By J.D. Alt
I’d like to propose an Essay Contest that might inform us better than any news talk show or presidential debate what we’re up against with our National Budget—and what might be the best course of action we should consider. Everyone in Congress should be required to participate, governors and state legislators who might become future congressional leaders should be encouraged to join in, and op-ed economic analysts invited to submit. The essays would be posted on a Congressional website established specifically to enable the public to vote on the best explanation of the topic. The topic I propose is this:
How the U.S. Reserve Banking System works—and why it matters to our National Budget.
I’m not suggesting that congresspersons and senators need to become economic experts, only that they explain, in their own words, their basic understanding of how the nation’s monetary system works. This doesn’t seem unreasonable: It can’t be asking too much from the people who are casting votes on Federal Budget issues on behalf of American citizens—or from the news media that informs us about their efforts. The essays don’t need to be overly long or go into great detail, just the basic gist of things, like you might explain it to your ten year old daughter if she asked one day, out of the blue, “Daddy, how does the U.S. Reserve Banking System work?”
To demonstrate and give this idea a test, here is my personal version of what I’d submit if I were a congressperson.
How the U.S. Reserve Banking System works (my understanding) By J.D. ALT, (pretend Congressman-elect from the state of Maryland.)
Most of us, including myself until about two years ago, believe the Reserve Banking system is a set of rules that establishes what percentage of a bank’s deposits the bank can lend out to other people. If a bank has $10 million in deposits from the American people, for example, the bank can only loan out, say, $8 million of those Dollars. The rest have to be kept in “reserve” in case some of the depositors want to withdraw their Dollars. That’s what “reserve” banking means, and its purpose is to make the banking system safe for depositors, while still enabling banks to make loans.
This seems to make a lot of sense. But just a little research and reading reveals that it’s nothing more than a myth.
The U.S. Reserve Banking system, in fact, begins with the Federal Reserve (America’s Central Bank) issuing sovereign fiat currency (U.S. Dollars) and the U.S. Treasury spending those Dollars—for goods or services, or to make transfer payments to individual citizens (e.g. social security payments). This is the only way it can begin. It cannot begin with people making deposits in banks, because until the Federal government issues and spends some Dollars, there aren’t any Dollars for the people to deposit. And it cannot begin with banks making loans to people because, by U.S. law, “bank dollars” (created when a bank makes a loan) must be convertible on demand to real U.S. Dollars (the ones issued by the U.S. government)—which is what happens when you convert the “bank dollars” in your bank account into real U.S. Dollars at an ATM machine. Before a bank can make a loan, creating “bank dollars”, real U.S. Dollars therefore must have been created first (in order for them to be available in the ATM machine)—and these real U.S. Dollars, as I’ve just said, can only have been created by the process of the Federal Reserve issuing them, and the Treasury spending them.
Because banks must, on a daily basis, be able to convert some portion of their “bank dollars” to real U.S. Dollars, they must keep a supply of real U.S. Dollars in a special account which is reserved specifically for that purpose. This is the bank’s “reserve” account. Each bank has a “reserve” account, and that account is located at the Central Bank (the Federal Reserve). Every business day, banks withdraw enough real U.S. Dollars from their reserve account to cover the ATM, check-cashing, and direct withdrawal transactions they anticipate for that day. Sometimes they miscalculate and an armored truck has to deliver the bank additional U.S. Dollars from their reserve account.
Banks use their reserve account in another way as well: When a customer writes a check on their account at bank A—say to buy groceries—and the grocery store then deposits that check in its account at a bank B, at the end of the business day the different banks have to “reconcile” this transaction. That means dollars have to be moved from the account at bank A to the account at bank B (to pay for the groceries.) But this transaction is not made with “bank dollars”, because bank B doesn’t want bank A’s “bank dollars”—it wants to be paid in real U.S. Dollars. So, at the end of the business day, the reconciliation is made between the two bank’s reserve accounts at the Central Bank: Some of bank A’s reserve Dollars are withdrawn and deposited into bank B’s reserve account to cover the amount of the check written for groceries.
