis Powell’s letter in 1971 to the head of the chamber of commerce. They have followed every recommendation and have far exceeded what he recommended. When you read it, you can see how paranoid he was.

                  • Ok Nick let me know when you sit down with the Kochs and discuss things. Yes, I have conservative friends I have beer and wine with and we can discuss things. Guess what! They don’t make the decisions but they do help elect the guys who do. Have you changed how they vote? I don’t confuse them with the people who are making the decisions. Those are the guys I’m after.
                    You sound like you don’t know right wingers. I’ve been in discussions with them and they don’t give anything. They hate anything that’s different from them. There are conservatives and there’s the right wing who pride themselves on not negotiating. They’ve also been very successful at taking control of the republican party. They call Obama a Muslim, Hitler, Stalin, a traitor, evil, etc. The conservatives are attempting to take back their party right now. There’s a real world out there and I suggest you read Bill Black’s series on what’s happening in Kansas. That is the real right wing world.
                    I still suggest you read the book I suggested on the American Liberty League. A lot of it sounds like what’s happening today.
                    I don’t call the other side names but I know who they represent and I’m honest about it. I realize how they’ve organized and how effective their organization is. Their votes tell me what I need to know. There are plenty of democrats who are bought off also. Why do you think inequality is at the highest levels since the 1920s. You believe that’s an accident? There’s a real world you should look at.
                    Read Powell’s letter and start understanding why they have out maneuvered the progressives and they surely have. They are very smart and very well financed and I don’t underestimate them.

              • Thats the best comedy I’ve seen all day John. Why would you ever try to make a point to me by referencing some general thing that politicians say?

                Politicians also say that more guns make us safer
                …that if we give money to poor people it will make them lazy but if we give it to rich people they will work harder
                ….that the country is running our out of money
                and on and on forever with examples of stupid things politicians say. Show me what they DO!

                R’s have a horrible record of doing during the O administration. There is no objective way to claim otherwise.
                D’s have a slightly less horrible record during the same time period.

                you can’t make the claim that the R’s in power would be any better because they SAY they want to continue to shrink the deficit if they win back the senate in 2014. In no way would shrinking the deficit help the economy right now.

          • I disagree. I believe full employment and prosperity for all is a progressive goal. Conservatives are much more concerned about profit at any means which is why jobs go overseas and minimum wages aren’t raised. As FDR said in his 1936 acceptance speech.
            “The royalists of the economic order have conceded that political freedom was the business of the government, but they have maintained that economic slavery was nobody’s business.”

            It’s much cheaper to have a stock of low wage earners for whom you bear no responsibility than it is to have chattel slaves.

            • Conservatives believe in orthodox economics, which says that raising the minimum wage will harm the very people it is intended to help (I know, there are studies, but there are other studies too. Watch Seatac for a real world experience that should settle that dispute once and for all. If Seatac prospers at $15, the support for much higher minimum wages will be unstoppable.) Jobs go overseas not because American wages are too low, but because they are too high for the product of those jobs. It makes no sense to blame the businesses who can’t sell their products at the higher price.

              • As Bernie Sanders said, the republicans don’t want to lower the minimum wage, they want to abolish it.

              • I thought this question of, “some studies say this, but other contradict…” was fairly well settled by research from Tom D. Stanley, Hristos Doucouliagos

                Doucougliagos and Stanely, “Publication Selection Bias in Minimum Wage Research? A Meta-Regression Analysis,” British Journal of Industrial Relations, 2009.

                Basically that there is no statistical evidence of loss of employment due to increases in the minimum wage

  3. Thanks Stephanie. Since running across your website and learning about MMT, I’ve tried to describe it to some friends but they tend to say it’s counter intuitive. I see it as basic double entry book keeping but they can’t see it.
    I’ve been seeing the idea of the government creating jobs being proposed more but they still don’t talk about the fiat system and how the government creates money. They are challenged answering how the government can afford to do it without running up a ruinous debt. I’ve been urging people to read Minsky and listen to Wray but it, mostly, falls on deaf ears. Most people can’t get past comparing the government finances to their household finances.
    Please keep fighting to get these ideas out.

