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- Soft Currency Economics
- Full Employment AND Price Stability
- A General Analytical Framework for the Analysis of Currencies and Other Commodities
- The Natural Rate of Interest is Zero
- 2004 Proposal for Senator Joe Lieberman
- An Interview with the Chairman
- What is Money?
- The Innocent Fraud of the Trade Deficit: Who's Funding Whom?
- Innocent Frauds
- Mosler Palestinian Development Plan
January 13th, 2009 at 5:04 pm
Warren,
Curious to hear your take on the recent documentary “I.O. USA” that aired on CNN a couple of days ago. The main premise behind the documentary clashes heavily with your last point in the article regarding the U.S. not ever having to face a day of reckoning from borrowing abroad to fund imports. Additionally, the documentary touches on the pending unfunded liabilities totaling over 50 trillion USD in the form of social security, medicare, etc.
Of course the Govt can always “pay” these debts by churning out the printing press. As you yourself say, the govt is the scorekeeper and the scorekeeper is never short of points (brilliant analogy by the way). But the obvious side effect of putting a lot of points on the scoreboard is each point means less… in other words inflation.
How do you reconcile the differences between your views and the views of such a documentary, while keeping inflation in the forefront of the discussion?
Thanks for your help. Your articles have been very helpful.
Reply
January 13th, 2009 at 5:56 pm
They are a bunch of ‘deficit terrorists’ that imply there is a solvency problem, rather than just an inflation problem.
In fact, most of them don’t think there is an inflation problem.
All govt spending is via data entry. there is no distinction between printing money and any other kind of govt. spending. They act as if there is a choice and govt. usually spends one unspecified way and gets in trouble when it relies on the printing press- total nonsense.
The reason why there’s so little inflation given the level of deficit spending is ’savings desires’ meaning desires to not spend income.
this comes from the tax advantaged savings plans- pensions, ira’, corp reserves, etc. that act as ‘demand drains’ and unless offset by deficit spending from some sector result in excess capacity/unemployment, etc.
see ’soft currency economics’ at this sight under ‘mandatory readings’ thanks!
Reply
Floccina Reply:
November 10th, 2009 at 5:29 pm
“this comes from the tax advantaged savings plans- pensions, ira’, corp reserves, etc. that act as ‘demand drains’ and unless offset by deficit spending from some sector result in excess capacity/unemployment, etc.”
Most of the money in pensions, IRA’, corp reserves, etc. are in the economy e.g. if I buy stocks or bonds someone gets that money. The way that I see it is the real savings are paid down loans. Paying down loans is contractionary because of fractional reserve banking.
It seems that most economists agree that the goal should be to keep spending on a steady growth path. Monitorists prefer quantitative easing to keep spending up in times like these, having the Fed buy assets that can later be sold if inflation comes. The Keynesians and most post-Keynesians seem to favor government spending and you differ a bit preferring a tax cut for the poor; a FICA cut (I also favor the FICA cut) but you seem to saying that quantitative easing cannot get the job done, why?
As an aside I think that monitorists prefer quantitative easing because they think that Government is already too powerful and allowing Gov. to spend more gives them even more power. They want the state to be forced to tax to spend so that the people see the cost of Gov. clearly. (I understand their position, who wants to give more power to people who put young men in jail for selling drugs to willing customers?)
Reply
Warren Mosler Reply:
November 11th, 2009 at 8:35 am
It’s all about aggregate demand, not ‘quantities of static balances’
So look at each of the above discussions that way and see if it now makes sense, thanks
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January 14th, 2009 at 8:00 pm
Thanks for the response…. helps shed some light, but also raises a few more questions.
On the topic of inflation… I read soft currency economics and I like what you have to say about the tax advantaged savings plans. But, if there is a lot of “extra” money being printed/spent/lent into society by the govn’t, and if a lot of that money is going into tax deferred plans, then wouldn’t that cause some “artificial” inflation aka a bubble in the stock market? Additionally, there are some critics like Peter Schiff who say that inflation figures are far understated by the govt as well. Lastly, it is my understanding that a lot of extra US dollars that are abroad are now funneled into US Treasury securities, effectively lowering the amount of USD in circulation? What happens if foreigners decide they don’t want to invest in a security that is denominated in a currency that will devalue?
Your take on all these points regarding inflation dynamics would be appreciated. Thank you.
Reply
January 14th, 2009 at 8:45 pm
Yes, there’s net spending that you call ‘extra’ best I can tell.
It’s not a lot, just a few % of gdp most years. In fact, from the general employment and capacity utilization data the better case is that the deficit is too small most of the time.
Yes, funds directed by ‘law’ into tax deferred plans with legally limited investments as well is part of the pricing for those investment assets.
Also, hard to say exactly what ‘inflation’ is with non convertible currency on a purely academic basis. The definitions commonly used have ‘further purpose’ such as indexing social security payments, etc. and are therefore political decisions.
Not sure what you mean by the amount of USD in circulation. probably not the actual cash?
Foreigners net sell goods and services to the US because they want the USD. It’s all voluntary and they know what currency they are getting paid in. The next question is what they do with those $ regarding the choice of $US financial assets- cash, tsy secs, corp bonds, stocks, etc.
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January 18th, 2009 at 3:06 pm
Thanks again for the response. So I guess the last logical extension of my questions is - can you envision a scenario where foreigners do not want to be paid in USD or invest in anything that is denominated in USD?
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January 19th, 2009 at 10:06 am
“…can you envision a scenario where foreigners do not want to be paid in USD or invest in anything that is denominated in USD?”
mmmmmmm…let’s see, China would have a lot less “reserves” and the U.S. would have to build and produce everything it buys from China at home (less lead in children’s toys?).
The Oil producing countries would have a lot less “reserves” and the U.S. would have to find alternative ways to produce fuel at home (Natural Gas?).
The ECB countries would have a lot less “reserves” and the U.S. would have no more , Mercedes,Veuve Qliquot etc, instead we will have Fords, Chevrolet”s and Korbel.
Get the picture?
As for the past, we keep all the “stuff” we bought from them and they take all the dollars and shred them , bad trade for them.
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January 19th, 2009 at 10:00 pm
right, we would at best have a balanced trade account, as our export revenues would be the only thing we could use to buy imports.
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January 20th, 2009 at 5:53 pm
Which is why the people who are so concerned about trade deficits are like the Sheriff in “Blazing Saddles” who threatens the townsfolk who want to kill him by putting a gun to his own head…
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February 22nd, 2009 at 11:36 pm
“The reason why there’s so little inflation given the level of deficit spending is ’savings desires’ meaning desires to not spend income.”
Saving = spending on capital goods (investment)?
If so, then there must be inflation in capital goods, no? Logically thinking, the government cannot just print money, get real goods for it and everybody else’s prices remain the same. It doesn’t add up, does it?
Every time the government collects back in taxes less than what it previously spent, it must be inflationary (assuming real wealth unchanged and no government borrowing).
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February 23rd, 2009 at 8:23 am
nominal Savings of financial assets includes holding of govt securities which doesn’t have anything to do with real savings.
Correct in that if there is no excess capacity or excess inventory additional spending tends to drive up prices.
this could have been more clear as well, thanks!