How does a bank get the real U.S. Dollars in its reserve account so it will have enough of them to cover these needs? They can borrow the U.S. Dollars from another bank, or from the Central Bank (something they actually do, as a matter of course, every business day.) But the main way they get the real U.S. Dollars is through Federal spending. When the Federal government pays someone a Social Security payment, for example—let’s say $1,000—the bank is instructed to deposit that amount of “bank dollars” in the person’s bank account. But another deposit is simultaneously made: the Federal government issues and deposits $1,000 of real U.S. Dollars in the bank’s reserve account. Two deposits, then, are made simultaneously—the S.S. recipient’s bank account gets 1,000 “bank dollars”, and that bank’s reserve account gets 1,000 real U.S. Dollars. But don’t imagine the citizen is getting cheated here—remember, he or she can always convert the “bank dollars” to the real U.S. Dollars any time they want (which is why the reserves are there in the first place.)
But why do we do things in such a complicated way? Why do we have these two kinds of “money”—real U.S. Dollars and “bank dollars”? The answer is because it is a direct reflection of reality: When a bank makes a loan, it is NOT temporarily giving to citizen B some of the money citizen A has deposited in the bank. Instead, it is temporarily creating new money which it uses to make the loan. But banks, by law, cannot create new U.S. Dollars (only the Federal government can do that)—so the bank creates “bank dollars” instead. From the perspective of the person getting the loan, there is no difference between getting “bank dollars” and getting real U.S. Dollars because, as we’ve already emphasized, by law the “bank dollars” are convertible to real U.S. Dollars on demand. The system works because only a small percentage of the “bank dollars” issued by banks are actually converted to real Dollars on any given day—and most of the “bank dollars” eventually get “cancelled” when the loans are repaid.
The Reserve Banking system, then, is a method that enables banks to leverage the relatively “small” number of real U.S. Dollars (which are issued and spent into the economy by the Federal government) into a great quantity of “bank dollars” which function very well as “money” in the vast majority of cases. In fact there’s only one thing you can’t pay for with “bank dollars”: you can NOT pay your Federal taxes with them. When you write a check on your bank account to pay your Federal taxes, the bank must make that payment good by delivering real U.S. Dollars from its reserve account because that is the only kind of “money” the Federal government will accept.
This last point is critically important for every Congressman (like myself) to understand when voting for items in the Federal Budget. The reason it’s important is because it shines a spot-light on one very simple calculation: When the Federal government spends it ADDS real U.S. Dollars to the reserve banking system. When the Federal government collects taxes, it SUBTRACTS real U.S. Dollars from the reserve system. This means that if, in a given budget year, the Federal government subtracts more Dollars from the system (tax collections) than it adds to the system (Federal spending), there will be net FEWER real U.S. Dollars in the system for the banks to leverage upon. Fewer real U.S. Dollars for the banks to leverage upon means the banks will have to reduce the amount of “bank money” they are creating with loans, and the economy will be forced to contract—increasing unemployment and social misery.
What is clear, then, is that there should be something called a “General Rule for National Budget Planning”, and it should be this: The Federal government always needs to spend MORE Dollars than it collects in taxes. That is the only way the Private Sector economy (operating on the leveraging and spending of “bank dollars”) can grow within the parameters and boundaries of the U.S. Reserve Banking system.
This is why it’s so ridiculous for us congress-people to be harping all the time about Federal “deficits”, as if it were an unconscionable crime for the Federal government to spend more Dollars than it collects in taxes—and why it is so ridiculous for the op-ed economic experts to claim the Federal government has to borrow Dollars to make up for its deficit spending. Federal government bonds are not “borrowed” money—they are simply savings accounts the Central Bank sets up for citizens to keep their own extra Dollars in when they can’t think of anything better to do with them. And, now that I think about it, the interest the Federal government pays on those bond “savings accounts” is another primary way that real U.S. Dollars get issued and spent into the Reserve Banking System.
I may not have everything just right, and I’d be happy for people to comment and suggest corrections where I’m wrong. That, ultimately, is the purpose of the essay contest: not for someone to actually win the contest, but for all of us, together somehow, to understand the way things really work.
If this is correct, does it follow that if the government were to approach zero net debt that there would be zero real U.S. dollars?
Pretty much, except for a small portion of them that were created without issuing Treasury securities. I believe the very first US dollars were created by the government buying British Pounds and Spanish Dollars, and holding those currencies as reserves. On the various metallic standards that have been used, the government issued dollars to buy gold and silver. During the Civil War, the government issued Greenbacks. All the money created that way, without issuing Treasury securities, is still there, but it amounts to very much less than the $16T of Treasuries.
