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The old line back to free market ideology still intact

The US economy is showing signs of slowing as the fiscal stimulus is withdrawn and the spending contractions of the state and local government increasingly undermine the injections from the federal sphere. The recent US National Accounts demonstrate that things are looking very gloomy there at present. In the last week some notable former and current policy makers have come out in favour of austerity though. Some of these notables contributed to the problem in the first place through their criminal neglect of the economy. Others remain in positions of power and help design the policy response. A common thread can be found in their positions though. A blind faith in the market which links them intellectually to the erroneous views espoused by Milton Friedman. His influence remains a dominant presence in the policy debate. That is nothing short of a tragedy.


The US Bureau of Economic Analysis released the June quarter National Accounts data for the US on Friday, July 30, 2010, which showed that:

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 2.4 percent in the second quarter of 2010, (that is, from the first quarter to the second quarter), according to the “advance” estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 3.7 percent.

While, the June release is subject to revision in late August, the results are signalling that the US economy is now slowing down as the fiscal stimulus is withdrawn.

The press clearly saw it that way.

The UK Guardian said on July 30, 2010 that US economy shows signs of slowdown as consumer spending falters. They amplified this headline with the following:

The US recovery appears to be faltering after a slowdown in consumer spending dampened growth and fuelled fears of a double dip recession … Slower growth across the US, where almost one in 10 are out of work, was expected by economists. But many expressed surprise at the extent of the slowdown and the continued anxiety among consumers. While business investment grew strongly, consumers sat on their hands. Spending on services was especially weak with figures showing a meagre 0.8% annual rise.

The following graph focuses on what is happening with the components of real GDP growth. It shows the percentage contributions of the main aggregate demand components from the first quarter 2008 to the June 2010 quarter.

A major problem for the US government now is that the stimulus at the federal level is being increasingly undermined by the the cuts occuring in public spending at the state and local government levels. The US federal system is working against itself. Further while private investment has been growing modestly, private consumption has tapered off again.

The BEA say that:

The deceleration in real GDP in the second quarter primarily reflected an acceleration in imports and a deceleration in private inventory investment …

The next graph shows the percentage contributions to the percent change in Real GDP from the first quarter 2007 to the June 2010 quarter arising from the trade sector. While exports have grown modestly (slowing in the June quarter though), imports have accelerated and drained 4 per cent from the real GDP growth in the June quarter.


Former US Federal Reserve boss, Alan Greenspan was interviewed on Meet the Press yesterday (August 1, 2010). David Gregory was the MSNBC chair.

Greenspan appeared along with the mayor of New York City, Michael Bloomberg; and governor of Pennsylvania, Ed Rendell.

Gregory asked Greenspan whether the US economy would get worse before it gets better. If you can work out the double-talk answer then you get a bonus point. This is what Greenspan said:

Maybe, but not necessarily. I think we’re in a pause in a recovery, a modest recovery. But a pause in the modest recovery feels like quasi recession.

He went onto explain how the top-end-of-town had received the benefits of the stimulus and that if there is a further fall in house prices then the economy might double dip back into recession.

He was asked where unemployment would be through 2010 and beyond. He replied:

I feel we just stay where we are. The–there is a gradual increase in unemployment, but not enough to reduce the level of unemployment … I would say that there’s nothing out there that I can see which will alter the, the, the trend or the level of unemployment in this context.

So nothing at all to say about this other than it won’t get better.

He was then asked about the need for interest rates to rise again. He said:

Well, the problem there implies that the government has control over those rates, meaning the Federal Reserve and the Treasury Department, in a sense. There is no doubt that the federal funds rate, that is the rate produced by the Federal Reserve, can be fixed at whatever the Fed wants it to be, but which the government has no control over is long-term interest rates, and long-term interest rates are what make the economy move. And if this budget problem eventually merges to the point where it begins to become very toxic, it will be reflected in rising long-term interest rates, rising mortgage rates, lower housing. At the moment, there is no sign of that, basically because the financial system is broke and you cannot have inflation if financial system is not working.

Greenspan knows full well, as does his successor Bernanke, that the central bank in tandem with the US Treasury could control investment rates if they wanted to. Please read my blog – Who is in charge? – for more discussion on this point.

But his reply also is an examples of one of those “well crowding out is a bad problem, but empirically there is no sign of it, but it is only a matter of time.” This sort of response is commonplace as the ideologues who just quote from mainstream macroeconomics textbooks cannot face the fact that their understanding of how the economy operates is false and the data is showing that.

The empirical world is being very harsh to the goldies, the Austrians and the neo-liberals at the moment. But rather than take a robust intellectual position and admit they got it wrong entirely, their ideological minds have to say – well it will get bad eventually. It might and it might not. But whatever happens – it won’t validate their erroneous theoretical conceptions.

Greenspan was then asked whether extending the tax cuts that are due to expire at the end of 2010 would be the solution. Greenspan had previously told a finance journalist in an interview that the Government “should follow the law and then let them lapse.”

The previous interview has then posed the problem that allowing the tax cuts to vanish would depress growth. Greenspan had answered: “Yes, it probably will, but I think we have no choice in doing that, because we have to recognize there are no solutions which are optimum. These are choices between bad and worse.”

