“Why, sometimes I’ve believed as many as six impossible things before breakfast.” (or what’s so hard about MMT)

Guest Post by John Armour

Last week Australia’s Prime Minister, Tony Abbott, said; “we are now borrowing to pay the interest on the money we’ve borrowed.” He added that if this didn’t stop we were “stuffed.”

This must make Abbott lead contender for the title of “The Stupidest Man in Australia.” His only serious challengers would be the Treasurer, Joe Hockey, and sidekick Mathias Cormann, who say equally dumb things on a daily basis.

Behind Abbott, Hockey and Cormann, one could reasonably nominate every member of the Press Gallery, the journalists (supposedly our best) who cover the important political issues of the day for the MSM, for the runner-up awards.

Last weekend, on the ABC’s “Insiders” program, four of the nation’s top journalists nodded sagely as one of them expounded on the necessity for “fiscal consolidation,” an oxymoron.

To those well versed in the mechanics of our monetary system it must seem as if our politicians and the press corps live in a parallel universe where black is white and water flows uphill.

Only in the blogosphere does one learn about the reality. Why is this so?

The answer seems to be that non-mainstream academic economists like Bill Mitchell decided to try using the internet to reach a wider audience, to describe how our monetary system really works, and bust a few myths, in the hope that the insights of MMT would then trickle up to policy makers and cut the rug from under the Neo-Liberal experiment.

One would have to say they have been spectacularly successful, but only up to a point.

Despite an enthusiastic lay following that seems to be growing exponentially, the advancement of MMT seems to have hit a wall when it comes to getting around the gatekeepers of the Neo-Liberal madhouse, the economists and financial and political journalists, who write for the MSM.

Keynes said the problem is not in understanding new ideas, but in getting rid of the old ones.

That’s certainly true, but MMT is just so damned confronting to deeply embedded “self-evident” truths. The instincts and “common sense” of Keynes’ “practical men” are of no help. MMT is counter-intuitive.

Proponents of MMT generally can’t understand why people don’t “get” MMT as it seems so obvious.  They may have forgotten however, that at their critical point of ‘enlightenment’ they had to jump a number of conceptual barriers to get to the other side.

In my experience, these are the six (seemingly) “impossible things” you have to believe (before or after meals, it doesn’t matter) to have any hope of ‘getting’ MMT.  Once you believe these “impossible things” however, the getting of wisdom follows quickly and logically.

The order of priority is based on my experience of the degree of ‘jaw dropped-ness’ as I’ve sought to explain to friends, family, and household pets.

(1) Taxes don’t fund anything

(2) The government doesn’t borrow from anybody to finance its spending

(3) The government’s fiscal balance (deficit) is the non-government sector’s surplus.

(4) The government creates currency by fiat (‘out of thin air’)

(5) Bond issuance is  not borrowing.

(6) Banks lend without reserves constraints imposed by the central bank.

They are of course not “impossible things” but the absolute reality of the sovereign fiat monetary system we actually operate under.

I could’ve added a few more but I needed just six to fit my literary allusion (“Through the Looking Glass”).

Warren Mosler’s great little book “Seven Deadly Innocent Frauds of Economic Policy” covers all these points in detail as does Frank E. Newman’s “Six Myths that Hold Back America.”

Do we need to balance our books in Australia? Yes, maybe, except they already are!

There is a lot of talk about Australians living beyond their means, previous Governments spending like drunken sailors, running an unsustainable economy, maxing out their credit cards, etc etc and we all need to learn to be more fiscally responsible. The Government is keen to help us balance the books by cutting services and increasing taxes.

They needn’t bother. The books are already balanced. According to the Reserve Bank of Australia their total assets are $146.356 billion and their liabilities ( as of 21 May 2014)  are also $146.356 billion. What a co-incicidence! The balance sheet balances!

http://www.rba.gov.au/statistics/frequency/stmt-liabilities-assets.html

Of course those keen to see children taught in classes of 35 or more, except their own of course, will point to the $79 billion in government securities shown on the asset side of the balance sheet. Presumably we have sold these securities and all others too, willingly to people who have wanted to buy them willingly. They balance the books not just of the RBA but the Treasury and the whole of governement too. So what’s the problem? If they hadn’t wanted to buy then I’m sure we’d have managed somehow. We wouldn’t have had to say “sorry kids no-one wants to buy Australian securities so you’ll have to put up with us sacking your teacher.”