The government did have zero debt at one point in time following Jackson’s success in blocking the renewal of Biddle’s 2nd US Bank. The debt was zero but money was still in the economy. Historical fact… Another point: If all banks were required to be trust banks then they would need to come up with about 19T$ and the only way to get it would be to borrow from the Federal government which would wipe out the debt, make the USA a creditor nation and there would still be money in the economy…
“The government did have zero debt at one point … but money was still in the economy.”
Right, but that money that was left was what was spent without selling bonds. It was spent to buy gold or Pounds or was just plain spent, without borrowing or buying another form of money. That was a significant part of the money supply at the time, but is not any longer.
I don’t know what you mean by “trust bank”, but if banks were suddenly required to behave as if they could only lend money that they had in their vaults, from deposits or capital, and had to sell all their Treasuries in order to raise that cash, and borrow the rest, I don’t see how that would change the amount of outstanding Treasuries, even if they had to borrow from the Fed (which doesn’t change their capital, so might not help depending on what it means to be a “trust bank”).
Golfer, a trust bank, as I used the term, is one that holds your money, stores it securely in cash and it is always available. One serious proposal for modifying our banking/monetary system is to convert all bank deposits to trust deposits which would require banks to come up with about 19T$ in cash which they do not have and the only place for them to get it is as loans from the US Treasury.
That would be an interesting conversion. Trust banks would not be allowed, then, to make any loans, only to hold depositors’ money securely?
I would think that the conversion would be done gradually, by liquidating the loans, either on the normal repayment schedule or by calling them in. Then banks would have money in their vaults in the amount of their deposits plus their capital.
If, instead, banks would borrow from the Fed in order to have the cash in their vaults, then that cash is owed to the Fed, not the depositors. How is that secure for the depositors?
And who satisfies the need for businesses and individuals to borrow, if banks don’t lend?
Golfer, the economist who proposed the idea says it all could be done over a weekend. The banks could not borrow 19T cash from the Fed., the Fed does not have the cash. It has to come from the BEP; they make cash. The trust banks would then have and hold cash not “books”. The loaning and crediting aspect of banking would be totally separate from the trust banking part.
And liquidation of loans would not raise the money for a very simple reason; the cash money is not in the economy to do it.
The reason is this:
Real US Dollars are ALL Fed liabilities. These include both reserves AND securities. So if the Fed were to do QE infinity, eventually there will be no securities, but those reserves would still be there. The only way Real US DOllars can be destroyed is by the Govt running a surplus. Otherwise, we would have $17T in reserves and $0 in securities. But the total number of Govt liabilities or Real US Dollars would not change. Remember, QE (and every other transaction the Fed makes) is just an asset swap, the Fed is legally barred frrom created NET new Real US Dollars on its own authority. Only Congress can pass spending laws that result in deficits and thus NET new Real US Dollars.
Yes, dollars are liabilities but I think the question was only about Treasuries going to zero, and I assume he means that would happen by running surpluses. It’s also possible to “mint the coin”, or change the law so that money could be spent without taxing or borrowing, and retire all Treasuries that way without removing money from the economy.
And I think the Fed creates net new government dollars (reserves) when it lends them, which it used to do (before QE) as required whenever the economy and the amount of bank loans expanded.
The government can spend without taxing or borrowing. It is done now with coins. It was done with paper currency as recently as 1971, the US Notes with the red serial numbers. There is existing law that allows it, the law that Abe Lincoln used to print greenbacks. I had never thought about it but selling treasury securities must be an executive branch choice. The national debt is a legislature choice and the debt is needed by the central bank. It is not needed by the federal government.
I don’t think the Executive has the option of not issuing bonds in the amount of the deficit, it’s required by law. If not, then the debt ceiling would not have been an issue.
I’m no expert on the greenback law, but didn’t it have a fixed limit on the amount, which today might be enough to cover only a few days of the deficit?