So “Meet the Press” asked him to clarify the statements made in the earlier interview:

MR. GREGORY: You’re saying let them all go, let them all lapse?

MR. GREENSPAN: Look, I’m very much in favor of tax cuts, but not with borrowed money. And the problem that we’ve gotten into in recent years is spending programs with borrowed money, tax cuts with borrowed money, and at the end of the day, that proves disastrous. And my view is I don’t think we can play subtle policy here on it.

The problem that the US economy has gotten into in recent years are the legacy of the blind faith in the market that Greenspan promoted vigorously during his term in office. This led to a massive grab of real GDP by the financial sector which then gambled it to advance their own greed.

The gamble failed and the real economy collapsed as private spending faltered. The only thing that saved us from another depression was the fiscal interventions with some monetary policy support.

The fact that governments are borrowing when they are sovereign in their own currencies reflects the dominance of the neo-liberal paradigm. It is voluntary and basically financially harmless but totally unnecessary. The political damage it is causing though is the problem.

Recall the Time article (which covered the Russian and Latin American debt crisis) as I watched the US PBS Frontline program The Warning which went to air in the US on October 20, 2009. It is available via the Internet now and is worth viewing if you have the time. It documents that struggles that Brooksley Born, who became the head of the US federal Commodity Futures Trading Commission had with the Committee that Saved the World.

I especially liked the segment which described Born’s first lunch with Greenspan after she was appointed as Head of the Commodity Futures Trading Commission. Apparently, Greenspan expressed a “disdain for regulation” and when she raised the issue of the problem of financial fraud Greenspan said that “the market would take care of the fraudsters by self-regulating itself”.

So never mind the real damage caused to people’s life savings or life-time employment entitlements (pensions etc) or jobs – the market will see to it that a monumental failure driven by fraud (for example, Enron) is sorted out. And … meanwhile … very few of the fraudsters ever really get rounded up and punished.

Born had wanted to regulate the growing and secretive Over the Counter (OTC) derivatives market and met with great resistance from Rubin, Greenspan and Summers. She told the program that “Alan Greenspan at one point in the late ’90s said that the most important development in the financial markets in the ’90s was the development of over-the-counter derivatives”.

When asked if Greenspan knew what he was talking about, Born replied “Well, he has said recently that there was a flaw in his understanding”. The last comment is in relation to testimony that Greenspan gave to the US Congress in October 2008 which I discuss below.

Born got involved in the law suit filed by filed by Procter & Gamble against Bankers Trust. It is clear that BT were screwing Procter by selling them derivatives that were too complicated for them to understand the risk. The program reveals audio-tapes of Bankers Trust brokers talking about their deliberate “intention to fleece the company” (Procter). One said “This is a wet dream” while there was a lot of laughing about how smart BT was in “setting up” Procter as a pigeon (victim).

At that stage Born saw the need for government regulation of the financial sector (particularly the banks) but she met incredible resistance from the Adminstration and Greenspan.

But Born’s efforts to seek ways of regulating the OTC market didn’t stop the awesome trio – The Committee to Save the World. She sought to develop a “concept release” – a plan for regulation within the legal jurisdiction of the CFTC.

The Committee to Save the World with another came out publicly on May 7, 1998 which this Press Release from Rubin, Greenspan and Levitt (SEC Chair) issued by the US Treasury:

On May 7, the Commodity Futures Trading Commission (“CFTC”) issued a concept release on over-the-counter derivatives. We have grave concerns about this action and its possible consequences. The OTC derivatives market is a large and important global market. We seriously question the scope of the CFTC’s jurisdiction in this area, and we are very concerned about reports that the CFTC’s action may increase the legal uncertainty concerning certain types of OTC derivatives.
The concept release raises important public policy issues that should be dealt with by the entire regulatory community working with Congress, and we are prepared to pursue, as appropriate, legislation that would provide greater certainty concerning the legal status of OTC derivatives.

This New York Times article from last year – Taking Hard New Look at a Greenspan Legacy provides a good summary of the events. It documents the fierce opposition that Greenspan, Rubin and Summers put up against any notion of regulation of the financial markets.

So now Greenspan is advocating fiscal austerity when he knows it worsen the economy and knows that unemployment will also rise.

He knows full well that public debt is unproblematic and is not akin to private debt. He knows that when there is such a huge reservoir of excess capacity in the US economy that extra spending is required and that the debt-repayments provides income to the private sector.

But his public comments would suggest he is stupid in relation to presenting an accurate portrayal of how the modern monetary system operates. But we know he is not stupid – he understands the opportunities the government has. So he is just choosing to deliberately mislead the public and advance his extremist ideological agenda.

He is nothing more than ideological warrior who is prepared to distort public perception. That should come as no surprise given that the extremist Ayn Rand was Greenspan’s intellectual light.

Please read my blog – Being shamed and disgraced is not enough – for more discussion on this point.

More fiction

On Thursday July 29, 2010 the CEO of the Dallas Federal Reserve Bank, Richard W. Fisher gave a speech entitled – Random Refereeing: How Uncertainty Hinders Economic Growth – to the Greater San Antonio Chamber of Commerce. So a forum stacked with business types.