But then the neo-liberals would have had to think of another reason!

 

“Positive Money” : A Fallacy Built on a Little Known Truth. (Part 3)

Positive money advocates a system of full reserve banking to address the problem, as they see it,  of private banks creating too much money in the process of credit creation.

Click to access Full-Reserve-Banking-in-Plain-English1.pdf

So how, in simple terms, would full reserve banking actually work? It is actually directed towards making banks work more in the way many mistakenly think they do already work. Current accounts, or checking accounts as they are known in the USA, would outwardly remain the same. No interest will be paid on these. The difference will be that the money in them would not be IOUs of the commercial bank but instead would be the IOUs of government. The commercial bank would therefore have to keep an account at the reserve or central bank, the BoE, the Fed, or RBA for example,  which held an amount equal to the total of all customer current accounts. This would cover the possibility that all  customers may simultaneously  wish to drain their current accounts. If the commercial bank became bankrupt customers would be easily able to reclaim their money from the account held at the central bank.

Interest bearing accounts would work slightly differently. Money would be deposited for a fixed term, say 6 months or 1 year and so the usual practice, from a customer’s point of view,  of easily moving their funds from one account to the other would have to end. This would give the bank the opportunity to lend out money during this period without having to create extra money itself. Money lent out from these accounts would not, according to PM, be guaranteed in the event of a bank failure. Although, I’m not quite sure why not. If banks weren’t allowed to write their own IOUs any longer then there would be nothing for them to default on. The pool of deposit money, having been lent out, would only be at risk if the borrowers of that money defaulted rather than if the bank itself defaulted. Depositors could choose to invest in relatively safe ways for a modest interest, or if they wished to take a greater risk could aim for a higher return.

The idea of course is that as all money is the IOU of government, therefore the money supply is totally controlled by government and problems of inflation, booms and busts caused by stop-start bank lending will be ended.

Does this superficially plausible argument stack up?

The PM group tend towards the nonsensical quantity theory of money. The idea is that money simply in the process of existing has an effect on prices. Would doubling the supply of money mean the price of bread doubled? Maybe, if it were spent and the doubling caused spending to double but if it just sat as cash in a bank vault it would obviously have absolutely no effect whatsoever. It is the spending of money which has an effect on prices. Not its mere existence. Lenders of money, almost by definition, have no pressing need to spend it. Borrowers do. So all lending tends to have an inflationary or stimulatory effect in the economy. Changing all lending to be via government money does not change that in the slightest.

It should be recognised that no country anywhere in the world has a system of full reserve accounting. If any one country tried to impose one it would cause the banks, in that country, to be at a disadvantage to their foreign competition. It would risk pushing any problem underground or, more likely, overseas.   There is no reason why , in the age of the internet, any bank operating in a country, would need much physical presence at all in that particular country. It would be quite possible for a Hong Kong based bank to offer a banking service to UK customers in UK £. If that bank was well capitalised, and their issued IOUs were credible then no sensible person or organisation would refuse to accept them. (edit: see Neil Wilson’s comment about this below)

But leaving these practical arguments aside, would FRB work any better in principle? Would making all money an IOU of government rather than an IOU of the bank stop the cycle of booms and busts? That would happen if all banks were nationalised and put under the control of the central bank. If they carried on as normal then nothing much would change, so the type of IOUs, pe se, cannot be the fundamental problem. Governments, at present, have control over the lending practices of banks, except they tend to misuse it.

It is often said, especially in MMT circles, that banks don’t lend out their reserves ie they don’t lend out government created money. This is literally true. If I borrow £1000 then the bank just credits my account by keystroke. The bank has created the money out of thin air as we hear often enough. But, if I then put my bank card into the ATM and take the money in cash, or use it to pay my taxes, or maybe buy some premium bonds, or whatever, then effectively the bank has done just that. ie lent out some of its reserves. Even if I left it in the bank until spent via, say, an internet transaction,  I would almost certainly use that money to purchase goods and services. Sooner or later, whoever held the IOUs created by the bank would want to buy UK government bonds or pay UK taxes, or they would be held by a different bank which would not want to hold another bank’s IOUs. My  bank would have to take them back and pay with real government cash. The half-life of any bank created money is probably no more than a few months.