Its almost as if I said exactly this: “The only way Real US Dollars can be destroyed is by the Govt running a surplus. “
Those dollars are not destroyed by a surplus. They are stuck right back into the economy by paying off bonds ad treasury securities. Government fiscal action is currently totally neutral with respect to the quantity of money in the economy and it will remain so as long as the rule that spending minus taxes equals treasuries sold/bought by the US Treasury.
“If a bank has $10 million in deposits from the American people, for example, the bank can only loan out, say, $8 million of those Dollars.”
Very, very misleading and wrong Mr Alt.
A bank that has 10 million(bank money) in its vaults from American depositors can then generate, using the money multiplier(approx 10), $100 million and only needs to keep 10% of that as reserve assets. The bank then has $90 million to loan out as they please. That’s 900% profit for nothing, by the way.
The money multiplier in banking is defined as commercial bank money/central bank money and is also the reciprocal of the reserve bank ratio 1/RR.
Consequently, in the above post, I am a little astonished at the relatively poor explanation of what system the US banking system is based on.
Was it deliberate on the part of the author to actually forget that our present banking system is not just a “reserve banking system” but is actually a “fractional reserve banking system” with a very important and well-used money multiplier?
Nowhere in Mr Alt’s explanation do I see any proper definition or reference to the money multiplier. Using the money multiplier like this is one of the standard major ways that ordinary banks are able to make their money out of thin air. Moreover, I also think it important to say that the banking sector is perhaps the only corporate entity in existence that is able to generate money like this whilst producing nothing of value for trade and thereby contributing nothing to GDP.
And yes, I would prefer a full reserve banking system with no money multiplier. It would be so nice to see banks actually working honestly for their money for a change, rather than making 900% profit off their depositors (out of thin air) on a forever basis.
JD, the following statement is incorrect: “The U.S. Reserve Banking system, in fact, begins with the Federal Reserve (America’s Central Bank) issuing sovereign fiat currency (U.S. Dollars) and the U.S. Treasury spending those Dollars…” The fact is money was in the economy and in the vaults of commercial banks when the Federal Reserve was put into operation in 1914. That money was gold. The US Treasure printed and furnished paper notes via the Fed to the banks to for their use, the paper notes being receipts showing the amount of gold owed to the bearer of the note. That is how it started and as I recall at that start date the banks could issue notes for four units of gold for each unit of gold they had, a 25% reserve requirement which legalized the ancient practice of bank fraud. And I use the word “fraud” very precisely, making money by pretending to have something you do not have. FDR took away the gold backing in 1933 but the significant thing he did was convert those paper notes printed by the Treasury into money, fiat money, for American citizens. This also put the US Treasure into the position of creating money and giving it to banks. The final step to fiat money occurred when Nixon took away gold backing for international exchanges. Since then the US dollar has been a true fiat currency. And importantly, regarding your argument, the fiat money was already in the economy when it all started. The government did not have to spend it first. The notion that the government must spend it first is a neat story when explained allegorically as a family using chits to get their children to do their chores but that is all it is. It is a fairy tale when you try to apply it to the monetary system this country endures. All of that said, I fully support your proposal for posting essays describing ones concept of our monetary system as it exists. It is a good proposal.
Thanks J. D., one of the clearest explanations I’ve ever seen. Would love to see our policy makers think this through and post their understanding in their own words or just post it verbatim on their websites. They may want to come up with a few soundbites. Like Folks, as you know the Federal government, that’s you and I, create US dollars. That’s why we have money if we need to go to war. That’s why the Fed was able to come up with trillions to bailout the banks when we needed to. We know you’re hurting out there and we want to create meaningful jobs with our ability through the Fed to create this money and use it for you. So as of today there will be free medical care along the lines of Medicare for all. There will be free college education and a cancellation of student debt. Everyone who wants one will be provided a job at a living wage to better our communities. God bless America and God bless the Federal Reserve.
“If a bank has $10 million in deposits from the American people, for example, the bank can only loan out, say, $8 million of those Dollars.”
As has been pointed out, the math is off. If the bank has $10M in government money, which it got from deposits, it can loan out $100M in bank money, keeping the $10M in reserve to handle withdrawls. 10% is the usual number used in examples, but is only an example, not based on the current actual rules. In your example, if you wish to use 20%, the bank could loan out $50M, keeping $10M in reserve.