His speech continued to air the view that is now commonplace in the public debate that government policy is now making the recession worse and things would be better if the government just set some rules and let the market rip.

He said:

I have ascribed the economy’s slow growth pathology to what I call “random refereeing” – the current predilection of government to rewrite the rules in the middle of the game of recovery. Businesses and consumers are being confronted with so many potential changes in the taxes and regulations that govern their behavior that they are uncertain about how to proceed downfield. Awaiting clearer signals from the referees that are the nation’s fiscal authorities and regulators, they have gone into a defensive crouch.

Of-course, much of the “uncertainty” is being driven by the fact that the government stimulus is now being withdrawn and austerity programs which are cutting peoples’ incomes and pensions are now being pursued with vigour.

Fisher doesn’t mention that.

He claims that the government should set rules and stick to them.

I would not defend the performance of the US Government or the US members of congress. From a distance they seem to have little regard for the crisis they are overseeing.

Fisher claims that the current fiscal situation is crowding out private spending, making it impossible for the US government to deal with the recession (because they have run out of money) and hindering the capacity of “individuals to smooth their consumption over the business cycle” and raising the “probability of a debt crisis”.

So you realise that he is another free market ideologue who chooses to mimic the erroneous mainstream macroeconomics textbook mantras.

Underpinning of the crowding out hypothesis is the old Classical theory of loanable funds, which is an aggregate construction of the way financial markets are meant to work in mainstream macroeconomic thinking. The original conception was designed to explain how aggregate demand could never fall short of aggregate supply because interest rate adjustments would always bring investment and saving into equality.

Mainstream textbook writers (for example, Mankiw) assume that it is reasonable to represent the financial system to his students as the “market for loanable funds” where “all savers go to this market to deposit their savings, and all borrowers go to this market to get their loans. In this market, there is one interest rate, which is both the return to saving and the cost of borrowing.”

This doctrine was a central part of the so-called classical model where perfectly flexible prices delivered self-adjusting, market-clearing aggregate markets at all times. If consumption fell, then saving would rise and this would not lead to an oversupply of goods because investment (capital goods production) would rise in proportion with saving.

So while the composition of output might change (workers would be shifted between the consumption goods sector to the capital goods sector), a full employment equilibrium was always maintained as long as price flexibility was not impeded. The interest rate became the vehicle to mediate saving and investment to ensure that there was never any gluts.

The supply of funds comes from those people who have some extra income they want to save and lend out. The demand for funds comes from households and firms who wish to borrow to invest (houses, factories, equipment etc). The interest rate is the price of the loan and the return on savings and thus the supply and demand curves (lines) take the shape they do.

This framework is then used to analyse fiscal policy impacts and the alleged negative consequences of budget deficits – the so-called financial crowding out – is derived.

The erroneous mainstream logic claims that investment falls when the government borrows to match its budget deficit – the borrowing allegedly increases competition for scarce private savings pushes up interest rates. The higher cost of funds crowds thus crowds out private borrowers who are trying to finance investment. This leads to the conclusion that given investment is important for long-run economic growth, government budget deficits reduce the economy’s growth rate.

The analysis relies on layers of myths which have permeated the public space to become almost “self-evident truths”. Obviously, national governments are not revenue-constrained so their borrowing is for other reasons – we have discussed this at length. This trilogy of blogs will help you understand this if you are new to my blog – Deficit spending 101 – Part 1Deficit spending 101 – Part 2Deficit spending 101 – Part 3.

But governments do borrow – for stupid ideological reasons and to facilitate central bank operations – so doesn’t this increase the claim on saving and reduce the “loanable funds” available for investors? Does the competition for saving push up the interest rates?

The answer to both questions is no! Modern Monetary Theory (MMT) does not claim that central bank interest rate hikes are not possible. There is also the possibility that rising interest rates reduce aggregate demand via the balance between expectations of future returns on investments and the cost of implementing the projects being changed by the rising interest rates.

But the Classical claims about crowding out are not based on these mechanisms. In fact, they assume that savings are finite and the government spending is financially constrained which means it has to seek “funding” in order to progress their fiscal plans. The result competition for the “finite” saving pool drives interest rates up and damages private spending.

A related theory which is taught under the banner of IS-LM theory (in macroeconomic textbooks) assumes that the central bank can exogenously set the money supply. Then the rising income from the deficit spending pushes up money demand and this squeezes (real) interest rates up to clear the money market. This is the Bastard Keynesian approach to financial crowding out.

Neither theory is remotely correct and is not related to the fact that central banks push up interest rates up because they believe they should be fighting inflation and interest rate rises stifle aggregate demand.

Further, from a macroeconomic flow of funds perspective, the funds (net financial assets in the form of reserves) that are the source of the capacity to purchase the public debt in the first place come from net government spending. Its what astute financial market players call “a wash”. The funds used to buy the government bonds come from the government!

There is also no finite pool of saving that is competed for. Loans create deposits so any credit-worthy customer can typically get funds. Reserves to support these loans are added later – that is, loans are never constrained in an aggregate sense by a “lack of reserves”. The funds to buy government bonds come from government spending! There is just an exchange of bank reserves for bonds – no net change in financial assets involved. Saving grows with income.

But importantly, deficit spending generates income growth which generates higher saving. It is this way that MMT shows that deficit spending supports or “finances” private saving not the other way around.