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February 24th, 2009 at 1:18 am
Okay, I admit I haven’t read ’soft currency economics’ yet. Just got down with natural rate of interest is zero.
“The reason why there’s so little inflation given the level of deficit spending is ’savings desires’ meaning desires to not spend income.” Is this the only reason? I think that our offshoring of cheaper labor has had an even larger share of why we don’t see price inflation. Our savings rate is near zero (before the crash) which tells me we have no ’savings desires’. And in effect, we’ve offshored our inflation to other countries. (Yeah, that’s a Peter Schiffism.) Thus, I’m not certain that just because we don’t see price inflation that deficit spending doesn’t cause inflation. In my opinion there may be other factors that got in the way of this showing up on our shores.
Reply
Scott Fullwiler Reply:
February 24th, 2009 at 1:39 am
If I may, I would suggest that this is a theory of aggregate demand inflation, which is pretty much universally viewed as THE source of long run inflation by mainstream economists. Of course, even mainstream economists grant that there can be supply side factors, such as the ones you’ve mentioned, and certainly many others (oil prices, etc.). But mainstream economists see these as not sustaining inflation in the long run. Non-maintreamers are all over the map regarding whether supply side factors matter in the “long run.”
Regardless, though, the point here is to counter the mainstream approach to taming aggregate demand inflation, which is to increase the buffer stock of unemployed workers, and which is viewed as inefficient and downright destructive to overall well-being. The alternative view is, as you state, that aggregate demand inflation is driven by fiscal deficits relative to net savings desires. These two are the M and (inverse of) V, respectively, for a modern re-writing of the quantity theory of money. The implications of such a re-writing are enormous, as Warren lays out here, in SFC, and in Full Employment and Price Stability.
Also, while there have most obviously been supply-side factors driving inflation over the past few years, note that as aggregate demand turned down signicantly we are now hearing more about deflation, while household net saving just had its biggest spike in 40 years in the fourth quarter.
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February 24th, 2009 at 1:27 am
“..in order to actually collect taxes, the government, as the monopoly issuer of the currency, must, logically, spend (or lend) first.”
What about the private banking sector? And maybe I’m missing a part of this. It is my understanding that outside of government spending (which is well described by this paper) through the fractional reserve lending practices of our banking system, private banks in effect have the ability to create money supply. Is that not correct? This ignores the other aspect of velocity which can increase nominal supply of money too. Thus, is there really only a limited amount of money for paying taxes since the private sector and the constant changing of money between parties can “create” this new money? Are we really dependent upon our government (I’m speaking of treasury) to deficit spend to create supply?
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Scott Fullwiler Reply:
February 24th, 2009 at 1:48 am
1. We don’t have a fractional reserve banking system. Loans create deposits.
2. When you pay your taxes, your deposit account at the bank is debited, and your bank’s reserve accouht is debited. Though it is no longer your liability if you have a positive deposit balance when the Tsy presents your check to your bank, the overall tax liability is not settled until your bank has debited its reserve account.
3. If you want to buy a Tsy security, you can only do so with reserve balances, because final settlement of Tsy’s occurs only on the Fed’s book-entry settlement system. So, your bank, or its clearing bank, will debit your account, and then have its own reserve account debited to purchase the security.
4. The only way reserve balances come into circulation is from deficit spending (when Fed does an open market purchase, it purachases a bond that resulted from a previous deficit) or borrowing from the Fed.
5. So, in order to pay taxes or buy a Tsy security, there must first have been a deficit to create the net savings, or you must go into deficit yourself. There’s no other way.
Hope that helps.
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The Interest Reply:
February 24th, 2009 at 2:36 am
“We don’t have a fractional reserve banking system. Loans create deposits.”
So, in order to borrow $10,000 for a car, the bank has to have this amount at the Fed before it can loan me the money? And in order for the Fed to have $10,000, the government had to have deficit spent to create this?
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warren mosler Reply:
February 24th, 2009 at 7:30 am
No, the loan of $10,000 carries with it a deposit of 10,000 that in the first instance the bank gives to the borrower.
so the bank has an asset and a liability- the loan and the deposit.
that’s how all lending works under close examination
the question is what does the lender do if you want to ‘take your money out’ of that institution.
with today’s nonconvertible currency regime, taking the money out means the fed debits your banks reserve account at the fed, and credits the reserve account of wherever you redeposit the funds.
the means a negative balance at the fed for the first bank and an equal positive one at the second bank.
a negative balance at the fed is ‘automatically’ a loan from the fed and is booked as one if that overdraft is left unattended by the first bank
The Interest Reply:
February 24th, 2009 at 10:44 am
Then at the bank I originate my car loan from created the money out of thin air and didn’t rely on the government (treasury) to create that money first, correct? Or am I still missing something? So far all this sounds like are accounting entries between my bank and the Fed and the my bank and me. Treasury (government) hasn’t been a part of this exchange yet. Right?
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Scott Fullwiler Reply:
February 24th, 2009 at 11:22 am
You’ve got it!
Scott Fullwiler Reply:
February 24th, 2009 at 11:28 am
To be more precise, until you put reserve balances into the analysis, or currency, you don’t go to the Fed’s balance sheet, which means you didn’t refer to a previous deficit.
Of course, this is very different from saying you didn’t need a tax liability and a deficit in the first place for transactions to be occurring in “dollars” at all.
The Interest Reply:
February 24th, 2009 at 12:19 pm
Then back to my original point on this sub-thread, tax dollars don’t have to come from government spending first. Only that government spending and taxation made me enter the system using the state created currency. I may have confused the logic where I thought money only gets created by the government, when to be more precise, currency is created by the government and I have chosen to use that currency for my money when I transact with my bank. Right?
RichW Reply:
February 24th, 2009 at 12:46 pm
Scott in point 2 you’re talking about definitive money vs accessory money (from Understanding Modern Money)? Definitive money being that which the govt accepts as payment for taxes.
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Scott Fullwiler Reply:
February 24th, 2009 at 1:40 pm
That sounds right.
People sometimes confuse “transactions using dollars” with “transactions using reserve balances.” For instance, anytime someone says “chartalism makes no sense because I don’t hold money to pay taxes,” they are making this mistake.
February 24th, 2009 at 1:46 am
“Taxes do not finance spending, but taxation serves to create a notional demand for state money.”
Well put. Do we have an income tax only because it effectively forces anyone (most everyone) to pay this tax, where other taxes like gasoline taxes could be voluntary since I could ride my bike instead of drive my car to work? Isn’t this a little outdated of a concept? Since we trade and can charge import taxes or other fees, can’t this drive the usage of state money?
One more quick question. Does this mean that SS, medicare, etc. are never “in the red” and thus we don’t even need to have a tax on these services?
“Note that if one pays taxes or buys government securities with actual cash, the government shreds it, clearly indicating operationally government has no use for revenue per se.” AND “…when the U.S. government receives a check in payment for taxes…it does not enhance the government’s ability to make payment…”
Do you mean that when we pay our taxes in April this goes in the bit bucket? Thus, we’re living in a shroud of falsehood believing we really have to pay taxes and that this is somehow benefiting our government (or maybe someone on the inside is pocketing this money). Hmm. Great. Maybe Wesley Snipes was right. : )
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zanon Reply:
February 24th, 2009 at 1:04 pm
The Interest: You’re really getting close.