“A bank that has 10 million(bank money) in its vaults from American depositors can then generate, using the money multiplier(approx 10), $100 million and only needs to keep 10% of that as reserve assets. The bank then has $90 million to loan out as they please. That’s 900% profit for nothing, by the way.”
Maybe, if the banker can sell the loans and abscond with the proceeds, leaving its depositors in the lurch.
Your terminology is wrong and misleading. It’s wrong in that the $10M of deposits is not bank money, it’s government money: bills and coins in the vault, and to say it’s “for nothing” ignores a lot of people’s work, and the capital of the bank, put up by investors. It’s misleading because the bank doesn’t “generate” $100M of money for itself, of which it can then lend $90M. By lending, the bank creates $100M of bank money in the hands of its borrowers. That is the money multiplier.
And your math is wrong. The deposits created by the loans are liabilities of the bank. The bank creates $100M of liabilities when it makes the $100M of loans. Its profit is only the interest it manages to collect on the loans, minus its expenses (the interest it pays on deposits, losses when principal is not repaid, rent, salaries, and other operating expenses). That would be more like 10% of its original $10M, not 900%, if all goes well for the bank.
“Most of us, including myself until about two years ago, believe the Reserve Banking system …
This seems to make a lot of sense. But just a little research and reading reveals that it’s nothing more than a myth.”
Here Mr Alt is simply describing the way people usually believe the system works, not the way he thinks it works.
The reserve ratio doesn’t limit the amount of money a commercial bank can lend out.
This is because the reserve ratio applies after the lending not before. It happens in the next accounting period. Only then must the bank get the reserves to cover the reserve ratio for the previous accounting period, and it’s always able to do so, either borrowing from other commercial banks or from the FED.
BTW, in some countries the reserve ratio is zero.
True, but that’s MMT, not what people believe.
Thanks for your always-lucid writing. Your analysis is about what I’ve come to believe after six years of intesnive reading about the concept of money.
I believe more people should comment on what the author presents as the erroneous ‘man-on-the-street’ view of ‘fractional reserve banking’ and NOT on what he presents as the correct view. After all, the entire exercise is NOT about getting a (simplified, yes) CORRECT understanding of how money and banking and federal budgeting work, but a ‘correct’ understanding of the wrong story. We must insist on looking at the finger doing the pointing and NOT at the object toward which the finger is pointing, after all.
JD, everything is great except for this:
“This means that if, in a given budget year, the Federal government subtracts more Dollars from the system (tax collections) than it adds to the system (Federal spending), there will be net FEWER real U.S. Dollars in the system for the banks to leverage upon. Fewer real U.S. Dollars for the banks to leverage upon means the banks will have to reduce the amount of “bank money” they are creating with loans, and the economy will be forced to contract—increasing unemployment and social misery.”
A smaller deficit just means, cetirus paribus, that banks may need to acquire more borrowed reserves to maintain/increase lending. Ability to lend is not affected by the size of the federal deficit in any given year, although DEMAND for loans is.
The only part I found questionable was this:
“Fewer real U.S. Dollars for the banks to leverage upon means the banks will have to reduce the amount of “bank money” they are creating with loans, and the economy will be forced to contract—increasing unemployment and social misery.”
I thought a big point in MMT is that loans create deposits, even up to the level of reserves? So if a bank finds a credit-worthy borrower, they enact the loan. Then at the end of the period, if there aren’t enough aggregate reserves for this bank to borrow from other banks to meet their reserve requirement, then the Fed will lend them the required reserves (into existence) at a penalty rate. Thus the commercial bank’s profitability is lessened (soft restraint), but there would be no hard restraint to growing ‘bank dollars’ due to not enough reserves, if there’s a growing economy with plenty of people willing to borrow at those rates.
This would also put your “General Rule for National Budget Planning” in question. Again it basically has the same result but the logical reason is somewhat different. It just seems like you’re basically still using the ‘money multiplier’ story with slightly changed wording, taking a logical shortcut but ending at the right result (growing economy requires fiscal deficit at least for the US currently).
Thanks for these great comments and discussion.
Please tear it apart further.
This has to be UNDERSTOOD!