Acknowledging the point that increased aggregate demand, in general, generates income and saving, Luigi Passinetti the famous Italian economist had a wonderful sentence I remember from my graduate school days – “investment brings forth its own savings” – which was the basic insight of Keynes and Kalecki – and the insight that knocked out classical loanable funds theory upon which the neo-liberal crowding out theory was originally conceived.

Further, there is a zero probability that the US government will face a solvency crisis with respect to its debt issuance. There is not increasing probability of a debt crisis.

Finally, the consumer smoothing argument is based on the Ricardian Equivalence nonsense that I have blogged about regularly. Please read my recent blog – Defunct but still dominant and dangerous – for more discussion on this point.

Fisher then invoked the inflation myth:

Let me close this discussion of fiscal uncertainty with one more thought. Some of you may wonder whether our elected officials, faced with the truly monumental task of balancing the nation’s books, might simply throw in the towel and turn to the Fed to print us out of this enormous fiscal hole. If such a request were ever made, there should be no uncertainty: We at the Fed cannot and will not monetize the debt. We know what happens when central banks give in to those requests – it leads us down the slippery slope of debasing our currency and puts us on the path of hyperinflation and economic destruction. Neither I nor my colleagues are willing to risk that legacy.

Please read the following blogs – Operational design arising from modern monetary theory and Asset bubbles and the conduct of banks for further discussion as to why this is sheer nonsense.

The root source of the fiction

It all reminded me of a 1973 Playboy interview with Milton Friedman, which was one of the only times that I can recall (and I was young at the time) that the sycophantic press really homed in on the ideologue from Chicago.

At one point in the interchange Friedman was asked to explain how the Federal Reserve System causes inflation. He replied:

… The Fed, because it’s the government’s bank, has the power to create – to print – money, and it’s too much money that causes inflation. For a rudimentary understanding of how the Federal Reserve System causes inflation, it’s necessary to know what it has the power to do. It can print paper money; almost all the bills you have in your pocket are Federal reserve notes. It can create deposits that can be held by commercial banks, which is equivalent to printing notes. It can extend credit to banks. It can set the reserve requirements of its member banks – that is, how much a bank must hold in cash or on deposit with the Federal Reserve Bank for every dollar of deposits. The higher the reserve requirement, the less the bank can lend, and conversely.

These powers enable the Fed to determine how much money-currency plus deposits – there is in the country and to increase or decrease that amount.

So I would fail the now deceased Chicago professor if he submitted this to me as an answer. I would fail it because it doesn’t reflect the way the monetary system functions nor the way the central bank interacts with the commercial banks.

This is the mainstream macroeconomics text book view that you will still see in books like Mankiw. In his Principles of Economics (I have the first edition), Mankiw’s Chapter 27 is about “the monetary system”. In the latest edition it is Chapter 29.

In the section of the Federal Reserve (the US central bank), Mankiw claims it has “two related jobs”. The second “and more important job”:

… is to control the quantity of money that is made available to the economy, called the money supply. Decisions by policymakers concerning the money supply constitute monetary policy (emphasis in original).

In the blog – Money multiplier – missing feared dead – I explain how the money supply is endogenous (that is, the central bank cannot control it) and depends on the credit-seeking behaviour of the private sector and the commercial banks’ responses to this behaviour.

The idea that some money multiplier exists that scales up the central bank creation of the monetary base is totally false. There is in fact no unique relationship of the sort characterised by the erroneous money multiplier model in mainstream economics textbooks between bank reserves and the “stock of money”.

See also the September 2008 edition of the Federal Reserve Bank of New York Economic Policy Review – Divorcing Money from Monetary Policy – where they explain that the central bank targets the short-term interest rate as an expression of monetary policy and cannot control the money supply.

Please read the following blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – for further discussion.

It is a myth that the reserve requirements constrain the bank’s capacity to lend. They just mean that the central bank has to ensure there are at least that volume of the reserves in the system. They might try to supply those reserves at a prohibitive rate but then they will compromise their target policy rate.

Please read my blog – Money multiplier – missing feared dead – for more discussion on this point.

I will write more about Friedman’s errors in another blog later this week sometime.

Playboy continued to probe this issue and Friedman said that the Federal Reserve system was vulnerable because:

it’s a system of men and not of rules, and men are fallible … we can take some of the discretionary power away from the Fed and make it into a system that operates according to rules. If we’re going to have economic growth without inflation, the stock of money should increase at a steady rate of about four percent per year – roughly matching the growth in goods and services. The Fed should be required to take the kind of limited action that would ensure this sort of monetary expansion.

So once again there is an erroneous claim that central banks could control the money supply. This belief led to the embarrassing period of monetary targetting which was the flavour of the decade from the mid-1970s. Friedman’s ideas were very influential in this period.

Central bankers were conned into believing that by controlling the money supply they would control inflation. Milton Friedman told the profession that if the central bank reduced the growth rate of the money supply to the potential rate of real output growth then the inflation rate would stabilise at zero.

So if you desired a 1 per cent inflation rate and your “fully employed” economy could generate real GDP growth at 4 per cent, then the nominal growth in the money supply should be set at 5 per cent. This was the basis of monetary targetting.