The banks understand all this and they know they can’t be quite as gung-ho about creating new money, or writing out IOUs, as the PM group would have us believe. Having said that, the problem for most banks is usually not that they have too little government money but they have too much. It is therefore not a restraint on their lending. Because governments, in the UK , the USA and Australia tend to issue more money into the economy than they receive back in taxes, it is easy to see that the excess is going to largely end up with the commercial banks. This causes them a problem. It pays no interest if they just hold it. So their first reaction might be to ask if other banks wish to borrow it from them. They ask 5%, or the pro-rata equivalent for a short term loan, but they have no takers. All the other banks have plenty of government cash too! So they ask 4%, 3%, 2% and they eventually drop down to almost 0%. There is hardly any point lending it out if it really is 0%!

So, as part of the Government’s monetary policy their central bank set a floor on interest rates by taking their money back temporarily. Not that they need the money. Why would they? They can write out as many IOUs as they like. They do it to control interest rates in the economy and therefore the level of lending. So rather than let the level fall to 0% they will intervene and offer interest at, say,  3% (pa) pro-rata on an overnight rate. The Australians have the most descriptive term. They call it the OCR or overnight cash rate. The Australian Reserve Bank, like all central banks, sets the level at whatever rate it likes. Governments and their central banks also have the power to mop up excess reserves on a longer term basis, which they do as part of their monetary policies, through the issuing of bonds/gilts and other securities which pay a return to those holding them. As the RBA put it themselves:

“Monetary policy involves setting the interest rate on overnight loans in the money market (‘the cash rate’). The cash rate influences other interest rates in the economy, affecting the behaviour of borrowers and lenders, economic activity and ultimately the rate of inflation.”

Note that the banks would get short shrift if they tried to ask for 3% on money they have created themselves! That would make life just too easy for them. The Central Banks may be generous enough to pay interest on their own issued money but they aren’t quite so generous as to pay it on someone else’s issued money. Positive Money really ought to do more to explain that.

As the system works at present, the commercial banks can choose to lend risk free to their central banks at a rate influenced by the overnight rate or they can choose to lend at a higher rate to home buyers, industry and others but with the acceptance of a higher associated risk and administrative expenses.

Therefore I would argue that Governments already have the ability to control the level of lending without having to radically change their banking systems. If they want banks to lend more they should lower interest rates. If they want them to lend less they should increase them. It all seems simple enough. So why don’t they just do it?

The answer to that is they like the temporary effect of banks’ over-lending. It makes the economy zip along. The banks’ issued IOUs end up back with government, in taxes,  which are then exchanged for real government money from the banks and so the governments finances look temporarily very good. Their deficits fall. They claim the credit for reducing unemployment. Until the crunch comes of course. The blame for letting that cycle happen rests with government itself. Not the banks. In the boom times they should raise interest rates to slow down lending, but to keep the economy moving they should increase their deficits. If inflation starts to be an issue they should think about raising their interest rates rather than just reducing their deficits which is their first reaction right now.

The main problem governments have right now is that interest rates are far too low. They are almost at zero in many countries.  Incidentally this is the main reason for high house prices, another PM concern, FRB wouldn’t necessarily fix that. Governments can’t do anything with monetary policy. They have relied far too much, for far too long, on it to keep their economies growing and forgotten they have fiscal policy at their disposal too.  But they are so debt averse that is almost unthinkable!  If pressed, they will try any other kind of irrational approach instead such as the nonsense known as Quantitative Easing.

“Positive Money” : A Fallacy Built on a Little Known Truth. (Part 2)

The major fallacy of Positive Money (as written in Part 1) is to consider commercial bank created money as equivalent to government money, or central bank created money. Yes, commercial banks can write out IOUs or create money, in the process of creating loans, but that money doesn’t stay in the economy until the loan is repaid. It is not the repaying of loans which causes a recession it is the removal of money from the economy as that newly created money is taxed away by Government.

