Mansoor H. Khan's  Instablog

Here is how the banker's game works:

 

1)  Get the government to issue some currency (cash -- paper or reserves at the central bank -- reserves are government issued cash central bank deposits).  Government issued cash is around 5% of the currency (money) supply.  The government issued currency is put into circulation by the government simply spending it.

 

 

2)  The rest (95%) of the currency is issued by the private banks.  Each customer loan is a new bank deposit (i.e., new currency) and increases the currency (money) supply of the economy.  Note that this newly created money (currency) is put into circulation by the borrower spending it.  Most currency (about 95% America's currency supply) has been borrowed into existence and when bank customer pays the loan back that amount of currency is removed from circulation.   The banking system cannot go backwards (fewer net loans) as time moves on because fewer net loans means fewer currency in circulation in the economy.

 

Accumulation of interest charges on outstanding loans means that the currency supply must constantly increase even if it means giving out lower quality loans.  Think of it like a plane flying it must fly at some minimum speed or else the plane (the banking system) will crash (i.e., banking system collapse).

 

 

3) The bankers make dam sure that the common public does not understand how the monetary system works meaning that the private banks issue 95% of the currency. This is whole another topic how they do this.

 

 

4) The system works until real economic capacity of the economy grows and debts can be serviced and interest charges paid.  Most of the time the economy oscillates between boom (growth) and bust (recession) because bust is needed to clear debts and start a new lending cycle.

 

 

5)  Eventually, one of these cycles goes so deep that currency supply (and demand) falls so low that too many debts become un-serviceable.  The recession becomes a depression now.

 

 

6)  The bankers then have to decide how to "reset" the system.  One way to reset the system is to let the depression takes its course.  But of course this path is very chaotic because people lose jobs and may become violent.  Once most debts are cleared lending can start again and the currency supply is replenished.   Wars are a good way to get initial money (currency) into an economy after a depression to get demand going again.  This is the great depression scenario.

 

 

7) Another way to "reset" the system is to get the government to print too much money and spend and destroy the currency and blame it on the government.  This justifies issuance of a totally new currency (note that hyperinflation clears debts) and the lending cycle can start again.

 

 

8) The banking system (as is) is setup to maximize the power and influence of the global bankers and NOT for the maximum general well being of people.  By the way this is a global game.  This is the only system around no matter what country you are in.   The global banking cartel makes sure that no competing systems are allowed to exist (so they might be copied and global bankers will lose power).

 

 

 

For more details on this stuff please read the following articles in order listed below:

 

 

 

seekingalpha.com/article/209386-modern-m...

 

 

 

aquinums-razor.blogspot.com/2011/08/what...

 

 

 

aquinums-razor.blogspot.com/2010/07/why-...

 

 

 

 

 

seekingalpha.com/article/210346-should-n...

 

 

 

 

seekingalpha.com/article/192375-cause-of...

 

 

 

 

seekingalpha.com/article/160269-a-radica...

 

 

 

 

seekingalpha.com/article/146658-great-ba...

 

 

Mansoor H. Khan

 

aquinums-razor.blogspot.com/

 

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The real issue in discussions about money (MMT, debt, high powered money, fractional reserve money, gold standard, etc) is the question that is rarely fully discussed:

What is the relationship of money to the production process (i.e., production of goods and services)?

I believe this question needs to be answered fully and clearly and un-ambiguously by economics before "money" can be fully understood.

I will take a stab at this question here:

Just imagine in your mind entrepreneurs, factories and labor turning raw materials into finished goods (e.g., production of "loaves of bread"). How does currency relate to this picture?   I would suggest to you that there are three primary relationships the production process has to currency.


They are:

1. By spending currency consumers generate demand. Demand is basically information (signals) which tells entrepreneurs what to produce and how much to produce (spending generates demand).

2. Currency allows efficient trading of raw materials, labor and finished goods and services between businesses and between businesses and consumers (this is trading).

3. Entrepreneurs and labor can and do work and produce real goods and services just for acquiring currency itself with the expectation of purchasing real goods and services later (this is savings).