“a big point in MMT is that loans create deposits, even up to the level of reserves”
I don’t understand. Loans and deposits are much bigger than reserves. Loans are not reserve-constrained.
golfer: It seems like you understand…that was precisely the point JGK and I both made simultaneously, while both agreeing with the rest of JD’s post. “Loans are not reserve-constrained” because loans create deposits (deposits at the fed-level being called ‘reserves’), not the other way around (where the amount of reserves dictates the amount of loans that can be made).
Yes, I know that part. It’s “even up to the level of reserves” that I don’t understand. As if the level of reserves was some limit to the amount of loans. Not only is it not a limit, but it has long ago been exceeded. In fact, if the reserve requirement is less than 100%, and without QE, is it even possible for the amount of loans and deposits to ever be less than the level of reserves?
Oh I think this is just an interpretation problem of the word ‘level’. I mean there’s commercial banks where everyone has deposits, and then you go ‘up a level’ and get to the central bank level where banks have deposits (reserve accounts).
I was excited when I first read your essay. In my working life I designed and implemented large-scale computer systems for large enterprises. In that work I often read documents that purported to explain how a particular business worked. From these documents I was expected to apply computer technology to new systems that would not only automate (where possible) the current business, but would also support the introduction of new services, products, and efficiencies. When I first heard of the MMT collection of experts, I thought that was what they were doing: I thought they had designed a new system to replace the current financial/economic system of the United States. I was excited then too. I wanted to read all about how that new system would work, I wanted to make my own assessment of how such a system could be implemented. How long would it take? How much would it cost? What would be the benefits?
The process my generation followed in those long ago years was iterative: the descriptions of how a business worked would contain errors or confusions and would have to be corrected, reevaluated, and corrected again until we would be ready to design a new system. When I first started reading MMT articles and books, when I watched many videos, and when I read the articles of those who opposed MMT, I hoped to find that all of the grunt work of designing a new system had been done. I kept searching for a new paradigm, a new model, a new system description. But it is not there. What I have found, in overwhelming proportions, is a petty war going on between those out of power (MMT theorists) and those in power—you know who they are far better than I. The debate, and all economic debates in the entire world, seemed to be about the past instead of the future. I could not understand this situation. If the MMT theorists knew what was wrong with the current system, why hadn’t they written a large, detailed book on how the new system would work? Then I realized that the MMT theorists really don’t want to do that. They only want to argue. I realized that the argument was not about what was right, but who was right.
For example, to me, the essay contest idea is fun and our politicians are easy targets. But, the better thing would be to have a contest to design an MMT-based system to replace the Fed, followed by other descriptions of new systems to replace our current ones.
If such descriptions exist, then please let me know. Forget about me, let the world know. If the MMT approach is the right approach, and I think it is—but I can’t be sure, then commit to it. Put it into practical terms that ordinary American can understand. They are already convinced that our current systems are crap. Give them something to implement.
There is one and there are many spin offs from it. The “Chicago Plan” as envisioned by Irvin Fisher in 1936 and very recently analyzed using modern models by the IMF. Many documents can be read about the plan which has 100% reserves as the keystone provision. This is from the title page of the 2012 IMF white paper:
IMF Working Paper
The Chicago Plan Revisited
Prepared by Jaromir Benes and Michael Kumhof
Authorized for distribution by Douglas Laxton
In my working life I debugged operating systems on large-scale computers. I think MMT is a lot more like my former job than it is like yours.
A big part of MMT is not oriented to designing a new system to replace the existing one(s), it’s about explaining how the existing ones really work. People don’t understand how it really works. As this article points out, they have a view of the existing system that is wrong. (Or, mostly not so much “wrong” as obsolete: the system has evolved, and their view of it has not.)
Our current unemployment level is the manifestation of a bug in our economy, like a computer crashing is the manifestation of a bug in the operating system. My job was to find out why it crashed, where is the “bad” line of code. The bad line of code in our economic systems is not that we have a Federal Reserve, it is that we are trying to make the Federal Reserve do something that it is not equipped to do. Our system is crashing for lack of aggregate demand, and the Fed can’t fix that, only the Congress can. MMT points out how to do it. Shoots the bug. Shows why the system crashed, and how to avoid similar crashes in the future. Now it’s up to the developers to implement the fix that MMT indicates.
There’s nothing wrong with the design of the system, in terms of its parts (Fed, Congress, etc.). You can do it different ways, and different countries have different designs. They all can work. It’s the implementation that has a flaw.