Statements like:  “it’s almost impossible to reduce our debts without causing a recession” (1)

are at best missing the point and at worst simply wrong. Typically recessions occur just a few years after  “binge” lending by banks. The 2008 crash followed after a peak of lending in 2006. The 2008 crash was not caused by those loans being repaid. There wasn’t time. Most of the lending was for property with a repayment period over, typically, 25 years. There was time though for much of that new money to be sucked out of the economy by governments’ very efficient tax collection systems. Some of them even boasted about having been able to run a surplus or at least a much reduced deficit in the years before the GFC.

Money as an IOU

To look at the nature of all money we  need to look at who wrote out the IOU. An IOU written out by bank X wouldn’t be the same as one written out by bank Y. Neither of them would be the same as an IOU of government. Normally, this is not at all apparent. It would be very unlikely for any of the big banks to completely fail, but as we know from the GFC of 2008 , it is not impossible. So on an everyday basis we don’t even think about the difference. We don’t have to.

Yet, PM doesn’t consider money created by government to be an IOU. They argue for debt free government issued money. (2)

If the main fallacy of Positive Money is based on the little known truth that banks can indeed create a form of money out of thin air, the next fallacy of PM (and it is probably debatable which is the greater) is that money can be issued on a debt free basis. This fallacy, is not based on anything much at all. The much better known truth is that, if governments create money, they are creating their own debt or a liability for themselves.

On a technical note I should say that the so-called National debt doesn’t include this liability. It includes bonds and other government securities but not currency per se. If you ever hear an economist talk about how Government can pay off its National Debt any time it likes by printing money, they’ll be making use of this definition of National Debt.

Does it make any sense not to include the money base? I can’t see how. If we think of a closed economy of say 1000 people and they elect a government which issues 10 currency units to each person then the total liability of that government is 10k currency units. If each person saves , on average, 1 currency unit  and the government covers the loan of those 1k currency units with bonds paying say 10% interest, the issue of those bonds would change the governments liability to 9k in currency units + 1k in bonds before any interest was paid. PM would argue that as the money base didn’t have to be financed by interest payments that therefore it wasn’t debt. Conversely, as the bonds had to be financed by interest payments it was debt. Incidentally, its not just PM who take this position. It is a broadly held view among many economists.

This argument may have some superficial appeal when interest rates are relatively high, but let us just do what all fiscally sovereign governments can do. Set our interest rates at will. We will make the interest on the bonds 1%. Are the bonds still debt but cash isn’t? What about 0.1%? The cash is not a debt but the bonds still are? What about 0.001% or the tiniest number imaginable? Say a $1  or a £1  bond paid out a cent, or a penny, of interest over the lifetime of the universe, does that 1 cent or 1 penny make that bond any different to a $1 bill or a £1 note?

Of course this is absurd, and the only logical way out of the absurdity is to consider all money, including government issued money, as debt and all bonds as debt. Cash doesn’t pay any interest but bonds or gilts do. They are both just different forms of government IOUs.

(1) http://www.positivemoney.org/issues/debt/

(2) https://www.positivemoney.org/2011/10/debt-free-money/

When Joe says he wants a surplus, he means for government but a deficit for everyone else!

The Australian public have just been told that: The ‘Age of Entitlement’ is over, we have been living beyond our means, we can’t afford to spend more than we earn, we are leaving an unsustainable debt burden for the next generation. Think of a neo-liberal falsehood and the chances are Joe Hockey will have used it in yesterday’s  budget speech. Most of all, we are told “we” need to move to balance the budget and achieve a surplus. Note that Joe means a surplus for government and a deficit for everyone else!

If the governments take more out of the economy than they spend back in, as they would by the definition of a surplus, and at the same time individuals and companies within that economy wish to save some of the money they earn, and if there is a drain of money from the economy to pay for net imports, then isn’t that a recipe for crashing the economy, Greek style?

There won’t even be any ‘improvement’ in the deficit. Joe knows that. All sensible economists know that depressing the economy will make it higher not lower. Tax revenues will simply fall by an equal or greater amount than the cuts he has made, as the economy spirals downwards. If he genuinely wants to reduce the deficit, if that is what is really important to him, he needs to press the fiscal accelerator pedal, not puts his foot on the brake. That way the economy grows, the tax take rises, people are more confident to spend and invest more, and as unemployment falls, workers start to pay tax rather than receive welfare benefits. If Joe hasn’t abolished those completely!

