Category Archives: MMT – Modern Money Theory

The ‘fountain pen of money’ – Bryan Gould. 

Steven Joyce, NZ Minister of Finance, has recommended the formal establishment of a committee to help the Governor of the Reserve Bank decide on where to take interest rates, thereby following the example of other central banks around the world.

Also Grant Robertson, Labour’s shadow Finance Minister, has made a similar recommendation concerning a Monetary Policy Committee to help the Governor, but has also followed another overseas example by supporting an extension of the Governor’s remit, so that he would, in addition to restraining inflation, be required to take account of the desirability of full employment.

Most people believe, and it is a belief assiduously promoted by the banks themselves, that the banks act as intermediaries between those wishing to save and those wishing to borrow, usually on mortgage.

In this view, the banks are benefactors, bringing together those with money to spare and to deposit with them, and those who wish to borrow, often for house purchase.

The banks make their money, so it is said, by charging a higher rate of interest to the borrowers than they pay to the depositors, the equivalent of a small fee for the administrative costs of bringing the parties together.

But this benign view of their operations is inaccurate and misleading. The banks do not lend you on mortgage money deposited with them by someone else.

They lend you money that they themselves create out of nothing, through the stroke of a pen or, today, a computer entry.

The banks make their money, in other words, by charging interest on money that they themselves create. Not surprisingly, they are keen to lend as much as possible.

But the consequences of this bizarre scenario go much further. It is the willingness, not to say keenness, of the banks to lend on mortgage that provides the virtually limitless purchasing power that is constantly bidding up the prices of homes in Auckland and, now, elsewhere.

It is the banks that are fuelling the housing unaffordability crisis, a crisis that is leaving families homeless and widening the gap between rich and poor.

So far, the government has washed its hands of this aspect of the crisis.

It is content to leave the crucial decisions on monetary policy to the Reserve Bank.  That way, it can disclaim responsibility and leave the Governor, himself a banker, to carry the can.

Leaving monetary policy (which is usually just a matter of setting interest rates) to the Reserve Bank is usually applauded as ensuring that it does not become a political football. But monetary policy should have a much greater role than simply restraining inflation and has a huge influence on so many aspects of our national life.

Why should the Government be able to hide behind the Governor of the Reserve Bank and duck responsibility for a policy of the greatest importance to so many Kiwis?  Why should ministers not be held to account in Parliament and to the country for failing to deliver outcomes they were elected to deliver?

It is no surprise a former Governor of the Reserve Bank should seek to defend the banking system from its critics. But in denying the accuracy of points I made in the Herald about how the banks operate, Don Brash accused me of “peddling nonsense”.

I made two basic points. First, I asserted the banks do not, as usually believed, simply act as intermediaries, bringing together savers (or depositors) and borrowers to their mutual benefit.

Secondly, I said the vast majority of new money in circulation is created by the banks “by the stroke of a pen”, and they then make their profits by charging interest on the money they create.

If this is “nonsense”, the “peddlers” include some very distinguished economists.

In my original piece, I referred to a Bank of England research paper, published in the bank’s first Quarterly Bulletin 2014, which describes in detail the process by which banks create money.

“One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them. That ignores the fact that, in reality in the modern economy, commercial banks are the creators of deposit money. Rather than banks lending out deposits that are placed with them, the act of lending creates deposits – the reverse of the sequence typically described in textbooks.

Bank deposits make up the vast majority – 97 per cent of the amount of money currently in circulation. And in the modern economy, those bank deposits are mostly created by commercial banks themselves.

Another common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money – the so-called ‘money multiplier’ approach, but that is not an accurate description of how money is created in reality.

Banks first decide how much to lend depending on the profitable lending opportunities available to them – which will, crucially, depend on the interest rate set. It is these lending decisions that determine how many bank deposits are created by the banking system.

The amount of bank deposits in turn influences how much central bank money banks want to hold in reserve (to meet withdrawals by the public, make payments to other banks, or meet regulatory liquidity requirements), which is then, in normal times, supplied on demand by the Central Bank.

Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created.

For this reason, some economists have referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans.”

Commercial banks create money, in other words, by placing loans [or credits] into the bank accounts of borrowers. They then charge interest on, and demand security for and repayment of, those loans.

They have no capacity to create money in any other way or for any other purpose [though the central bank can pursue “quantitative easing” to increase the money supply if it thinks that is needed].

Is it wise to entrust such wide-ranging powers – so significant in their impact on the whole economy – to the banks, and then to arrange that the only person able to regulate that impact was himself a banker – the Governor of the Reserve Bank.