My own stupid nation was one of the first to implement this stupidity in March 1976 just after the conservatives “stole” the federal government with the help of the CIA (see Australian constitutional crisis for more on that).

In Australia, as elsewhere, the policy was a total failure. There was no clear relationship anyway between the measured growth in the broad monetary aggregates (the money supply) and the rate of inflation.

Further, the between August 1978 and the time the conservatives were thrown out of office in March 1983, actual monetary growth exceeded the targets. And … both inflation and high unemployment remained at high levels.

Interestingly, the Labor party (the so-called political arm of the trade union movement) which swept to office in 1983 continued with the policy. This was the early warning sign that the progressive party in Australian politics had sold out to the neo-liberal agenda. It got worse from then on. Unfortunately, we are still caught in that mindset.

At the time though, the “markets” – which are still seen as the oracles of good policy – were strongly behind targetting despite its total failure. The Labor party scared they would put the “bond traders” off-side, retained the policy.

By the mid-1980s it was clear the policy approach was a total crock. The central bank could not control the money supply. The stupidity was abandoned in Australia in January 1985.

It demonstrated that the mainstream macroeconomics text book models were (and remain) useless for understanding how the monetary system operates.

Yet these modern day monetary commentators still appeal to the same starting points and hold out Friedman as if he has anything to offer us. He had nothing to offer when he was alive and in his “prime”. He has nothing to offer us now as a legacy of his work.

All I remember him for is the damage he did in Chile after the democratically-elected Allende government was overthrown by a brutal military dictatorship with the support of the US government. Please see the film – The Battle of Chile – for more information on this.

Now, back to the Playboy interview. Friedman was then asked if the central bank was forced to set monetary policy by rules “wouldn’t the Fed lose its emergency powers – powers that would be useful in a crisis?”. Friedman said:

Most so-called crises will correct themselves if left alone. History suggests that the real problem is to keep the Fed, operating on the wrong premises, from doing precisely the wrong thing, from pouring gas on a fire. One reason we’ve so many government programs is that people are afraid to leave things alone when that is the best course of action. There is a notion – what I’ve called the Devil Theory – that’s often behind a lot of this …

PLAYBOY: But you prefer the laissez-faire – free-enterprise – approach.

FRIEDMAN: Generally. Because I think the government solution to a problem is usually as bad as the problem and very often makes the problem worse …

So we are just getting a reprise of this basic view.

Friedman was asked at one point (not in this interview) how long it would take for unemployment to fall back to its so-called (mythical) natural rate after rising to kill off inflation. He said about 15 years. So 10 or more percent unemployment for 15 years … and that is if his model of self-correction works.

The modern proponents of the “government makes things worse” lobby won’t even put a figure on what would have happened if the stimulus packages were not introduced nor will they tell us how long it would take before trend growth is resumed and whether the trend remained undamaged (via the hysteresis).

My advice: any comments this lot make in the public debate should be instantly disregarded.

An aside – self-promotion and more fiction

It is not only the mainstream economists who have a crying need to pursue celebrity at the expense of compromising themselves with lies and misrepresentations. Even so-called progressives do it.

In a recent Interview in the Australian media, Steve Keen was quoted as saying:

I’m not a fan of what’s called Chartalist economics that argues the government can run any size deficit it likes … I believe there are limits there, but nonetheless if you have private sector deleveraging, then the last thing you want to have there is the government doing exactly the same thing – it will just take cash flow out of the economy and push it down.

When have any MMT economists said that there are no limits on the size of the public deficit? Answer: Never.

When have MMT economists said that the government can run any size deficit it likes? Answer: Never.

The statement that a sovereign government is not financially constrained is not equivalent to either of the previous statements.

Associate Professor Steve Keen (an academic ranking which is below full professor in the Australian system) – clearly doesn’t understand what Modern Monetary Theory is about despite continually making public statements criticising it.

Or, perhaps, he chooses to deliberately misrepresent it because he realises his own forecasts of what was going to happen as the crisis unfolded have been found to be badly wanting and he knows that MMT is the only theoretical position left standing at present that has any credibility.

But then if you cannot get simple accounting correct I suppose there is not much to expect beyond that.


It is clear that reinvention and historical revisionism is the order of the day. More and more of these neo-liberal zealots are speaking out again – after being initially shamed and silent.

The irony is that fiscal policy has reduced the damages their actions (or inaction) caused yet they are doing their best to undermine it. Given their links to the top-end-of-town which has clearly profited massively from the public handouts, it is no surprise that they want to stop the fiscal expansion in its tracks for fear that some of the largesse might be spread a little further to the unemployed.

It is a pity the ordinary Americans couldn’t see it within their powers to redux their revolution when they threw the British (and French and Spanish) out. This time their targets should be Wall Street and all its connections in the political sphere.

Some people have just stopped earning the chance to be listened to any longer.

That is enough for today!

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    This Post Has 109 Comments
    1. Paul,

      Money is not just debt instruments regardless of the history of the monetary system. In the current system money are tokens of exchange, just numbers. As long as the currency remains the legal tender it is irrelevant where it comes from. They can either be injected by the government or created by the banking sector.

      The system can obviously fail – like in the Weinmar Republic in 1919-1923 or Zimbabwe.