    • “Most people can’t get past comparing the government finances to their household finances.”

      Then that’s where to start. They’re missing everything if they can’t get past that. The first thing to know is what monetary sovereignty is, and the difference between a currency user and a currency issuer.

  4. reserveporto

    I’m also “convinced MMT is the right approach”, though I’m wondering whether the coupon story is sufficient. The gov’t does indeed have full power to make the coupons, but in practice it has almost entirely turned the use of that power to the private financial sector. Private sector debt (hence, the combined money supply) is larger than federal debt (the high-powered money supply). More importantly, central banks have shown a strong willingness to fully back the private money supply in the event of a crisis of confidence in private bank money. Garaunteeing that the material gains available from the business of creating money are moved from the public sector (which obtains very little of its current funding from seignorage) to the private financial sector. Lax regulation and strong central bank backing, combined with a desire to reduce the cost of proper underwriting, has allowed the private banking to create money at no risk to themselves by shoving that risk off on uninformed investors who might more properly be named “dupes”.

    • The problems with banking are quite manageable regardless of the system chosen. In our current system, we didn’t have to let speculators have access to the Fed as lender, and we didn’t have to let FDIC-insured institutions engage in speculation. We didn’t have to allow commercial banks to make risky investments and do shoddy or fraudulent underwriting, or commingle their assets with other subsidiaries doing speculative ventures. These are minor tweaks that were made over the years that, if they had not been made, would have avoided the greatest concerns of the GFC.

      Given that anyone can “create money”, by issuing IOUs, I don’t see how you can move the material gains from that activity out of the private sector in a free society.

    • Mark Robertson

      reserveporto writes:

      [1] “The gov’t does indeed have full power to make the coupons, but in practice it has almost entirely turned the use of that power to the private financial sector.”

      Yes. America’s GDP is about $15 trillion. During fiscal year 2013 (1 Sep 2012 – 30 Oct 2013), the US government spent about $3.45 trillion into the economy (but took back $2.77 trillion in taxes). Private agents issued trillions more as credit (i.e. as various types of loans). We need much more government spending, since that money is not borrowed, and is not issued as loans.

      Repeat: the US government does not borrow any of the money it spends. Not one penny from anyone. Nor does it need or use tax revenue. Instead, the US government creates its spending money (creates its “coupons”) out of thin air, simply by crediting bank accounts. For example, if you receive Social Security benefits of $1,000 per month, then once a month the US government instructs your bank to increase your digital account balance by $1,000, thereby creating $1,000 out of thin air.

      Banks also create money out of thin air by crediting accounts, except that this money exists only as loans, and thereby increases our personal debt. The one exception is interest. Once again, banks create interest money out of thin air, but in this case they do not issue it as loans. If the banks go overboard in this, then their digital books can get out of whack, and the banks can get into trouble.

      Not so with the US government. It money supply is literally infinite.

      We need much more government spending (not bank loans) if we are to escape from the current recession. However the rich and their toadies want the opposite, called austerity, since austerity increases the gap between the rich and the rest.

      The US government does indeed have a “deficit crisis.” The deficit is far too LOW.

      [2] “Private sector debt (hence, the combined money supply) is larger than federal debt (the high-powered money supply).”

      For the USA, the “federal debt” is a misnomer. It simply represents the amount of money that investors have deposited in their savings accounts at the Fed. It is trivial, and by itself places no limit on the US government’s ability to create and spend money. (All monetary limitations on the US government are strictly voluntary and political.) The US government does not need or use those Fed savings deposits, just as it does not need or use tax revenue.

      When you but a T-security worth $1,000, your checking account at your bank is debited by $1,000, and your savings account at the Fed is credited by $1,000. When the T-security matures, the reverse happens. Your Fed savings account is debited by $1,000, and your regular bank checking account is credited by $1,000, plus interest. That’s all there is to it.

      Again, this is all a trivial Fed matter that has no effect on the government’s ability to spend. For the US government, all monetary limitations are strictly political.

  5. I’d like to see the story progress and clearly explain what really matters as in what really matters is will the economy have the productive capacity…

  6. “Chris, a former banker, comes to MMT from the Austrian camp”

    Somebody put this guy on a stage, in front of a camera. His is a classic and powerful story: “I once was lost, but now am found; was blind, but now I see.” A story shared by many readers here, too.