Edit: Further reading
http://bilbo.economicoutlook.net/blog/?p=27823

“Positive Money” : A Fallacy Built on a Little Known Truth. (Part 1)

Ask most people how banks work and they’ll tell you that they take in deposits from customers and lend them out to other customers. They’ll tell you that banks make their money by charging more interest to borrowers than they pay to their depositors, or lenders. It is a nice idea that the Positive Money group would thoroughly approve of, but unfortunately it does not work like that. The positive money group (see http://www.positivemoney.org) is quite right to tell us all that is just not the case at all.

If we look into our bank accounts we see what we usually assume to be £ or $ of exactly the same form as we see in our purses and wallets. There is a key difference though. The banknotes in our wallets are, nearly always but with a few exceptions, the IOUs of central banks. In the USA this is the Federal Reserve. The Bank of England, in the UK and the Reserve Bank of Australia (RBA)  in Australia. If we take a pile of banknotes into our bank to deposit into our account the bank will, in turn, put those notes into its own account at the reserve or central bank. Then it will just credit our account with the same amount. So they replace central bank IOUs for their own IOUs whenever someone deposits banknotes. The same process would apply to a government cheque to pay a soldier’s salary for example.  If someone deposits a bank cheque from the same bank then the process is much simpler. The bank cheque is used as an authorisation to credit our account by a set amount. If from another bank, the process is handled through ‘clearing’ which is simply the process of cancelling each others bank IOUs by contra, with any remaining imbalance being settled from the banks’ reserve accounts at the central bank.

Banks also create their own IOUs when they lend. If we borrow money from a bank they simply create their own IOUs at the touch of a keystroke. Effectively they have created new money “out of thin air”. This causes the PM group to become very alarmed!

They blame the commercial banks for pretty much the whole of the difficulties the western economies have had recently. Is this really justified? Well, partly. The banks’ stop-start approach to lending causes all sorts of problems. However governments do have the ultimate power to regulate their economies using a variety of fiscal and monetary methods. If bank lending is causing problems, it is down to governments to act to nullify them .  Nationalising banks or forcing them to adopt 100% reserve accounting, or whatever other remedies PM  may advocate, could possibly have worked  30 ir 40 years ago, but in the age of the internet when banks can be located anywhere in the world that kind of ‘solution’ is no longer an option.

The crunch issue for all banks, wherever they are, is that they do have, from time to time, to back up the money they have created supposedly “out of thin air” with real government money. The mistake which I think many are making is to assume that bank created money, created when loans are issued, stays in the economy until that loan is repaid. It doesn’t.

Suppose I borrow £1000 from my bank. The bank edits my account upwards to show that extra money. So its just been created. “Out of thin air”! Fair enough. I then write out a cheque for £1000 to the taxman. The taxman puts the cheque through the clearing system but he doesn’t want bank money, bank IOUs, he wants real government money. The bank supplies this from its reserves. At the same time it edits my bank account downward so eliminating the newly created “money”. I still owe the bank £1000.

This would be relatively unusual but possible. A more usual scenario would be that a bank would lend money to a business, say a builder, who would hire bricklayers, joiners, buy raw materials etc for his building project. Every transaction would attract the usual government taxes. Income tax. VAT, NI contributions, Corporation tax etc. As the newly created money is spent and respent it rapidly dwindles until there is nothing left. It has nearly all gone to the government’s taxman who doesn’t want the money as it was originally created. He insists that banks convert their IOUs to government IOUs. Of course if they can’t do this they are in default just like you and I would be in default if we wrote out a cheque with insufficient money in our accounts to back it up.

When banks are lending money freely governments tend to have high tax returns too. So much so they’ll often boast how competent they are in their fiscal policies which may well have even produced a budget surplus. Unless governments are in charge of economies which are net exporters, like Germany, it is a mistake for that to happen. It is  a sign that they have allowed private lending to get out of control and that a recession will be about to follow.

Although some would claim that banks have a licence to print money, it isn’t quite like the PM group lead people to believe on their website. If this were really the case then banks could never go broke of course.