Item number one above (generation of demand) and two above (efficient trading) are not hard to understand. The last statement (savings) is where the confusion lies. Let us go back to the image of entrepreneurs, factories and labor turning raw materials into finished goods. Now with this image of production in mind what is savings? 

Savings is that portion of production (excess "loaves of bread" produced) which is not consumed or traded for other real goods and services immediately. Notice, when it comes to savings the acquirer of currency (the saver) does not care whether it is freshly printed by the government or whether someone who previously saved it is giving it to them in exchange for real goods and services.

If these savings are not "used up" then we will have deflation. In this case deflation is a signal to producers to produce less (and thereby causing the economy to run below capacity).

This is where the philosophical divide exists. Should the government step in and spend money (borrowed or printed) to "use up" the excess productive capacity of the economy for social good?

The reverse is also true. If the economy heats up and private spending causes inflation should the government tax and destroy money and reign in inflation?

It seems to me that we as a society which cherishes private management of economic resources have not settled on the above two questions.

Instead of talking in purely monetary terms you need to always relate the monetary system to real goods and services production capacity of the economy.

Why is printing money (via the FED) and "spending" it into the economy a problem if unused capacity of the economy is being "used up" for social good?

In the end what really matters is productive capacity of the economy. Monetary system is an accounting and control system to manage the production system (i.e., the real economy).

Our monetary system is an accounting system in a sense it keeps track of (and limits) who is "allowed" to spend (i.e., "use-up") what portion of the available productive capacity. It is a control system because it can be used to "reign" in spending when spending outpaces production capacity (i.e., inflation ensues) via the FED's open market operations or we may even need to tax and "destroy" money in order to reign in inflation.

Yes. There is a lot of central planning involved in our "fiat" monetary system. 

A factory does not care how much national debt exists or what our unfunded liabilities are or even how much private debt exists the factory is perfectly capable of producing "goods and services" no matter what all these accounting entries say.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

 

Modern Monetary Theory, Inflation and Idle Resources

In this essay I would like to discuss Modern Monetary Theory (MMT) and the insights it offers into the relationship of money, money supply, inflation and idle resources.   While discussing MMT with others I quickly find that first we need to agree on the definition of money.  The most common and generally accepted definition of money is:

a)      It is the most common medium of exchange.

b)      It is the most vendable good.

c)       It is the most liquid asset of a civilization.

d)      It is a store of value.

e)      It is a unit of account

To this definition we should add a few more attributes when modern money (i.e., fiat money) is being discussed:

f)       It is a claim or a promise enforced by legal tender laws of the state and the ability of the state to tax.

g)      Most fiat money (by far) is issued (i.e., created) by the banking industry by the act of funding a loan and Not by the state.

h)      In order for savings (a bank deposit) to exist a debtor (a borrower) must exist.  

It is the last attribute listed above (item h) that is the most troublesome.   I have found that most people do not think of modern money this way.  Conclusions of MMT are very heavily dependent on understanding and accepting that in order for savings to exist a borrower must exist.   All savings is a promise or a claim of some kind.  The exception is commodity or convertible to commodity money (e.g., gold, silver or barrels of oil).   Since we don’t have commodity money all savings is a promise or a claim. 

Once we have this understanding of modern money we can then discuss conclusions of MMT.  I realize there are many people who see modern money as “the problem”.  I am not going to discuss this here.   

Again, the implicit assumption and insight of MMT is that for a saver to exist a debtor must exist.   With MMT frame of reference we can see the issues of national debt, unfunded social security liabilities, trade deficit and budget deficit in a very different way.

Here are some conclusions of MMT:

1)      In order for the private sector to save (net savings) the government must have deficit spending or we must as a nation have a trade surplus with our trading partners (i.e., our trading partners must run a trade deficit with us on net basis).

 

2)      If we have balanced trade (no trade surplus or no trade deficit) and the government has a balanced budget then no net private sector savings is possible.

 

3)      All private sector income (i.e., production of goods and services) must be consumed by the private sector or invested by the private sector or exported or spent (i.e., consumed) by the government.  This is not specifically a MMT conclusion but I want to highlight it here because it clarifies MMT insights.