    Maybe you can get him to explain what he now sees as errors in Austrian theory. Possibly the same things you see, but possibly with a different twist, more convincing to other Austrians. And he may have a way to explain it differently, a way that is more in tune with their way of thinking.

  7. Mark Robertson

    Thanks for posting this, Ms. Kelton. I’m happy that Mr. Mayer is starting to wake up, and that the facts about MMT continue to spread.

    However, if I may indulge myself, I still wince when I see Mr. Mayer exhibit vestiges of his right-wing programming…

    [1] “This is not to say there aren’t bad consequences from issuing too many coupons, or from government spending in general.”

    Oh? What bad consequences? Inflation? For governments with true monetary sovereignty (like the US government) there is no connection between deficit spending by itself, and inflation. In fact, deficit spending has NEVER caused inflation in the USA. Also, what are the “bad consequences” of “government spending in general”? No explanation is given.

    [2] “There are real-world restraints on how much government spends.”

    Oh? What restraints? Again, no explanation is given. The US government can create infinite amounts of money as easily as changing the numbers on the screen of a computer monitor. Even Mr. Mayer admits this.

    [3] “You don’t have to like this. (I don’t.)”

    Why not? No explanation is given. Perhaps Mr. Mayer imagines that he will convince right-wing people by saying to them, “I’m just like you. I don’t like this. But it is true anyway.”

    If so, then Mr. Mayer is sadly mistaken. Right-wing austerians are cult fanatics. Everything for them is faith-based. “You are with us, or against us!” they cry. “You are absolutely wrong, and we are absolutely right!” Trying to reason with them is foolish and wimpy.

    Modern Monetary “Theory” is like the “theory” of aerodynamics. Either MMT is correct, or it isn’t. Either the airplane flies, or it doesn’t. There is no “sort of” flying, no “kind of like” flying, no “viewed from one perspective” flying. In short, there is no need for timid, half-hearted declarations of the laws of aerodynamics. It is the same with MMT.

    [4] “My own view of the state is that it is, at best, bumbling and incompetent and wasteful. At worst, it is an evil force on society.”

    Whoa! MAJOR right-wing silliness! Where there are humans there is society. Where there are societies there are states. This is unavoidable. Therefore, let us dispense with this silly word “state” and use the term “government,” which is obviously what Mr. Mayer means. He doesn’t like government. I’m sorry, but without some form of government, there can be no society. In the communist USSR the government was the politburo, plus the communist party, and various regional and local divisions thereof. In the USA the government is rich oligarchs. Their toadies are pundits, politicians, and (most) professors.

    Rule by bureaucracy, or rule by plutocracy. Take your pick. Ideally we need a balance between freedom and government. This balance can never be perfectly achieved, but it is worthy star by which to steer a nation.

    When right-wingers condemn “government” and “the state,” they mean anything that narrows the gap between the rich and the rest, and which inhibits the “rights” of the rich to enslave the lower classes. All such things must be “reformed”; i.e. they must be made to serve only the rich. Anything that eases the suffering of the lower classes must be “structurally adjusted.” Anything in government that helps average people is “big government.”

    On the other hand, when a government serves only the rich, then it is praised as being a “small government,” even if it is gigantic. The more it fosters inequality, the more it is said to be “efficient.” The more it lets oligarchs build barriers to social mobility, the more it is said to value the “free market.” The more it lets rich tyrants enslave the masses, the more it is said to “value liberty.” That’s why the Koch brothers, for example, call themselves libertarians.

    [5] “The state’s ability to enforce tax liabilities, fines and fees drives the demand for money. Or as Mosler says, ‘Taxes drive money’.”

    I have never agreed with this. I say that demand drives money. If there were no demand, then there would be no circulation of money, and thus no economy. When there is no economy, taxes become irrelevant.

    I admire Warren, but I say that taxes do not “drive” money. Demand does. Nor does the US government use taxes to control inflation (not today, anyway). No, the purpose of federal taxes is to maintain the legitimacy and authority of the currency (the dollar), the monetary system, and the issuing sovereign (the US government). Taxes are the primary means by which the federal government maintains its power and authority. Federal law requires us to pay taxes, and only in dollars.