As others have said, banks can create money ex-nihilo by expanding both sides of their balance sheet, which is what they do when they make loans. But every private sector asset must be matched by a private sector liability, so net, the entire private sector must zero out.
The Government can run deficits in perpetuity, so this is where you get the “seed” money from. Some people call Government deficit money creation “vertical” and bank money creation “horizontal”.
Since you pay taxes to the Govt, the money for those, net, have to come from the Government. Paying taxes uncreates money. Only Government spending can (net) create money. Whether or not banks create (net) money depends on whether you think loans are money.
If the Govt creates more money (higher G, lower T) and that money is saved, then you don’t see a change in CPI (dollars are not chasing goods). Money in the bank really does not do anything. It certainly is not required to fund investment.
Scott’s right in that we don’t have an FRB system, except of course that we do. Scott’s point is that the bank does not need to loan out a deposit, the bank just makes the loan (out of nothing) which then becomes a deposit somewhere else.
Banks do have reserve requirements, but in essence, these have no impact on anything. They certainly do not constrain lending. They are a convoluted way for the Fed to set short term interest rates (the Federal Funds Rate).
The Government needs to tax to 1) create demand for its currency, and 2) control inflation. It does not need to tax to spend. But hey — demand for currency and controlling inflation is important too!
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Scott Fullwiler Reply:
February 24th, 2009 at 1:33 pm
Perfect.
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Scott Fullwiler Reply:
February 24th, 2009 at 1:43 pm
Interest . . . you might want to check out “A General Analytical Framework for the Analysis of Currencies and Other Commodities” in the mandatory readings. That’s where you will find the “horizontal” and “vertical” distinction Zanon is making. Sorry about all the reading suggestions . . . but you seem to have an interest (no pun intended!) in working your way through the paradigm.
The Interest Reply:
February 24th, 2009 at 2:03 pm
Awesome. I’m trying to use the Internet to test what I’ve learned. And this info is exactly what I’m looking for. Thanks for your help!
February 24th, 2009 at 9:01 am
Interest -
“we’re living in a shroud of falsehood believing we really have to pay taxes and that this is somehow benefiting our government”
Pretty much. It’s not that taxes don’t serve a function. They just don’t serve it in the way people think they do, and other things could accomplish the same function. All taxes do is reduce private demand to make room government spending. A program which forced people to save could reduce demand just as much, and give them financial assets instead of sending it to the bit bucket. There might be some problems with such a system, and it might not be better than the bit bucket, but it’s one of the policy possibilities (like a permanent zero interest rate, no goverment borrowing model) that becomes possible once you have a true understanding of the monetary system.
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February 24th, 2009 at 1:54 pm
Interest, not sure if you’ve run across this site or not. Has many excellent articles from multiple sources that provide additional info about the topics discussed here. It’s been very helpful to me.
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February 25th, 2009 at 11:37 am
Scott, or Warren, or other. What is the accounting sequence of operations that occur when the treasury department pays a private citizen, say A, an amount, say X to A’s bank, say B. We know the treasury credits A’s account at B, +X. Since the treasury pays out in reserves and we know that A’s account is bank money is the sequence as follows:
1) add +X bank money to A’s account?
2) add +X reserves to B’s reserve account at the FED?
If this is the case, can we also conclude that not only do loans create deposits, but government spending creates deposits as well, but with no matching asset?
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Scott Fullwiler Reply:
February 25th, 2009 at 12:05 pm
Let me just go through it here for you and others that might be interested . . . .
Person A’s Bank’s Balance Sheet
Assets: + reserve balances
Liabilities/equity: + to A’s deposit account
Person A’s Balance Sheet
Assets: + deposits at Bank
Liabilities/Equity: + net worth
So, for bank, changes to assets and liabilities net to 0. For person A, only add to deposit on asset side, but no matching LIABILITY (I think you might have meant to say liability when you said “no matching asset”). This is what we mean when we say that a deficit raises “net financial assets” or “net savings” of the non-government sector, since that is what net worth is.
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September 20th, 2009 at 1:52 am
Taxation serves to create demand for government currency.
Why does the government want to create this demand? It doesn’t need currency to get what it wants, the government can just take whatever it wants.
So there must be some other reason, why the government wants to be currency issuer, no?
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September 22nd, 2009 at 8:28 am
yes, it could somehow just take what it wanted, if it could maintain a military without a monetary system, which many nations have done in the distant past.
the monetary system is one way to move real goods and services from private to public domain. there are a few others of the ‘command’ type as well that we don’t choose to use.
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September 22nd, 2009 at 12:48 pm
The government not issuing currency doesn’t mean no monetary system, it just means no vertical component of money.
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September 23rd, 2009 at 9:29 am
without a tax liability (or fines, fees, etc) denominated in the govt’s currency there is no such currency
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October 17th, 2009 at 5:29 pm
“Taxation serves to create demand for government currency” . . . but not necessarily federal taxation, which could (and I suggest should) be reduced to zero.
State and local taxation presumably would be sufficient, so long as all government entities are required to collect taxes in federal currency and are precluded from issuing their own currencies.
The issue of what to do about inflation seems to center on money supply. While reducing money supply may reduce inflation, it also can adversely affect economic growth. Wouldn’t increasing the demand for money also reduce inflation, while have a less negative affect on economic growth?
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October 18th, 2009 at 9:41 pm
yes, state and local currencies result in some residual ability for the federal govt to spend without federal taxes, as we’ve previously discussed and agreed.
however the issue of inflation has nothing to do with the ‘money supply’ also as previously discussed. changing interest rates, which is all the fed does, has little, none, or even reverse effects regarding inflation.
‘inflation’ comes from ‘too much spending power chasing too few goods and services’ in a competitive economy, and is directly related to fiscal policy, not monetary policy, along with other aspects of institutional structure.
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November 9th, 2009 at 11:54 pm
if the banks are public-private partnerships whose loans are required to be issued in the government currency…
then taxes are unnecessary to establish the currency because demand for bank loans will establish the currency.
right? there’s a lot of demand for those ‘out-of-thin-air bank loans’ creating those ‘FDIC-insured deposits’. why would that demand disappear just because the govt. stopped collecting taxes? why would the supply of profitable bank loans dry up?
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Curious Reply:
November 10th, 2009 at 2:23 pm
Yes. We had a discussion about “loan driven” money under this article
http://www.moslereconomics.com/mandatory-readings/a-general-analytical-framework-for-the-analysis-of-currencies-and-other-commodities/
and nobody presented any rational argument why it wouldn’t work. So I agree with you.
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Matt Franko Reply:
November 10th, 2009 at 4:30 pm
Perhaps you two are confusing “money” with the currency unit?, as getting a loan in a foreign country (in foreign currency) with FFNC (Free Floating Non Convertable) also creates deposits over there. Resp,
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Curious Reply:
November 10th, 2009 at 11:13 pm
No Matt, I’m talking about money.
If I borrow $1 from the state, I have a $1 debt to the state.
If the state tells me that I owe $1 in taxes, I have a $1 debt to the state.
What’s the difference?