 

4)      The national debt represents accumulated deficit spending by the government.  By the way of MMT it also represents net accumulated private savings (domestic savings or savings by our trading partners).

 

5)      If the savings rate increases and private investment does not increase and the government spending does not increase and our trading partners don’t buy more from us then the economy must slow down (quantity of production of goods and services must decrease).

I will now discuss some common questions in FAQ format which I get when I have explained the above conclusions of MMT to people.  These questions are usually from non-economist and non-financial types:                                   

But I can save money without a debtor being on the other side of the transaction.  Can I not simply put physical paper cash in a safe deposit box?

The above statement is true.  However, only a very small part of the money supply exists in the form of physical paper cash.  Even this form of savings is dependent on the existence of the state to enforce legal tender laws and the ability to tax.  We would certainly not want to save any significant amount of our society’s money supply in this form.  For example, it would be absurd to try to “fund” unfunded social security liabilities by this method. 

Can I not save value by storing gold in safe deposit box?  No debtor is required. 

The above statement is only partially true.  The future economic value of gold is highly dependent on market price of gold in terms of the most common medium of exchange at the time of the exchange.   Again, it would be an economic disaster to try to “fund” unfunded social security liabilities by this method.

You say that in order for a bank deposit to exist, a borrower must exist.  But isn't one of the problems we have right now is that banks are sitting on more deposits than usual, i.e. refusing to lend?  Doesn't that mean that at least some of those deposits exist (can at any time be claimed by the depositor) without a borrower existing?  Just because one thing is often paired with another doesn't mean that it has to be. 

You are only partially (and very partially correct).   When banks don't lend the money supply shrinks (total amount of customer deposits shrink, as existing debts are paid off deposits are destroyed!) and banks excess reserves (cash) deposited at the central bank increase.  Yes, base money (cash, reserves) does not require a borrower in order to exist.  But our banking system does not operate on 100% reserve basis or anywhere near it.   Even if did it would not change the substance of my arguments with respect to MMT.  As I have explained earlier, even this form of savings (paper cash or reserves at the central bank) is dependent on the existence of the state to enforce legal tender laws and its ability to tax.  In this sense even a 100% reserve bank deposit (like physical paper cash) would be a promise or a claim (like a debt obligation) and not that different from a private borrower’s obligation.

But how does MMT relate to prices and inflation?   

As a starting point let us consider the equation of exchange by Irving Fisher:  

Total Amount of Money supply * Velocity of Money = Price Level * An index of Goods and Services Produced 

Total Amount of Money Supply = Total of Coins + Paper Cash + Bank Deposits

Velocity of Money = the average frequency with which a unit of money is spent in an economy in a given period

Price Level  = measure of overall prices for some representative set of goods and services,  approximated with a price index, a change in the price index is a measure of inflation

An index of Real Production of Goods and Services = index of the amount of goods and services produced in the economy in a given time period

Even though the inputs in the above equation are at an aggregate level or consist of indexes or cannot directly be measured (i.e., velocity of money) the equation is extremely useful as a mental model for seeing the relationship between money supply and inflation.   This equation helps us see that:

I)                    An increase in the money supply will lead to inflation only if velocity is unchanged (or at least does not decrease) and the economy does not expand its production of goods and services because it is running at capacity (i.e., no idle resources or other constraints are present).

 

II)                  A decrease in the velocity of money will lead to deflation (a decline in general price level) if the money supply does not increase and the quantity of real production does not decrease.

 

III)                A decrease in bank lending activity (i.e., which determines the money supply) with constant or decreasing velocity will lead to deflation (a decline in general price level) if the quantity of real production of goods and services does not decrease.

Point number I above tells us that governments can increase economic activity by borrowing and spending without introducing inflation if there are idle resources in the economy (i.e., idle labor or idle factory capacity).  In my view all idle resources are wasted resources.   Many people automatically assume that deficit spending = inefficient spending.  With the help of MMT we can see that if deficit spending uses up idle resources for infrastructure spending and/or tax cuts and/or "social credit" then it is not inefficient.  In fact, we will be receiving more in goods and services for our investment in physical capital (e.g., idle factory capacity) or people capital (e.g., ready, willing and able idle labor).