    Personally I would like to see ALL federal taxes eliminated, since the above function could be performed by state, county, and municipal taxes. The federal government does not need or use tax revenue anyway, and in fact destroys such revenue upon receipt, by removing it from the money supply.

    [6] I love the last item about Italy. Warren Mosler actually used the principles of MMT (and exploited the stupidity of others) to make $100 million.


    • Excellent Post, Mark.

      I agree that the deficit is too low, because most businesses can produce more of their products at the same price level if demand for their products increased. Until we see wage inflation which invalidates my last statement, the deficit is too low.

      You stated that there is no connection between deficit spending and inflation. Also, you state that all Federal Taxes should be eliminated (but not Federal Spending). I have read a bit about inflation in Brazil in the 1980’s and 1990’s, and it is generally attributed to deficit spending. So there is some evidence of the deficit spending / inflation correlation.

      • I expected someone more informed to respond already, but didn’t Brazil have debts denominated in dollars?

        Anyway, even MMTers, when they are being precise, only say there has been no demand-pull inflation in the US since 1971. When pressed, some will attribute the rising prices in the late 1960’s to excessive pursuit of “guns and butter” on the part of government. That was a very mild pull, though, compared to what we consider unacceptable inflation today.

    • Goodness, Mark! No need to get personal. Some quick thoughts to your bullet points.
      [1] How about the war in Iraq? I’d consider that a negative consequence of spending.
      [2] How about the budget process? That’s a real world restraint on how much Gov’t can spend.
      [3] Well, maybe right-wingers are cult fanatics – but they make up a good part of the country and we should try to reach them. (Also, I hope the irony of your own post is not lost on you. You exhibit the same qualities you criticize in your own post with all the name-calling and such!)
      [4] Seriously, how many wars and genocides do we have to go over to at least get you think that States might be an “evil force in society” in some circumstances? Just because you think government can be a constructive force, doesn’t mean you have go completely blind to its crimes and think of it as Santa Claus.
      [5] Well, you said either MMT is right or it isn’t. And this is a big part of it. And you say you don’t believe it. Hmm…
      [6] Agreed. I love that item as well.

  8. ray lapan-love

    one fisherman catches 4 fish, another catches none. F2 gives IOU to F1 in exchange for the 2 fish which were more than needed anyway. No waste, everybody eats. Next day, the opposite occurs and the debt is payed. F2 now has his IOU back and what is… what it always was, a piece of paper worth 2 fish that can be used again.
    Would this then be a currency backed by a commodity, or a fiat currency tied to productivity, or both?

    • Neither. Although it is convertible to fish at a fixed exchange rate, I don’t think it would be called “backed” by a commodity since no fish are held in “reserve” by F2 to back it up. Likewise, I don’t think it should be called “fiat” because there is no edict or decree (other than the IOU itself and the desire to eat fish and the desire of F2 to maintain a good relationship with F1) backing up demand for the IOU; i.e. there is no fish-tax. If F2 had seniority over F1 and could enforce an obligation on F1 to give him 1 fish per week, then it could be called fiat.

      But perhaps someone else with a better handle on the commonly accepted definitions would answer otherwise?

      • ray lapan-love

        If there is no bank involved, and with a democracy being about ‘we the people’, it seems to me that each fisherman assumes the role of government and thereby provides a decree with an IOU?
        And as for holding a commodity in reserve, did the Egyptians hold grain in reserve, or was there an assumption that not all who demand an exchange do so at the same time? Did the USA have enough gold to make good in 1971 with only the French demanding the ‘guaranteed’ exchange, or at any time if gold were to be sought by everyone at once?