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Warren Mosler Reply:
November 11th, 2009 at 8:32 am
Depends on the penalty for not paying your loan to the govt.
if it’s unsecured and non recourse, and you can just walk, there’s a big difference. (those are the terms the Fed gave the foreign cb’s for their swap line advances)
if the loan from the Fed is collateralized the obligation is more like a one time tax than not.
That’s why I state in my papers the price level is a function of prices paid by govt when it spends and/or collateral demanded when it lends.
Matt Franko Reply:
November 11th, 2009 at 9:52 am
C, Perhaps if they had debtors prisons to enforce. Here’s an excerpt from Wiki: “A paradise for speculators: In the last decade of the eighteenth century the United States had just three banks but more than fifty different currencies in circulation: English, Spanish, French, Portuguese coinage, scrip issued by states, cities, backwood stores, and big city enterprises. The values of these currencies were wildly unstable, thereby making it a paradise for politically indifferent currency speculators thriving on uncertainty. In addition, the value and exchange rate was almost always outdated or unknown by the party agreeing to receive it, especially the farther it moved away from the coast; and because of distances, primitive roads, and absence of communications technology, values were not only unknown but unknowable as well. Speculators in the United States bought up bonds for about 15 cents and through Hamilton’s plan were paid their face value of one dollar.
Supporters of the bank argued that if the nation were to grow and to prosper, it needed a universally accepted standard coinage and this would best be provided by a United States Mint, aided and supported by a national bank and an excise tax.”
So it would be like going backwards IMO, we could still use sharpened bird feathers and inkwells too, or Warren could could faciitate the info exchange on this blog with a team of carrier pigeons,etc..ie it may work in some fashion, just not as well as with today’s modern info. technology. (btw I observe that advances in information technology generally are not given enough credit in their facilitation of modern money systems, they were truly the “game changer” to enable transition to FFNC currency IMO.)
Curious Reply:
November 11th, 2009 at 3:58 pm
That makes sense Warren.
Warren Mosler Reply:
November 11th, 2009 at 10:23 pm
because there wouldn’t be any goods and services for sale in exchange for that currency.
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Curious Reply:
November 11th, 2009 at 11:07 pm
Of course there would be.
As long as the state is as vigorous in enforcing debt repayment as it is in enforcing tax collection, there is no difference.
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Warren Mosler Reply:
November 12th, 2009 at 10:21 am
right, a tax is a debt payable to the state.
but debt follows taxation
if there were no taxes, no currency, and the state announced loans in a new currency, why would anyone borrow it? there would be nothing to buy with it.
want to borrow my business cards?
borrowing is for further purpose than just to have a loan to pay back. with interest.
Curious Reply:
November 12th, 2009 at 3:18 pm
The moment I borrow your business card, I have an obligation to repay it.
That gives your business card value.
Why would I borrow it? Because I want something that someone else has and I have nothing to trade for it.
In effect, I am trading my future production, because I will have to produce something in the future, to get the business card back and return it to you.
November 10th, 2009 at 12:07 pm
wrong.
‘establish’ means create sellers of real goods and services who want to exchange them for that currency.
I can call my business cards my currency, and offer to lend them at low rates, but that doesn’t mean they’ll buy anything.
see ‘turning litter into money’ on this website
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Curious Reply:
November 10th, 2009 at 2:26 pm
Warren, could you post a link to the article you’re referring to? I can’t find it. Thanks.
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November 10th, 2009 at 2:36 pm
taxes and money
Posted on Friday, October 23rd, 2009
[Skip to the end]
you are addressing a room full of people.
you tell them taxes turn litter into money.
you try to sell your business cards to the group for $5 each.
probably no takers.
you offer your cards to anyone who stays to help clean up the room
no takers.
you then point to the man at the door with [...]
Read the rest of this post…
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November 12th, 2009 at 11:13 pm
Curious Reply:
November 12th, 2009 at 3:18 pm
The moment I borrow your business card, I have an obligation to repay it.
RIGHT.
That gives your business card value.
YES, TO YOU, AS YOU OWE THE CARDS, BUT YOU ALSO HAVE THE CARDS YOU BORROWED, SO ALL YOU NEED IS ANY INTEREST DUE. SO YES, YOU WOULD SELL GOODS AND SERVICES TO GET THOSE EXTRA CARDS YOU NEED.
Why would I borrow it? Because I want something that someone else has and I have nothing to trade for it.
WHY WOULD SOMEONE ELSE GIVE YOU ANYTHING FOR MY BUSINESS CARDS?
In effect, I am trading my future production, because I will have to produce something in the future, to get the business card back and return it to you.
WHY WOULD YOU BORROW THEM AND PUT YOURSELF IN THAT POSITION IN THE FIRST PLACE UNLESS YOU SAW THINGS YOU COULD BUY WHERE THE SELLER WOULD TAKE MY CARDS?
SO LET’S REALLY DO THIS.
DO YOU WANT TO BORROW MY CARDS AT 5% INTEREST? I’LL LOAN THEM TO YOU IF YOU AGREE TO THAT IN WRITING. YOU CAN’T SPEND THE CARDS AFTER YOU BORROW THEM. AND YOU HAVE TO GIVE ME WHAT I WANT TO GET THE ONES YOU NEED TO PAY ME BACK, BECAUSE NO ONE ELSE HAS THEM.
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November 13th, 2009 at 12:36 am
“YES, TO YOU, AS YOU OWE THE CARDS…”
No, to anybody. In effect, I become a slave to anybody in possession of that card.
“WHY WOULD SOMEONE ELSE GIVE YOU ANYTHING FOR MY BUSINESS CARDS?”
Why are foreigners willing to trade goods for Uncle Sam’s business cards? Same reason.
“…UNLESS YOU SAW THINGS YOU COULD BUY WHERE THE SELLER WOULD TAKE MY CARDS?”
That’s precisely the reason why I borrow them. The seller knows that I will have to get them back from him, which gives them value, which is why he accepts them.
“…YOU CAN’T SPEND THE CARDS AFTER YOU BORROW THEM…”
If I can’t spend them, why would I borrow them?
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Scott Fullwiler Reply:
November 13th, 2009 at 1:30 am
People in the US are willing to ship goods and services to other countries for Uncle Sam’s business cards, so to get the goods and services, foreigners will accept US business cards. But nobody has to pay taxes in Warren’s business cards, though, so nobody will accept them from you.
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Curious Reply:
November 13th, 2009 at 4:09 pm
Nobody has to pay taxes in Warren’s business cards, but they have to pay their debts to him in his business cards.
As long as the government enforces debt repayment as vigorously as tax collection, I don’t see a difference.
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Scott Fullwiler Reply:
November 13th, 2009 at 4:22 pm
“but they have to pay their debts to him in his business cards.’
You are assuming they are borrowing his business cards. Why are they doing that if they can’t buy goods and services with his business cards? Who else NOT IN DEBT with Warren would accept his business cards as payment in the first place to make borrowing his business cards something anyone would want to do in the second place?
Until you can answer these questions (and we’ve been at this for a few months and you still have not, by the way) then you aren’t getting it. I’m not blaming or accusing there . . . it could be that we haven’t posed the question in the right manner yet . . . still trying to get it right.