      As a software engineer I can use my analytical experience and describe the monetary system as a decentralised hierarchy of balance sheets storing these numbers. A small number of physical tokens remains in circulation as well but these are still accounted for on the balance sheets. Legal and accounting rules define operations which can be performed on the records (numbers). Legal rules also determine how these numbers relate to the real goods and services.

      This knowledge is enough. We don’t need any more information to describe the system.

      Please do not concentrate on the ontology of money. This is the thing i believe one of our friends got wrong. He thinks in terms of a magic substance called money created as an offset to debt which cannot be destroyed on balance sheets. But we have to think in operational terms or we may not progress much further than Mt Kosciuszko. Our theory must start from the accounting not philosophy.

      Now the second issue. I agree that “official” theory of value which links the use value to the so-called exchange value is plainly incorrect. But what is your value theory? Do you agree with Marx that the value of goods is determined by the amount of labour?


      But this theory has its own limitations. What about the intrinsic value of the natural resources? What if it is multidimensional?

      So my ultimate question is how you define the value of “resources” you are referring to.

      Can you define a metric space based on your measurement of value?


      Personally I think that what you have presented so far doesn’t disprove any relevant elements of MMT. MMT is just a monetary theory showing how the decentralised monetary database system operates within the framework of modern state institutions. It does not come with its own value theory. We have a responsibility to BYO.

      It is also our responsibility to use the existing financial system to achieve individual and social goals – and do not kill ourselves by destroying the environment.

    2. You call it [trading bonds for dollars] “printing money”which is misleading, because it leaves out the payment of what MMT people call a subsidy to the private sector. (Most people call this interest). No, that is not what MMTers call printing money. Bill does not like the term, but let us use it. Printing money means running a printing press and getting dollar bills out of it. Then the government uses them to buy stuff. This spending is the real money printing/creation. The bonds etc are a sideshow, which are not necessary, forget about them. The basic idea is that the normal state of a government is to issue more dollar bills than it destroys by taxation. The difference is the deficit. No bonds need be sold. No borrowing or interest of any sort. Let’s say the US converts to Islam and makes it illegal.

      From a purely theoretical standpoint, and as an academic exercise only – even if you had to start a pure-credit system from scratch, the (brand new) central bank could “bootstrap” the system by buying real assets from the private sector (and issuing HPM to do so), or by lending to the private sector using private assets as collateral (again, creating HPM to do so). This HPM would be backed by real assets so the central bank would be in the black from the start so long as the government provided it with some real assets (e.g. land) as an equity buffer. The initial value of the currency would be set by the amount of HPM created to pay for the assets.

      In your academic exercise, you seem to have a currency backed by convertibility into government land, OK. (a) you say the govt (the treasury and the central bank combined) uses its HPM to buy real assets from the private sector. That’s the deficit right there. A fiscal, monetary deficit – the government spent more HPM than it took in (apparently zero) (b) you say the private sector could borrow HPM; that is the govt spending HPM to put this HPM loan to the private sector on its balance sheet. Again, there’s the deficit. (And unless it is a negative interest rate loan – wish I could get one – where is the private sector going to get the HPM to pay it back?)

      What you are trying to do is impossible. What sectoral balances, deficit = private savings, things adding up to zero, etc are based on is: that if I give you one whatsit, my balance sheet’s whatsits decreases by one, yours increases by one and the total number of whatsits is unchanged. Take me =govt, you = private sector; My whatsit deficit = your whatsit savings. If we don’t agree on this, as a mathematician, I am interested in your number system!

      If you don’t get the basic identities that MMT and other forms of macroeconomics use, you aren’t defining things the standard way that MMT and other forms of macroeconomics use.

    3. AK

      “Money is not just debt instruments regardless of the history of the monetary system”

      Agreed. I didn’t mean to claim an overarching definition of money, there are many different definitions.

      What I meant was that under the central banking system, purchasing power resides in the total net debt of all net debtors. If the increase in “total net debt of all debtors” exceeds production of real assets desired for purchase in any given time period, inflation is generally the result (although there may be lags). For the purpose of the discussion, and in the context of the central banking model only, my idea of “issuance of currency” is equivalent to “creation of purchasing power”.

      Physical tokens are a liability of the central bank to the holder. (Again I refer only to the current central banking model). These are interchangeable by private banks for HPM reserves. The central bank is required to ensure its assets exceed its liabilities, so each physical token and each unit of HPM has a corresponding asset on the central bank balance sheet.

      I believe that value cannot be objectively determined. We can come close in some cases, but not in others.

      Each individual has a subjective value that he or she places on each thing in the world. These subjective values usually don’t have numbers, but the individual has preferences for one thing over another. I agree with the Austrian theory of marginal utility here (but I don’t agree with Austrian theory on many other points).

      Some real assets individuals can obtain for money, whereas other real assets cannot be obtained for money.

      When the individual desires a thing that can be obtained for money, and he or she decides to obtain that thing, he or she subjectively values the thing more highly than the money with which he or she is parting.

      The market is the sum of many such individual subjective decisions, and we get close to an objective money value of real assets through the market. This bears the hallmarks of an objective value, for most intents and purposes, even if it is not truly objective.