        • each fisherman assumes the role of government and thereby provides a decree with an IOU

          Unless there’s a tax imposed by the IOU issuer (or something similar), it’s materially different from what chartalists mean by “fiat”. In either case is still a financial asset of the holder.

          as for holding a commodity in reserve
          That’s a matter of definitions, isn’t it? I don’t know what the “official” definitions are, but (intuitively) I would call the fish-IOU with no fish-reserves “commodity based” and fish-IOU with fish reserves (full or partial) “commodity backed“. But I don’t know if that distinction is made by those learned in the field, or just by me. 🙂 Also, one might consider the river or ocean (or whichever fish-housing-aquatic-ecosystem) to be their “reserve” of fish. 🙂

          So (back to your earlier question) perhaps it should be called a commodity based currency tied to production (since skilled labor time is required to retrieve the fish). Impose a fish-tax and then it’ll also be fiat.

          • ray lapan-love

            Maybe we are creating a new system? ‘Commodity Based’.
            As for a tax, yea, I agree, but I also feel that the definition of ‘fiat’ could accommodate the decree or guarantee between any two parties to be essentially the same as a guarantee by a government. In fact, one could find examples which governments don’t allow legal proceedings against their agencies, or due process, in legal disputes that are allowed when one citizen disputes the legality of an action by another citizen. Try, for example, satisfying your right to due process by filing a suit against the Social Security Administration or a branch of the military and edicts or decrees take on an unreliable aspect which has precedent in regards to currency via the Nixon Shock; so… the notion that ‘fiat’ is made more reliable by government decree is not entirely solid.

            • I don’t think we’ve created any new system. As I understand it, most ancient monetary systems started out commodity-based in as much as they used a commodity unit (shekels of silver, bushels of grain) for their initial unit of account. Nonetheless the “moneyness” of the system emerged from the credit not from the commodity.

              ‘When I use a word,’ Humpty Dumpty said… ‘it means just what I choose it to mean — neither more nor less.’
              ‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’
              ‘The question is,’ said Humpty Dumpty, ‘which is to be master — that’s all.’

              Whether you want to have a broad or narrow definition of “fiat” is somewhat beside the point. I’m just a humble(?) blog commenter and not a practicing economist, so I’d assume the definitions “belong” to those who need and use the terms the most.

              Functionally, whether a currency is “decreed” as “legal tender” or to some extent even whether particular types of IOU are strictly enforced is mostly irrelevant. From the chartilist perspective (as I understand it), the functionally more important feature of “fiat” is whether one party can and does enforce extra obligations (beyond the IOUs themselves) like taxes, fees, or fines, which the IOUs can then extinguish. A government that has nominal taxes but doesn’t enforce them will have a hard time getting people to accept their IOUs. A mafia don who doesn’t consider himself the government but is none-the-less very effective at extracting “protection money” will strengthen demand for that which is necessary to pay his “taxes”, and people will want to accumulate (net-save) his IOUs to be sure they can keep him happy.

              • ray lapan-love

                I don’t see you as a “humble blogger” at all. In fact, you have allowed the local nonsense to bolster your confidence to a rather lofty position. But this is what people do, they find affirmation for illogical beliefs and then they build from there. The notion at the core of your premises for instance, ” convertible to fish at a fixed exchange rate”, shows a complete misunderstanding of money and value. The integral flaw in your thinking being that the exchange rate is not ‘fixed’. The value of the fish is a matter of supply and demand and therefore always in flux. So, the value of the IOU rises and falls as fish are more or less abundant. If for example F2 and his family are hungry when F1 exchanges a fish for an IOU, then that IOU has value, but if F2 already has more fish than he can utilize when F1 offers to make an exchange, then the IOU has less value. Accordingly, mediums of exchange derive a flexible value from what someone is willing to trade for them. Thus, the notion that… what a currency is backed with, or based on, or whether taxes are necessary, is all just folly.

                • Yeesh. Since I’m not a blogger at all, I’m also not a humble blogger. 😛 So I’ll try to ignore your first three sentences of substance-free ad hominem. I thought we were having a pleasant exchange up until that point. Sorry for offending you so.

                  You started by asking a question of categorization, i.e. what things are called, and I was saying what I thought the definitions might be. But language is determined by its users and jargon is defined by those who work closest with the concepts in question. That’s not me, so I am rather unconfident that my definitions are spot-on. We can decide the definition of “fiat” (or any other word) is “purple elephants shortly after a mud bath” or “any and all credit/debt contracts with legal standing” or whatever else you want, but if it doesn’t closely match what other people think it means then we are going to fail at substantive communication. This has nothing whatsoever to do with whether a particular concept (labeled “fiat”) is good, bad, right, wrong, or indifferent.