Bryan Gould


Modern Money Theory: Deadly Innocent Fraud #7: It’s a bad thing that higher deficits today mean higher taxes tomorrow. – Warren Mosler. 

Fact: I agree – the innocent fraud is that it’s a bad thing, when in fact it’s a good thing!!!

Why does government tax? Not to get money, but instead to take away our spending power if it thinks we have too much spending power and it’s causing inflation.

Why are we running higher deficits today? Because the “department store”has a lot of unsold goods and services in it, unemployment is high and output is lower than capacity. The government is buying what it wants and we don’t have enough after-tax spending power to buy what’s left over. So we cut taxes and maybe increase government spending to increase spending power and help clear the shelves of unsold goods and services.

And why would we ever increase taxes? Not for the government to get money to spend – we know it doesn’t work that way. We would increase taxes only when our spending power is too high, and unemployment has gotten very low, and the shelves have gone empty due to our excess spending power, and our available spending power is causing unwanted inflation.

So the statement “Higher deficits today mean higher taxes tomorrow” in fact is saying, “Higher deficits today, when unemployment is high, will cause unemployment to go down to the point we need to raise taxes to cool down a booming economy.” Agreed!

Modern Money Theory: Deadly Innocent Fraud #6: ​We need savings to provide the funds for investment. – Warren Mosler. 

Fact: Investment adds to savings.

This innocent fraud undermines our entire economy, as it diverts real resources away from the real sectors to the financial sector, with results in real investment being directed in a manner totally divorced from public purpose. It might be draining over 20% annually from useful output and employment – a staggering statistic, unmatched in human history. And it directly leads the type of financial crisis we’ve been going through.

“The paradox of thrift”

(The paradox of thrift (or paradox of saving) is a paradox of economics. The paradox states that an increase in autonomous saving leads to a decrease in aggregate demand and thus a decrease in gross output which will in turn lower total saving. The paradox is, narrowly speaking, that total saving may fall because of individuals’ attempts to increase their saving, and, broadly speaking, that increase in saving may be harmful to an economy.

Both the narrow and broad claims are paradoxical within the assumption underlying the fallacy of composition, namely that what is true of the parts must be true of the whole. The narrow claim transparently contradicts this assumption, and the broad one does so by implication, because while individual thrift is generally averred to be good for the economy, the paradox of thrift holds that collective thrift may be bad for the economy. Wikipedia)

– In our economy, spending must equal all income, including profits, for the output of the economy to get sold.

– If anyone attempts to save by spending less than his income, at least one other person must make up for that by spending more than his own income, or else the output of the economy won’t get sold.

– Unsold output means excess inventories, and the low sales means production and employment cuts, and thus less total income. And that shortfall of income is equal to the amount not spent by the person trying to save.

Think of it as the person who’s trying to save (by not spending his income) losing his job, and then not getting any income, because his employer can’t sell all the output.

So the paradox is, “decisions to save by not spending income result in less income and no new net savings.” Likewise, decisions to spend more than one’s income by going into debt cause incomes to rise and can drive real investment and savings.

“Savings is the accounting record of investment.” Professor Basil Moore

Unfortunately, Congress, the media and mainstream economists get this all wrong, and somehow conclude that we need more savings so that there will be funding for investment. What seems to make perfect sense at the micro level is again totally wrong at the macro level. Just as loans create deposits in the banking system, it is investment that creates savings.

So what do our leaders do in their infinite wisdom when investment falls, usually, because of low spending? They invariably decide “we need more savings so there will be more money for investment.”(And I’ve never heard a single objection from any mainstream economist.) To accomplish this Congress uses the tax structure to create tax-advantaged savings incentives, such as pension funds, IRA’s and all sorts of tax-advantaged institutions that accumulate reserves on a tax deferred basis. Predictably, all that these incentives do is remove aggregate demand (spending power). They function to keep us from spending our money to buy our output, which slows the economy and introduces the need for private sector credit expansion and public sector deficit spending just to get us back to even.

In fact it’s the Congressionally-engineered tax incentives to reduce our spending (called “demand leakages”) that cut deeply into our spending power, meaning that the government needs to run higher deficits to keep us at full employment. Ironically, it’s the same Congressmen pushing the taxadvantaged savings programs, thinking we need more savings to have money for investment, that are categorically opposed to federal deficit spending.