Best,
Scott
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Scott Fullwiler Reply:
November 13th, 2009 at 4:23 pm
I think you should just borrow some of his business cards . . . that’s probably the only way to make the point. Best, Scott
Curious Reply:
November 13th, 2009 at 11:20 pm
Yes Scott, I will try that, as soon as I can persuade Warren to stand at the door with 9mm and really shoot anybody who tries to leave without returning the cards they borrowed. :-)
November 14th, 2009 at 6:32 am
no man at the door needed.
you can borrow my cards any time at 2% interest, payable in more cards, and agree that if you don’t pay the cards back you’ll pay a $100 penalty.
How many do you want to borrow?
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November 14th, 2009 at 2:29 pm
Thank you for proving my point Warren, or do you still doubt that they would have a value?
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November 14th, 2009 at 3:55 pm
I’ve said from the beginning that if you were foolish enough to borrow my cards they’d have value to you.
But the larger point is that no one would borrow them, not even you, in which case they remain valueless, right?
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November 14th, 2009 at 5:03 pm
OK, so you agree that the cards would have a value to me.
If they have value to me, then whoever has them can trade them to me for something else. So the cards have value to anybody.
Now, why would I be foolish to borrow them?
I need food. If I had a choice of dying of starvation or borrowing your cards, would I borrow? What do you think?
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Scott Fullwiler Reply:
November 14th, 2009 at 10:08 pm
Who else has them that would trade them to you?
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Curious Reply:
November 15th, 2009 at 2:52 am
I am trying to explain why do the cards have value in someone else’s possession.
Of course, others have to trade something to me first, in order to get them.
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Scott Fullwiler Reply:
November 15th, 2009 at 3:09 am
They’re trading the cards TO YOU and getting goods, services, or $ in return. You’re getting the cards.
Why did you borrow cards in the first place to give away your goods, services, or $?
And, before any of this happens, how did THEY get cards? Were they, like you, willing to give their goods, services, or $ away? If so, why?
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Curious Reply:
November 15th, 2009 at 2:33 pm
Example:
You are a merchant and you want to sell a book. I want the book, but I have nothing to trade for it.
So I borrow Warren’s business card.
If you trade me the book for that piece of paper, you will be able to trade that piece of paper back to me later for goods/services, because I will need the business card back, to return it to Warren. Will you trade?
If you agree and trade, that’s how you get the card into your possession.
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Scott Fullwiler Reply:
November 15th, 2009 at 2:39 pm
Borrow Warren’s cards and see how well that works for you.
Scott Fullwiler Reply:
November 15th, 2009 at 2:45 pm
Forgot to ask . . . where will you get the additional cards to pay the interest?
Curious Reply:
November 15th, 2009 at 4:41 pm
The extra cards for interest will come from Warren. Call it Warren’s deficit spending.
Scott Fullwiler Reply:
November 15th, 2009 at 5:12 pm
OK, then, borrow a million business cards at 1% interest. Why not 10 million?
November 14th, 2009 at 9:20 pm
there would be no food for sale that anyone would give you for my cards, so why borrow them?
borrowing them doesn’t cause anyone to sell you food to get them who wouldn’t have given you credit to buy his food to begin with.
try it. try borrowing my cards at 2% interest and see if you can get any food for them
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November 15th, 2009 at 3:01 am
You agree that the cards have value.
Anything that has value can be traded. Would you agree?
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Scott Fullwiler Reply:
November 15th, 2009 at 3:15 am
They don’t have EXCHANGE VALUE if you’re the only one that wants them and you’re the only one that has them. Of course, anything can have value . . . a pile of rotten garbage can have value to someone. Who cares? We’re not talking about subjective value . . . we’re talking about objective value in exchange. If the cards are valuable to you but worthless to everyone else, you haven’t proven anything; certainly no credible definition of money is consistent with such an example.
You still haven’t explained why anyone but you has these cards in the first placek, which you are so sure you’re going to be able to obtain . . . and how, even if this is true, it is even the slightest bit rational for you to borrow cards from Warren so that you can give your goods, services, and/or $ away to obtain cards from them so that you can pay your interest to Warren.
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Curious Reply:
November 15th, 2009 at 2:11 pm
So US dollars have no EXCHANGE VALUE to foreigners, because Americans are the only ones that want them and Americans are the only ones that have them, right?
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Scott Fullwiler Reply:
November 15th, 2009 at 2:44 pm
Apples and oranges. You are setting up a completely ad hoc story to try and create exchange value where one person initially and fairly irrationally borrows business cards that nobody else has or has any need for to that point, whereas 300 million Americans (and many foreigners earning income in the US) have to pay taxes in $. If you got rid of the need to pay taxes in $, then it would not have exchange value here or most anywhere else rather quickly.
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warren mosler Reply:
November 15th, 2009 at 4:35 pm
more important, people borrow dollars in response to things they see for sale where the sellers already want dollars.
and foreigners do same- collect dollars because they can see things for sale where the sellers already want dollars
i’m dropping the rate to borrow my cards to 1%. want to borrow any?
if not, figure out why not and you independently have your answer.
Curious Reply:
November 15th, 2009 at 5:02 pm
Thanks Warren, I have my answer.
The fact, that I haven’t heard a single rational counter argument to my idea, certainly doesn’t prove that my idea is valid.
But the fact that an economist of your caliber couldn’t do it, speaks volumes.
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Scott Fullwiler Reply:
November 15th, 2009 at 5:11 pm
The fact that you can’t understand the counterarguments to the point you don’t think there has been one speaks volumes.
warren mosler Reply:
November 15th, 2009 at 4:49 pm
i’m offering to loan you my cards at 1%, payable in more cards.
want to borrow any? if not, figure out why not, and you have your answer.
Hint: if you do borrow them and sign a note to pay them back you are putting yourself in a very ugly position while you try to trade them for something. your only selling point to try to trade them would be that you might need them if i press you for payment
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Curious Reply:
November 16th, 2009 at 12:45 am
Warren, I levied a tax on all my family members payable in my business cards, so they have value, correct?
Can I send you some business cards and please, try to purchase something with them in your neighborhood.
If you can’t purchase anything with them, does it mean that tax driven money is an unrealistic concept?
If not, then why will no merchant in your neighborhood accept them?
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November 16th, 2009 at 1:18 am
Because you aren’t the government so you can’t levy your tax on anyone else, your family members make nothing the rest of us need or want. We can’t even trust you to collect that tax.
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November 16th, 2009 at 7:16 am
i’d have to see the contract between you and your kids, enforceability, what they are offering for sale in return for cards, etc.
i agree my cards would be worth something if you agreed to borrow them at any rate of interest.
that’s why i’m trying to lend them to you. it would be a case of you voluntarily taxing yourself to give my cards value at your personal expense.
and that’s why you don’t want to do it.
and that’s why it taxes taxes to drive a currency in any non trivial way.
taxes are a debt imposed by govt.
people can’t be counted on to impose debt on themselves for nothing in return directly
like president Bush said in response to Buffet and Soros saying they favored higher taxes- ’send it in, we’re not stopping you!’
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Scott Fullwiler Reply:
November 16th, 2009 at 9:52 am
Exactly.
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November 16th, 2009 at 11:43 am
Hello Mr. Mosler,
I posted an exposition of inflation and its causes over on Nick Rowe’s weblog and after he deleted my comment you offered a response. Where would be a good place to discuss my argument and your terse and uninformative response?