      The class of real assets that cannot be obtained for money do not have anything close to objective values, as there is no market to provide the approximation. However, they still have subjective value to individuals, and sometimes this subjective value is high to the vast majority of individuals. Individuals still have subjective preferences for one of these real assets over another (e.g. more public education vs. lower taxes). It is a mistake to ignore these real assets because they cannot be priced.

      In addition, aquisition of or creation of real assets that cannot be obtained for money can and does have an effect on the production of real assets that can be obtained for money down the track. e.g. better public education today, resulting in greater knowledge and understanding within the population, may result in higher GDP fifteen years from now.

      In summary, any government attempt to create “value” – i.e. subjective value in a high proportion of all individuals, needs to take into account quantifiable (priceable) costs and qualititative (unpriceable) costs in terms of usage of real assets, and quantifiable and qualitiative benefits in terms of creation of real assets. Any government decision is made by a set of individuals, each with their own subjective values. These people have a responsibility to make an effort to determine the broad subjective values of the population, rather than merely using their own, although often this is not practical, and this is part of the problem with the spending of taxpayer funds.

      Market pricing is a rough approximation of an objective value for some things, and I believe the best that is available. It has another huge benefit, and that is that it represents the free actions of a free society. Everyone plays their part in determining the price of things. Because an objective value does not exist, all methods of valuation are approximations. For example the labour theory of value is a much less accurate approximation.

      “Personally I think that what you have presented so far doesn’t disprove any relevant elements of MMT”.

      To demonstrate this you need to refute the arguments already given earlier in the thread.

      “MMT is just a monetary theory showing how the decentralised monetary database system operates within the framework of modern state institutions.”

      It actually shows how the system would work if one of the key rules of central banking did not apply. This is akin to showing how chess would work if the checkmate rule did not apply.

      “It does not come with its own value theory”

      It implies that an increase in the private sector net claims on others is a good thing, and hence valuable, in and of itself. This is not the case.

    4. Some Guy,

      “Printing money means running a printing press and getting dollar bills out of it”

      The central bank does this when private banks request bank notes. Banks can swap HPM reserves for bank notes, and back, at will. Any bank notes returned to the central bank in excess of those required, are credited to the bank’s HPM reserve balance, and stored as “inactive” notes. These can be released again to save printing costs.

      This means that all active bank notes have corresponding assets on the central bank balance sheet. The government and the central bank are constrained by central banking laws from simply printing dollar bills without the corresponding accounting adjustments, as they are prevented by law from releasing inactive notes.

      So in and of itself, printing physical bank notes is not a way out of government deficit problems, unless the law were to be broken by the central bank.

      I can understand why Bill does not like the term “printing money”, because it very rarely is used to mean actual physical printing, and it is often used to mean different things (e.g. central bank purchasing of government bonds, or simply government issuance of bonds, or government spending from its central bank account which is later drained by issuance of bonds).

      If you do not agree with the above, then anything we have to say to one another will probably not make sense.

      Of course, the government could change the laws and the above would not apply. I am referring to things as they are under the current laws.

      “What you are trying to do is impossible. What sectoral balances, deficit = private savings, things adding up to zero, etc are based on is: that if I give you one whatsit, my balance sheet’s whatsits decreases by one, yours increases by one and the total number of whatsits is unchanged. Take me =govt, you = private sector; My whatsit deficit = your whatsit savings. If we don’t agree on this, as a mathematician, I am interested in your number system!”

      I’ve said before that I agree with this if savings is defined as the increase in net claims on others held by the private sector.

      Keynes himself defined saving as:

      “the excess of income over expenditure on consumption”

      He then defined consumption as:

      “Consumption is, therefore, any purchase/sale that is not between entrepreneurs”

      so Keynes himself did not include consumption of part of the private sector – “entrepreneurs” – in his definition of saving.

      Therefore the statement you have made is not correct when using Keynes’ own definition of saving. Proponents of MMT should make their definition clear whenever they make statements like to one you have made.

    5. Dear Paul,

      “if the increase in “total net debt of all debtors” exceeds production of real assets desired for purchase in any given time period, inflation is generally the result (although there may be lags)”

      This may not be correct I believe. The price levels on individual markets depend on how many tokens are to be used for purchasing goods and services available (what you call assets) in any given time period.

      This is not the same as the increase in monetary stock (“total net debt of all debtors”).

      Further, the tokens (money) do not have to be practically backed by debt obligations. This is the key point.

      Private money is created when loans are extended so the money (as assets) has to be balanced by the liabilities (and further by existing assets of the private sector or a predicted future income stream). This process of M1 creation may lead to an injection of M0 to the system.

      But the government debt is not real debt.

      1. From the private sector point of view one asset (a bond) can only be exchanged into another asset (money). It is irrelevant where this money comes from – taxes, rolling over the debt or new money creation. Private sector has to repay its debt by selling goods and services in order to get money from someone else.

      2. At least short term government debt is included in “broad money”.

      3. If a significant amount of the public debt is held by the Central Bank this is equivalent of having the same amount of money not backed by debt in the system (on the private sector’s balance sheet). So instead of having assets in the form of debt instrument it is currency what appears there.