I sympathize with your feelings about the “petty war”. Working with computers tends to take the emotions and personalities out of our jobs. The code doesn’t get mad at you and call you names, so you don’t feel like you have to respond in kind. It makes it much cleaner, more civil. Most of the people doing economics today are driven by their politics, which is based on deeply rooted values, and that leads to uniquely human aspects of the process, which are often not very attractive.
MMT can be presented in ways that ordinary people can understand. I’ve seen it done. What is lacking is the megaphone. MMT needs to get some people on mainstream TV, where the mainstream economists now have a monopoly.
There is a bug in the present system and that bug is the cause of the crashes of the system on a regular bases. The bug is given life by allowing privately owned, for profit institutions to control the money supply in our economy. The actual bug can be found in the mathematics defining the method by which this control of the money supply is effected. The mathematics of the bug are not hard to unravel. I’ll give you a hint. The form of the bug is (1 + i)^n , a well know exponential function, and it defines the lending rate banks must follow in order to maintain a fixed quantity of money in the economy. That is correct, in order to maintain a fixed quantity of money in the economy bank lending must increase exponentially. And that exponential can exceed the fixed amount of money in the economy. As that point is approached there is a boom from the rapidly increasing lending rate of banks. When the process is stopped, and it has to be stopped, we have the bust. Look at a plot of money supply vs years from 1990 to 2010. You will see it very graphically. And Jamie Dimon was correct when he opined as quoted in Elizabeth Warren’s book, “Fighting Chance” that every few years there must be a bank crises. Dimon pegs it at 5 to 7 years. As much as I admire Warren, she was wrong when she said Dimon was wrong. The bug is in the math and oversight and regulation will not defeat the math.
Golfer1john and J. D. Alt:
Thanks for your responses. I have heard others say what both of you have just said, but I have read one of the founders of this school of explanations (I was going to say this school of ideas, but it is really not that according to you) say that his purpose and presumably your purpose was to have the MMT approach replace the current system. I am pretty sure that it was Warren Mosler in his book about the seven whatchamacallits. I can’t put my hand on the exact page at the moment and I have to hit the road in a few minutes. But I will get a chance to look it up later today. So I got the idea about what you guys were trying to accomplish from Mosler. It is a pity that you folks aren’t more ambitious especially since your ideas could do so much good.
But let me ask you a few questions about your strange, and ultimately barren, endeavor. Do you think it is worthwhile to adapt MMT ideas into the current system, or even to replace the current system altogether? Or do you know something that you aren’t telling us? For example is this all a kind of computer game of fantasy? If you think that it is possible to adapt MMT ideas and if you think it is worthwhile to do, what would you do if you were the ones chosen to do it (and I know that you have no intention whatsoever of ever doing it even if it would save the world)?
Wait, one of my assistants has found the remark by Mosler that caused me to think he intended to save the world with his ideas. He wrote: “The awareness of how currencies function operationally inspired this book and hopefully will soon save the world from itself.” It is at location 1757 on my kindle. Oh, I should have said that it is from “The 7 Deadly Innocent Frauds.” He has just told the story about preventing Italy from defaulting. How is that “save the world from itself” project going? First Italy and then the world! How “soon” is “soon?” Is Mosler alone in this effort? Is he still working on it?
But since I intend to save the world with these ideas I must apparently go it alone. Oh, well.
By the way, for the record, I first heard the ideas that you now call MMT starting in the summer of 1949. My father, Uncle John, and a few of their friends, for some reason, started talking about going back to the gold standard. I think it was Uncle John’s wish to return to it. Anyhow they would discuss the pros and cons of such a change off and on, over a period of years. Sometime early on, my father introduced the hypothetical that the Rocky Mountains were made of gold and America would thereafter have an unlimited supply of money. The group started discussing the possibilities and, over time, realized that they would have to worry about inflation and very little else. They realized that the lives of ordinary Americans would be transformed. They were all children of the Great Depression and most of them were veterans of WWII, so they fully appreciated just what a boon unlimited money would be. From viewpoint as a little boy, and then later as a teenager, I presumed that our government would implement such a change as soon as it could. But you know the rest.
Thanks for returning me to the right path.