                  As for the rest, the face value of a fish-IOU remains “fixed” at one fish per one fish-IOU. This is generally what people mean by “fixed exchange rate”, isn’t it? Just because the supply or demand for gold goes up or down doesn’t change that a gold standard currency has a fixed exchange rate. Likewise, the utility value of fish will go up and down, or the expected value of the IOU will go up or down based on whether you think the issuer can make good on their promise, or the present value might be less the face value assuming a maturity on the IOU… But none of this changes that it’s called a “fixed exchange rate” by definition, does it? Or do I have the definition wrong?

                  Lastly, you said “the notion that… whether taxes are necessary, is all just folly”. Necessary for what? Necessary to fit a particular definition or categorization (which is what I thought we were originally talking about)? Or necessary for some particular form of utility? Anyway as I understand it, chartelism doesn’t claim that tax obligations are necessary to give value to an IOU, but that they are sufficient.

                  • ray lapan-love

                    Ignore what you will, but you said: ” I’m just a humble(?) blog commenter ” and then:”I’m not a blogger at all, I’m also not a humble blogger”. So what would Humpty sat about that ‘mastery’?
                    And where did I say that I care what the charletists think or say about anything? My point all along has been that money can only represent the the value of what it can buy. And, that whether it is fiat or backed it can never be ‘fixed’. So, your assertion that “face value” is “fixed” was beside the point, a sort of dah moment, as if I need to be told that one means one and a 5 is always a 5, gee whiz!

                    Your first answer, “neither”, is incorrect. All currency is tied to production in a supply and demand system, and all currency is ‘fiat’ whether backed or not. The translation from Latin comes out as “let it be done”, “it shall be”, which could just as easily mean than ‘if paper currency be brought, it shall be exchanged for gold’. But of course there are misunderstood terms and concepts all through the field of economics and so the dynamics of numbskulls has allowed ‘fiat’ to imply that a currency is not “state-issued money which is neither convertible by law to any other thing, nor fixed in value in terms of any objective standard*”, and so… there lies the rub. It being imbedded in the fact that a commodity can never have an ‘objective standard’ in the first place. The only ‘fixable’ thing here is of course he ‘face’ value. But the value that matters is that which can not be be fixed on two dimensions. First, there are the supply and demand factors of the commodity being used and these are in part independent in regards to demand because the commodity always has utility; and secondly, the demand for any form of promissory notes, whether backed or not, is subject to the needs and wants of hungry, or not hungry, fisherman and whoever.

                  • Um… Wow. “Blog commentor” is not the same as “blogger” is it? Bloggers have and write blogs. Blog commentators populate their peanut gallery. Communication with you is proving difficult. Enjoy yourself!

                  • ray lapan-love

                    Well, I stand corrected and I’m sorry for not having a better understanding of the noun ‘blogger’. Turns out, according to the folks at American Heritage, one who blogs, or is blogging, or has blogged, is someone who must only: “write entries in, add material to, or maintain a weblog”. But, that someone is not a ‘blogger’ without being “a person who keeps and updates a blog”.

                    As for the rest, I’ve felt that communicating with you was “difficult” from the start (patronizing/condescending while mostly beside the point). So, I’m not at all reluctant to move on either.

  9. Pingback: How Fiat Money Works | The Money Chronicle | Sc...

  10. Ian Winograd

    What bothers me most about people’s ignorance of MMT is that voluntary health organizations such as the American Cancer Society, Pancreatic Cancer Research, etc have to fundraise. These groups should be provided as much funding as needed by the Federal Govt without adding to any debt. A point will be reached where the organization can no longer justify additional funding, so oversight might be required. Better treatments would be available had the US taken this road. And at what costs? Possible inflationary pressures? Even if so, would the benefits not be worth the costs?

  11. To the extent that MMT is an accurate description of reality, remarks that amount to expressions of subjective preferences (I like MMT or I don’t like MMT for X or Y reasons), are out of place. Amazing how much print is wasted on unintelligent subjectivisms.