      This currency is not offset by the debt held by the private sector. The rule has already been violated even if the CB cannot legally purchase debt instruments from the Treasury directly.

      Money is nominally offset by the debt hidden on the balance sheet of the CB but practically is not offset by anything.

      The Central Bank is a part of the Government Sector. Despite repeated denials the Fed is actually “printing” already, possibly to manipulate the yield curve. Some people may still stubbornly believe in the money multiplier effect.

      “(Reuters) – The Federal Reserve on Tuesday took a small but significant step to counter a weakening U.S. economic recovery, saying it would use cash from maturing mortgage bonds it holds to buy more government debt.”

      ” Treasury debt prices rose sharply, with the yield on benchmark 10-year notes slipping to 2.77 percent, near 15-month lows”

      “Under the new regime, the Fed will keep its holdings of domestic securities steady at around $2.054 trillion, primarily by buying government securities ranging from two to ten years in maturity.

      Investors were still trying determine just how much mortgage- and housing agency-backed debt held by the Fed would be maturing each year, with estimates hovering between $100 billion and $150 billion.

      While not insignificant, the amount was not generally seen as large enough to have a substantial simulative impact on the economy.”

      “That policy is not without drawbacks. It could expose the Fed to charges that it is printing money to help fund the government’s large budget deficit — something Fed officials have repeatedly vowed not to do.”


    6. Adam,

      I can’t assess most of your statements because the definitions of the terms you use are not clear. You need to define “tokens”. In one part you define tokens as money, but then you need to define money. What does “nominally offset” versus “practically offset” mean? You seem to be using the word currency inconsistently.

      Re: bonds held by the Central Bank: it is not practically possible for the Central Bank to take more than a small portion on to its balance sheet, so there are limitations to this form of currency creation, even if you do not accept that the Government’s debt to the Central Bank is real.

      The reason is that every bond added expands the asset and liability side of the CB’s balance sheet equally (because there is no net income stream from the bond), and therefore reduces the capital of the CB (as a percentage of assets) and brings it closer to technical insolvency. If the CB were to become technically insolvent, the Government would need to restore the capital, and the only way to do this is to donate tax revenue to the CB, or to sell more bonds to the private sector.

      Of course, currently in the US the CB pays interest on HPM reserves – this decreases further the extent to which CB purchase of government bonds can be performed.

      You could argue that such a situation (technical insolvency of the CB) could bring the CB era to an end and I don’t discount that possibility, but while the CB rules are in force, the need for the CB to remain solvent limits the amount of currency which can be created by the CB purchasing government bonds.

    7. Paul,

      Technical insolvency of the CB is irrelevant and this is the whole point.

      Please read the following document carefully, the second part is neoclassical to the extreme but in the first part the author spills the beans.

      “As pointed out by Ed McKelvey (2008), the size of a
      central bank’s existing stock of assets says little about
      its capacity to increase its assets in a hurry. Consider
      the case of the Fed. Normally, increased holdings of
      assets (typically US Treasury securities), are funded by
      increasing the stock of base money. Technically, this
      means that the increase in Fed assets is financed by borrowing,
      that is, through higher Fed leverage. Since the
      borrowing is through the issuance of non-interest-bearing,
      non-redeemable debt instruments (base money),
      there is, in principle, no limit to the amount of monetary
      borrowing the Fed can engage in, and therefore
      also no limit to the domestic currency value of the
      assets it can hold on its balance sheet. The Fed’s
      $900bn balance sheet can therefore, should the need
      arise, be doubled or increased tenfold overnight, should
      there be a compelling financial stability or economic
      stability case for it.”

      “…of the two common concepts of
      insolvency – equitable insolvency
      (that is, failure to pay obligations as
      they fall due) and balance sheet
      insolvency (the condition that
      liabilities exceed assets) – equitable
      insolvency is the relevant one.”


      Indeed, it holds over 2 trillion now… The total Federal debt is USD8.7tn and total public debt is USD14.3tn

      Is this insignificant?


      Also you have forgotten about the coupon rate of the bonds what affects the capital of the CB but this is rather marginal in this context.

      Please be aware that I am a guy who doesn’t trust anybody and I have spent a significant amount of time recently cross-checking the claims made by Bill. So good luck if you find a hole, I haven’t found one…

    8. The key words are “in principle”.

      His comments on leverage echo my point that direct holdings of Government Bonds decreases CB equity as a percentage of CB assets.

      In practice, at present the Fed is paying interest (3%) on base money. Ed’s comments predate this policy. If there was no limit in practice to the size of the CB balance sheet, there would have been no need to start paying interest on base money.

      In practice, increased leverage in the CB reduces confidence in the CB system. All of the powerful interests (i.e. net creditors) want the CB system to survive, for obvious reasons.

      Don’t forget, Ed is a banker. Bankers sell credit for a living. MMT helps them do their job, by helping perpetuate the myth that the credit is free.

    9. Note also how Ed’s comments, when working for Goldman Sachs, helped prepare the ground for the Fed purchasing dodgy Fannie and Freddie MBS from the banks. This was essentially a bank bailout by taxpayers, without congressional approval, because if the Fed’s balance sheet is impaired as a result, the government will need to recapitalise the Fed. In the meantime the banks got face value in base money, now safely invested at 3%.

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