I appreciate your comment very much, but it did not end up where I thought it was going. Here’s what I thought you were going to say:
“What I discovered was that you are NOT an ‘expert’ who is describing a ‘new’ monetary system concept that we ought somehow to implement—instead, you are simply an essay writer trying to describe the way the EXISTING monetary system actually DOES work.”
My understanding of MMT is that it is describing present reality, not future possibility. The purpose of the essays I’ve been writing, over and over again, is simply to get people to SEE the reality. There’s nothing really “new” to implement—only to “see”.
This is the URL:
Jerry: The main point of arguing with ‘those in power’ about basics such as money, banking, sectoral balances, and other macroeconomic concepts would be that you must understand those in order to get to reasonable policy solutions. MMT is primarily trying to dispossess people of their incorrect economic views and clue them into logical & operative realities.
Are you seriously disappointed in the MMT bloggers for not wowing you with some grand vision for system redesign that no one has thought up before? Are you expecting them as philosophers to put together a modern Plato’s Republic? You’ve stated in other comments that you’ve worked for 9 years to come up with a design for a new system that you hope will take off like a bird once you share it with some people enthusiastically enough. Are you really more annoyed that the MMT bloggers haven’t caught up to your vision or don’t share that that’s the goal here?
You’ve stated that you’ve studied history and come up with a new system that implements MMT concepts, but has no income taxes, and is too complex to write in this blog’s comments. Would you mind just writing it somewhere and sharing a link, rather than continuing to browbeat the bloggers here for not ending up with your vision?
There was a post not too long ago by Randy Wray called ‘MMT Does Do Policy’ (http://neweconomicperspectives.org/2014/04/mmt-policy.html). Was this not what you’re looking for? There’s no obvious MMT-based reason to “replace the Fed” as you say here, but Wray has a pretty specific recommendation about losing 99.9% of the staff and implementing algorithms to automatically set overnight rate as .5%, pay IOR .25%, and be the lender of last resort. His other general policy proposals are to correctly use fiscal policy counter-cyclically, move to an employed buffer stock rather than an unemployed buffer stock, jail the criminal financiers and regulate the rest appropriately, downsize wall street, pass consumer protection laws, moratorium on foreclosures, possibly forgive 50% student debt, cap CEO pay to 50x average employee pay. Is this the solution to your quest, or are these considered too boring and not enough of a new idea?
Hey, Gus, nice to hear from you.
I don’t have time to respond in detail to your points, but I can say that overall I am not satisfied with what your group has done so far. I think that you need to publish a grand design. I have one, and you would do even better. Then the debate with the powers-that-be would change. Two grand designs. Which is better? No longer would we be hearing MMT people bitch about what is wrong with the current system. Everybody is already convinced that the current system is crap, the powers-that-be will never change their minds or give up their power. So, yes, you have not done enough. Yes, I have worked alone for nine years on my design and it is very different from the one you and your cohorts have outlined in piecemeal form. I am sure that you will reject mine and criticize it in detail. But at the end of the day, nothing will have changed. If all you want is to complain then admit it, because that is all you are doing. So, let me very clear: the work you MMT theorists have done is not nearly enough to earn the recongition and acclaim you seem to think you are already entitled to. Get off your lazy asses and finish the job.
The saddest thing of all is the bluff of economic hope and change and the consequent ease with which the US political machine distracts and deflects from its other real hidden agendas at the behest of the top 1%. The red bloody finger of accusation is never ever pointed at the government so their Judas demogogue influences are so easily able to fool a nation.
It is also a very sad reminder that we never ever learn from the vast knowledge and lessons of history. They knew all about this problem way back when.
“When governments fear the people, there is liberty. When the people fear the government, there is tyranny. The strongest reason for the people to retain the right to keep and bear arms is, as a last resort, to protect themselves against tyranny in government.” — Thomas Jefferson
Perhaps somewhat strong — but by what other means or mechanism can the ordinary disenchanted citizen change a grossly unfair democratic political system that is wholly rooted, based and run directly through the no-stop greed, influence and corruption of the elite 1% ?
There are many fine freedoms that have been defined for American democracy. But I think a knew freedom should be added to the democracy score that should apply only to the present day ruling elite 1%: That is the freedom, without any hinderance whatsoever, to influence and corrupt our government and laws according to their own sole whims, monetary benefit and power.