Regards,
Gary Marshall
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warren mosler Reply:
November 16th, 2009 at 6:17 pm
right here?
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November 16th, 2009 at 2:49 pm
“…it would be a case of you voluntarily taxing yourself to give my cards value at your personal expense.
and that’s why you don’t want to do it.”
Am I not voluntarily taxing myself when I borrow US dollars?
“and that’s why it taxes taxes to drive a currency in any non trivial way.”
I’m not sure I understand what do you mean by non trivial way.
“taxes are a debt imposed by govt.”
Yes!
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Zaid Reply:
November 17th, 2009 at 3:12 am
“Am I not voluntarily taxing myself when I borrow US dollars?”
That’s not the same thing as giving Mosler’s business cards value at your expense. You can be sure that your borrowed dollars will be accepted for something of value because they have enforceability by the IRS under the threat of imprisonment.
Who’s going to force you to pay back Mosler’s cards? How can we be sure you won’t default?
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November 16th, 2009 at 7:13 pm
Hello Mr. Mosler,
I posted the piece well below on Nick Rowe’s weblog Worthwhile Canadian Initiative. He deleted the entry and posted a rather cryptic response from you that appears directly below.
You say,
****************
the currency is a simple public monopoly
the price level is necessarily a function of prices paid by govt when it spends (and/or collateral demanded when it lends)
****************
You say that the currency is a simple public monopoly. But currency only makes up about 4% of the stock of money. I assume the other 96%, created by the commercial lenders, is not?
The meaning of your comments on the price level escapes me. For example, if the price level of homes is x, then this price is a function of prices paid by government when it buys a home?
Regards,
Gary Marshall
Hello Mr. Rowe,
In your comment to Winterspeak you mention inflation being the effect rather than the cause of too much money floating about. I agree.
You also mention the cause of too much money floating around as too much lending. I agree, but with a proviso. Inflation would require a general rise in prices.
We have seen periods in which people and firms have taken on far too much debt to purchase the things they desire. Unfortunately, when such borrowing has moved beyond reasonable there has always been recompense for the overeachers. Debts are restricted to one’s income or revenue or worth. There is always a limit to which one can borrow. The current housing crisis in the States and to some extent here confirms this. With lenders plentiful at modest interest rates, borrow they did for homes sending housing prices soaring. When prices reached inordinate levels, borrowers, viewing their diminutive incomes and the incredible prices, ceased to buy. We all know the results. The prices of homes moderated and in some places collapsed forcing lenders and householders to face the consequences in the ruthless markets. The price inflation for homes was followed by a rapid price deflation.
Those who could not buy before and wisely or luckily waited have seen the rewards.
So a few items in the consumer’s basket rose in price and subsequently declined in price. Surging stock markets and home prices are not general price rises.
But what if the inflation endures without any correction? What sort of borrowing would stifle corrections or cause general price increases?
One could not point to individuals or firms. Individuals borrow conscious of the possible results. Firms borrow to increase wealth or lower costs, intent upon a return. If the benefit does not arise, then perhaps they will survive, perhaps not.
Well, what organization out there can borrow without such petty considerations of income and revenues? What organization can squander $billions on the most worthless enterprises without penalty and without regard to the rate of inflation?
Only one I know of.
Which brings me to my point. A general rise in prices, not just home prices or stock prices, is almost always caused by excessive Government borrowing without any perceived benefit. And a general price rise is what is exactly how inflation is defined. You did make the point to some extent, but I thought I would add a few details.
Regards,
Gary Marshall
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November 16th, 2009 at 8:20 pm
Gary, please review the ‘mandatory readings’ on this site that I’d only be retyping to give you a complete answer.
Start with ’soft currency economics’ and then ‘full employment and price stability’ and let me know what you think
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November 16th, 2009 at 10:55 pm
Hello Mr. Mosler,
After reading only several articles, I find your beliefs about the financial system resemble those of Mr. Bill Mitchell. Am I correct?
Mr. Mitchell believed that a government does not have to raise money for its expenditures before they are made. I find this incredible.
You have said, “The federal government, on the other hand, is able to spend a virtually unlimited amount first, adding reserves to the banking system, and then borrow, if it wishes to conduct a reserve drain. ”
Mr. Mitchell refused to comment on a question related to the clearance of Government cheques issued to pay its bills. Perhaps you may.
****
The following is an commonplace example of a government cheque clearing.
The Government spends money handing out cheques. The Government cheque is deposited by a recipient in his account at the Bank. The Bank records a liability to the depositor. The Bank must now offset this liability with a corresponding asset. It submits the government cheque for clearance to the central bank. The central bank will then deduct money from the Government account, reducing the central bank’s liabilities. The central bank will also see its assets drop as it transfers the funds to the Bank. The Bank receives its money and marks the corresponding asset to the liability of its depositor official.
****
How does this operation cohere with your statements about Government expenditures?
Regards,
Gary Marshall
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Scott Fullwiler Reply:
November 16th, 2009 at 11:36 pm
Hi Gary
In your example, it goes like this:
Bank:
Liabilities increase as deposits increase for the spending recipient.
Assets increase as the bank’s reserve account is credited upon presenting the check to the Tsy (actually, it could be credited via Fed float temporarily).
Total: Both assets and liabilities have increased by the amount of the Tsy’s check to the recipient.
Fed:
Liabilities increase as the bank’s reserve account at the Fed has been credited by the amount of the check.
Liabilites decrease as the Tsy’s account is debited by the amount of the check.
Total: No net change to the Fed’s liabilities. Assets unchanged.
As an aside, the vast majority of the time, this is done by direct deposit, so the intermediate step using a check is skipped. End result is the same.
Best,
Scott
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November 17th, 2009 at 2:26 am
Hello Scott and Mr. Mosler,
That is fine. But the Fed is not usually, different these days, paying interest on the deposited funds, so the funds kept in the reserve accounts at the Fed are transferred out quickly. So the Bank’s asset side will change with a decrease in its Reserve holdings and an increase elsewhere. The Fed or one of its Reserve banks will then record a corresponding decline in assets and liabilities.
Now my main point - for the Treasury cheques to clear, there must be money in the accounts upon which the cheques are written. Otherwise, they do not clear. That money arrived through taxes and perhaps by the borrowing before disbursement, not subsequently.
How does this accord, Mr. Mosler, with your statment that, “The federal government, on the other hand, is able to spend a virtually unlimited amount first, adding reserves to the banking system, and then borrow, if it wishes to conduct a reserve drain. â€
Regards,
Gary Marshall
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November 17th, 2009 at 6:37 am
Yes, the Treasury, under current institutional arrangements, is not allowed to run an overdraft in its Fed account.
This is one of many of what I call ’self imposed constraints’ that are legislated by the US govt. but are not inherent in the monetary system. These include debt ceilings, budget limits, etc.
That’s why I always state it this way- ‘govt spending is not operationally constrained by revenue.’
(all this is in the literature under ‘mandatory readings’ on the website)
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November 17th, 2009 at 7:54 am
Gary
I don’t think you followed Scott’s explanation. The central bank’s total assets/liabilities do not change when the government spends - only the composition of it’s liabilities alters. There is simply an exchange of a non-monetary liability (treasury account) for a monetary liability (bank reserves). The Fed balance sheet does not contract as you suggest.