I will now discuss some common questions in FAQ format which I get when I have explained the equation of exchange and its implications to people.  Again, these questions are usually from non-economist and non-financial types:                                                    

So are you telling me that we can spend our way to prosperity?

Yes, the above statement is true if slack (i.e., idle resources exists in the economy).  We can increase our standard of living by simply borrowing and spending.  Of course, utilization of idle resource will most likely use up more energy resources (like fossil fuels) or other natural resources (like trees and iron ore). 

Doesn’t borrowed money have to be paid back with tax revenue?

Yes and no.  Let me explain.  Borrowed money does have to be paid back or the debt has to be rolled-over as government debt matures.  The Government (via the central bank) is a currency issuer and can always borrow more.  MMT helps us here too.  MMT views taxation as a reduction of purchasing power of the taxpayer and not a “transfer” of money from the taxpayer to the government.  At the time of maturing of the debt owed by the government the decision to roll-over or pay off the debt will depend on at least two variables:   The price level (i.e., inflation) and policy goals.  If inflation is below target then the government can “safely” print new currency units (via the central bank) and pay off the debt.  If inflation is above target then it must reduce its spending (reduce its own purchasing power) and/or tax (i.e., reduce private sector’s purchasing power) in order to keep inflation in check.

Won’t interest charges on borrowed money increase taxation ultimately?

Interest charges can be dealt with the same way as any other contemplated government spending.  At least three questions must be asked by government officials.   What is the price level (i.e., the inflation rate)?  Is it below the target price level?  What are the policy goals?   Based on the answer to these questions:

A)     The government can print fresh new currency units (via the central bank) and pay its bills.

 

B)      The government can borrow currency units from the private sector (again via the central bank) and pay its bills.  The difference between A and B is that B is little bit like taxation in that it “temporarily” suspends some of the private sector’s purchasing power.

            C)      Tax and permanently destroy some of private sector’s purchasing power and/or reduce its own spending.

 

Looks like that you view the economy like a machine which can be fine tuned?  Aren’t there too many variables and feedback loops?

Yes and no.  The government has to be good and objective at measuring the inflation rate.  The measurement will not be perfect but benefits of MMT are huge.  The government will be able to put idle resources to work (in deflationary times) by simply increasing its spending.

But the government has an incentive to understate inflation so it can spend more?

Yes we have to trust our government will not lie about inflation.  Perhaps the answer is to call for strengthening the independent monitoring of inflation. 

Why is deflation such a bad thing? I want prices to go down.  My savings buy more.

Yes savings do buy more in deflationary times.    There are many reasons why deflation is just as undesirable as inflation and maybe even more so.   Deflationary times usually lead to higher unemployment because labor markets don’t clear as well as predicted by neo-classical economics as described by John Maynard Keynes because workers resist pay cuts.

Also, sustained deflation can lead to depressions as described by Irving Fisher in his “debt deflation theory of depressions”.  

You say "MMT views taxation as reduction of purchasing power of the taxpayer and not a 'transfer' of money from the taxpayer to the government."  Isn't that the kind of statement that only a theoretician could make, essentially a distinction without a difference?  From the point of view of the person paying the taxes, it doesn't matter if a man's money is being "transferred" or his "purchasing power" is being reduced, the end result is the same -- he must get by with fewer loaves of bread.  Why do you expect him to be happy with less just because some high-sounding economic theory says it's good for him?

I never expected a person to be happy about their purchasing power being reduced.  But if we truly accept MMT we would not worry about balancing the budget.  We would think of fiscal responsibility in a very different way.  We would focus on inflation (and production capacity) and NOT try to maintain or worry about equality of government revenue and government expenditures.  Deficits would not be considered "bad" or surpluses considered "good" in themselves.   In fact, MMT tells us that if a government ran a surplus that leads to deflation then it would actually be harmful to the economy.

Disclosure: No positions 

 

 

 

 

 

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