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November 17th, 2009 at 11:08 am
Hello Paradigm,
When the US Treasury adds to its account at the Fed, do the Fed’s assets and liablities rise equally, a rise in the liability to the Treasury matched by a rise in the Fed’s money holdings?
So the money comes into the Fed, and it also leaves when the Bank to which the money is transferred draws down on its Fed account or takes a wire transfer. Is this not correct?
Regards,
Gary Marshall
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November 17th, 2009 at 11:40 am
Hello Mr. Mosler,
I was a little unclear to your meaning. What you mean is that Governments are constrained by the funds in their bank account, but they can always count on tax revenues or turn to the financial markets, assuming they are compliant, to raise more capital when taxes are not enough.
I am glad that has been cleared up.
Regards,
Gary Marshall
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November 17th, 2009 at 2:31 pm
Gary,
It’s a little more fundamental than that. Since a central bank in a floating rate currency regime is not subject to any demands to convert it’s liabilities to anything else, those liabilities are simply entries on a spreadsheet, that can be increased or decreased without any external constraint.
Think of it this way: if you have an account at your bank that says it contains $1M, implicit in that is that you can show up, at any time, and demand either $1M in cash or a check that you can then deposit in another bank which would require a transfer from your bank’s reserve account. Since your bank faces this constraint, it can’t just mark up your account willy-nilly - it has to have either cash, reserves, or the ability to get them quickly, in order to be able to fulfill any such request.
But if you take a $100 bill to your local fed bank and demand “payment”, the only thing they will offer you is a nice shiny new $100 bill. If you were a bank and had a reserve account, they could also credit your account $100. But that’s it - the “money” for the Fed is purely notional - like I said, numbers in a spreadsheet.
Since the Treasury spends directly out of it’s reserve account at the fed, and the fed is not subject to convertibility, the only limits on Treasury spending are self-imposed. When the Treasury writes a check and it’s presented to the fed for payment, there are no external limits (like there would be on a normal bank) on it’s ability to honor it. If the Treasury didn’t have enough money in its’ account, the Fed could just cash it anyway and mark it up as an overdraft. The money doesn’t “come from” anywhere in any case, and no matter what what numbers it enters into it’s spreadsheet, it’s never subject to any external demand for payment.
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November 17th, 2009 at 5:05 pm
Hello Mr. Baird,
Though the central bank certainly has unusual powers, it is a bank and it is subject to the rules that apply to all banks.
If the Fed wishes to credit the Treasury’s account in absence of funds, fine. The Fed can charge the Treasury accordingly. The liabilities will shift with an increase to the Reserve account of the Bank submitting the Government cheque and a negative sum attributed to the Treasury account. But the claimant Bank may still demand a transfer. The Fed is going to have to draw down on its money reserves to complete the transaction. Its assets (money reserves) will drop with its liabilities (decrease in money sitting in the Bank’s Reserve Account).
Is this not correct, Mr. Baird?
Regards,
Gary Marshall
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November 17th, 2009 at 6:12 pm
Gary
There are two ways in which an increase in the treasury account at the Fed can be accommodated on the balance sheet. The way this typically occurs, e.g. when funds flow in via taxation, is via a liability swap (debit bank reserves, credit treasury account). This causes the base money supply to drop.
The other way is via direct Fed purchase of government debt (credit treasury account, credit asset side of Fed balance sheet with treasuries). This has no effect on the base money supply, but does cause the Fed balance sheet to expand.
BTW, reserves are not Fed assets, they are Fed liabilities, although they are simultaneously assets to commercial banks. The Fed doesn’t transfer any of its assets to commercial banks when banks gain reserves from treasury spending, it simply credits a liability (reserves) and debits another liability (treasury account).
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November 18th, 2009 at 12:22 am
Hello Paradigm,
The Fed can certainly debit member bank reserve accounts, if the money is there with which to debit them. Usually, the member bank reserve accounts do not contain much money. So the member banks will have to transfer the funds. The Fed’s money reserves, Fed money assets, will rise, along with Fed liabilities as the members’ bank account balances rise. Then the money is transferred from member bank accounts to Treasury account.
Your third paragraph addresses an error. When I said that the Fed will draw down on its money reserves, I meant that the Fed would have to draw down on its money assets or its holdings of electronic funds as the member bank withdrew funds from its Reserve account. The Fed asset decrease matches the Fed liability decrease. Is that a little clearer?
Your second paragraph contains a bit of a dilemma. I do not believe the Fed can go out and purchase Government bond holdings if it does not hold sufficient funds. On this point I run into a lot of resistance among economists. In fact, it is probably the source of trouble in all my debates with them on monetary issues. I make a distinction between currency and what I call ethereal money and others call bank created money or inside money.
The Fed is certainly able to credit the Treasury account for the Government securities it takes directly from the Treasury office, but, unless it has electronic or ethereal funds to transfer, it cannot pay out claims against the Treasury account as Government cheques arrive for clearance, or at least it cannot transfer those funds to the claimant bank upon request.
The Fed could certainly pay with currency that it alone has the right to distribute, but that currency, issued on a demand basis only, would come right back to the Fed with the claimant demanding ethereal money in return for the notes. (I am also ignoring for the moment the long delays created in gathering, counting, conveying, and delivering the notes to the claimant Bank.) So either the Fed takes the currency in, sells the Government security in the financial market, gathers the electronic or ethereal funds, and debits the Treasury account, or it refuses to accept the currency. If the latter, a virulent type of inflation results.
I use the example of the Bank of Canada, but it may as well be the Fed.
My reasoning for this conclusion, which you may have seen on Bill Mitchell’s weblog or on Rowe’s weblog, goes as follows…
Hello Mr. Rowe,
All these scenarios are wonderful, but before running through them I must ask if the central bank has the powers which you attribute to it?
The central bank does not have the breadth or vigor to manipulate those weighty financial levers and it never has. So until the matter of central bank power is resolved, there is little point in going any further.
The Bank of Canada is a bank like any other, with several differences. It is comparatively small when measured against Canada’s big commercial banks. It does not pay interest on deposits and its lending is negligible. So it really is not much of a lending institution or rather market player.
The source of the BofC’s assets and liabilities lies chiefly in one prerogative, the issuance of currency. It alone supplies and meets the demand for Canadian currency. Those notes, assuming a small cost of production, provide all of its power. I think we are agreed on this point.
There is about $50 billion in currency in circulation amounting to about say 4%-5% of the stock of money of say $1 trillion. So one might say that just 1 out of every 20 financial transactions requires currency. The markets determine the usage of currency, not the central bank. If demand rises or falls, the commercial banks will adjust their currency holdings by requesting additional notes or returning the excess.
When the commercial banks receive those new currency notes, they are paid for with that money I call ethereal, intangible and existing only in bank records. Currency is outside money created by the Bank of Canada, and ethereal money is inside money created by commercial banks in the lending process. The Bank of Canada may also create ethereal money, but rarely ever does, often in small quantities, and only for brief periods. So to obtain currency, a BofC created liability, the commercial banks surrender ethereal money, a commercial bank created liability.
The BofC invests this windfall generally in Government of Canada securities from which it earns interest. The interest, after deducting a large agency fee for its operations, is then reinvested or returned to the Government of Canada.
It is safe to say that when currency is issued or returned, there is mutual redemption in that a currency dollar note goes one way and an equivalent ethereal dollar goes the other.
Imagine that the commercial banks discover an excess of currency of about $200 million in their system. They convey it back to the BofC. Upon acceptance, the BofC will have to return an equivalent amount of commercial bank liabilities. If the ethereal money is fully invested, the BofC will have to sell a government bond. If not, then it can draw down its ethereal money reserves.
I have said in previous postings that currency is an inferior form of money, comprising only 4% of the total. It has a physical state and earns no interest. For these reasons currency is used for immediate purposes, passed as quickly to another.
If the Federal Government were to have the BofC print up $50 billion in notes to pay its bills, which consist of about 40% of the GDP, it would not get very far, perhaps about 2 month’s worth of expenditures. The BofC would then print up and distribute currency to match the Government’s returning cheques, deposited by recipients in member banks and submitted for clearance. The BofC would now have $100 billion in liabilities and only $50 billion in government securities covering them.
The commercial banks would return most of the currency immediately having use for only a small fraction of it. To redeem the notes, the BofC would have to sell all its government bonds. Or it could compel the Government to come up with a $50 billion dollar bond to balance its liabilities. The BofC would then have to sell the bond on the financial markets in exchange for ethereal money to redeem the notes.
The BofC could just refuse to accept the notes. However, this would generate inflation of 100%. The market established balance between currency and money is 4% or about 1:20. Doubling the currency supply to $100 billion without reason will double the entire money supply to $2 trillion as banks rid themselves of the excess of currency by making loans to restore the formerly established equilibrium.
But why would the Government create such havoc, destroying the value of existing financial assets and transforming expectations for the fleeting pleasure of avoiding 2 months of disbursements? All it really had to do was float a bond and obtain the same results without the financial chaos.
In attempts to influence the exchange rate or the interest rate by printing up currency notes the result would be the same. Though the Bank of Canada has this privilege, it is severely restricted in its ability to use it.
The only method of profit in currency issuance comes from the receipt of commercial bank liabilities, i.e. ethereal money, which is used to buy interest bearing government securities. With these bonds, about $50 billion in total, the BofC can influence the exchange rate or interest rates in the medium, overnight or long term markets, but only to that amount and only in actually doing so. Empty threats will not bring about enduring changes in either. One must move out into the markets to create the desired effects.
But even $50 billion dollars will not go far against much larger competitors and in financial markets in the $trillions. It will not control interest or exchange rates when the other market players can draw upon sums far more immediate and ponderous.
Now all of this may be required reading for any economics novice, but I never saw a word of it. And had I, there would not now be a field of study in economics known as monetary policy.
Regards,
Gary Marshall
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November 18th, 2009 at 4:47 am
I’ve probably said this before, but thanks to Warren for creating this site. It’s great.
There was a witty/bad tempered argument above between posts 12 and 35 (or thereabouts) involving Curious, Warren etc on why Warren’s business cards can be made to have value in a hypothetical economy where there is no tax.
I agree with Curious that tax is not necessary to give value to a fiat currency. I disagree with Curious (and agree with Warren) that Warren’s business cards cannot be made to have value simply because Warren prints them and says “Hey, these cards have value – gimme that car in exchange for these cardsâ€. (I also agree with Warren that inflation is the big constraint on how much money can be printed, not how much is collected in tax.)
So how come cards (or dollars) ever have value? Answer is in the economics text books: money is whatever is GENERALLY accepted as performing the function of money. Once anything becomes GENERALLY ACCEPTED as money, that’s it. People and businesses have a desire to trade, and to trade with money because that is normally better than barter. And as long as the money issuer behaves responsibly the money concerned will work.
There are other systems that are difficult to boot, but once booted, normally run smoothly - you’re using one right now. There are also products other than money, which have a critical mass: insufficient general acceptance results in the product being uneconomic.
Why does Monopoly money in a game of Monopoly have value? Because the players want to trade, and most participants agree that the Monopoly money has value. That’s all.
Why did the currency in Krugman’s Washington D.C. baby sitting economy have value? Not because of taxation. It was because, 1, participants wanted to trade, 2, the currency was issued in a responsible manner, 3, the currency was generally accepted.
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JKH Reply:
November 18th, 2009 at 7:41 am
I think fiat issued currency is a specific example of “general acceptanceâ€. Taxation leverage would drive out any currencies that competed against it. Fiat currency thus is the “most generally accepted†among competing paradigms. I don’t recall Krugman’s model, but if it had included a taxman, the currency issued by the taxman would have won out.
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Curious Reply:
November 18th, 2009 at 4:29 pm
Ralph,
the baby sitting currency was convertible (pegged to babysitting hours). I think that’s where it’s value came from.
For a currency to be generally accepted, it has to have value first, otherwise, why would the very first person accept it?
As far as the discussion on Warren’s business cards, I agree that they can’t get value, just by Warren saying so. I didn’t think I suggested that, but if I did, obviously that doesn’t make sense.
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November 18th, 2009 at 1:50 pm
The “Krugman baby sitting economy†is here:
http://www.slate.com/id/1937/
For anyone who likes seeing economic theories and ideas illustrated by reference to ultra simple economies (like Robinson Crusoe and about three other people on a desert island), the baby sitting article is an enjoyable three minute read.
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November 18th, 2009 at 8:22 pm
those types of currencies- ithaca hours, etc- have value because people are willing to take a chance on losing their expended labor hours.
that is, they will do work for someone on the non enforceable hope that someone will do work for them in return. this happens where unemployment is high and it’s perceived there isn’t much to lose.
it’s ok as far as it goes
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November 20th, 2009 at 4:31 am
Re Warren’s point that Ithaca hours currencies only work given high unemployment, I agree.
That is because such currencies are in competition for the purchase of all goods and services with the national currency. And given an adequate supply of the latter, the Ithaca currency is driven out of business.
A game of Monopoly and the Krugman babysitting economy are different because the respective currencies are dominant: they purchase all goods and services in the economies concerned. And such currencies work without taxation which suggests to me that a fiat currency could work in a full scale economy without taxation.
Plus what gave the baby sitting economy added realism was that it suffered a recession, and the latter was cured by doing exactly what Warren quite rightly wants to do for the US economy: issue more money.
I also think that tax is irrelevant in that in a democracy people will only elect governments that supply them with goods and services they would have bought anyway: schools, health care, etc. To this extent, tax is just an alternative way of paying for things. In some cases tax is MUCH THE BEST way of paying for things, but that point is not dependent on whether a country has a fiat or commodity based currency.
Having said that, there IS one way in which tax greatly assists running a fiat currency: given a bout of irrational exuberance or inflation, it is desirable to reduce private sector net financial assets. Tax is a quick effective way of doing this.
Curious: I agree that it is difficult getting a fiat currency going in the first place without the initial units being based on some commodity. That was why I likened fiat currencies above to booting a PC.
Re the baby sitting units being pegged to one hour of work, this is an example of getting the currency going. After it has started, the peg can be removed (though I don’t think they actually did remove the peg in Washington). This “peg removal†happens in Monopoly: the price of houses and hotels is fixed initially, but thereafter players can buy and sell stuff for whatever price they agree to.
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