And, of course, it gets even worse! The massive pools of funds (created by this deadly innocent fraud #6, that savings are needed for investment) also need to be managed for the further purpose of compounding the monetary savings for the beneficiaries of the future. The problem is that, in addition to requiring higher federal deficits, the trillions of dollars compounding in these funds are the support base of the dreaded financial sector. They employ thousands of pension fund managers whipping around vast sums of dollars, which are largely subject to government regulation. For the most part, that means investing in publicly-traded stocks, rated bonds and some diversification to other strategies such as hedge funds and passive commodity strategies. And, feeding on these “bloated whales,” are the inevitable sharks – the thousands of financial professionals in the brokerage, banking and financial management industries who owe their existence to this 6th deadly innocent fraud.

Modern Money Theory: Deadly Innocent Fraud #5: The trade deficit is an unsustainable imbalance that takes away jobs and output. – Warren Mosler. 

Facts: Imports are real benefits and exports are real costs. Trade deficits directly improve our standard of living. Jobs are lost because taxes are too high for a given level of government spending, not because of imports.

In economics, it’s better to receive than to give. Therefore, as taught in 1st year economics classes: Imports are real benefits. Exports are real costs.

Put more succinctly: The real wealth of a nation is all it produces and keeps for itself, plus all it imports, minus what it must export.

A trade deficit, in fact, increases our real standard of living. How can it be any other way? So, the higher the trade deficit the better.

The mainstream economists, politicians, and media all have the trade issue completely backwards. Sad but true.

To further make the point: If, for example, General MacArthur had proclaimed after World War II that since Japan had lost the war, they would be required to send the U.S. 2 million cars a year and get nothing in return, the result would have been a major international uproar about U.S. exploitation of conquered enemies. We would have been accused of fostering a repeat of the aftermath of World War I, wherein the allies demanded reparations from Germany which were presumably so high and exploitive that they caused World War II. Well, MacArthur did not order that, yet for over 60 years, Japan has, in fact, been sending us about 2 million cars per year, and we have been sending them little or nothing. And, surprisingly, they think that this means they are winning the “trade war,”and we think it means that we are losing it. We have the cars, and they have the bank statement from the Fed showing which account their dollars are in.

Same with China – they think that they are winning because they keep our stores full of their products and get nothing in return, apart from that bank statement from the Fed. And our leaders agree and think we are losing.

This is madness on a grand scale.

We are benefiting IMMENSELY from the trade deficit. The rest of the world has been sending us hundreds of billions of dollars worth of real goods and services in excess of what we send to them. They get to produce and export, and we get to import and consume.

Is this an unsustainable imbalance that we need to fix? Why would we want to end it?

As long as they want to send us goods and services without demanding any goods and services in return, why should we not be able to take them? There is no reason, apart from a complete misunderstanding of our monetary system by our leaders that has turned a massive real benefit into a nightmare of domestic unemployment.

All we have to do is keep American spending power high enough to be able to buy BOTH what foreigners want to sell us AND all the goods and services that we can produce ourselves at full employment levels.

Where’s the “foreign capital ?” There isn’t any! The entire notion that the U.S. is somehow dependent on foreign capital is inapplicable.

Modern Money Theory: Deadly Innocent Fraud #4: Social Security is broken. – Warren Mosler.

Fact: Federal Government Checks Don’t Bounce.

As we’ve already discussed, the government never has or doesn’t have any of its own money. It spends by changing numbers in our bank accounts. This includes Social Security.

It doesn’t matter what the numbers are in the Social Security Trust Fund account, because the trust fund is nothing more than record-keeping, as are all accounts at the Fed.

50 years from now when there is one person left working and 300 million retired people (I exaggerate to make the point), that guy is going to be pretty busy since he’ll have to grow all the food, build and maintain all the buildings, do the laundry, take care of all medical needs, produce the TV shows, etc. etc. etc. What we need to do is make sure that those 300 million retired people have the funds to pay him??? I don’t think so! This problem obviously isn’t about money. What we need to do is make sure that the one guy working is smart enough and productive enough and has enough capital goods and software to be able to get it all done, or else those retirees are in serious trouble, no matter how much money they might have.

We know our government neither has nor doesn’t have dollars. It spends by changing numbers up in our bank accounts and taxes by changing numbers down in our bank accounts. And raising taxes serves to lower our spending power, not to give the government anything to spend.

The first thing our misguided leaders cut back on is education – the one thing that the mainstream agrees should be done that actually helps our children 50 years down the road. Should our policy makers ever actually get a handle on how the monetary system functions, they would realize that the issue is social equity, and possibly inflation, but never government solvency.

The amount of goods and services we allocate to seniors is the real cost to us, not the actual payments, which are nothing more than numbers in bank accounts. And if our leaders were concerned about the future, they would support the types of education they thought would be most valuable for that purpose. They don’t understand the monetary system, though, and won’t see it the “right way around”until they do understand it.

Meanwhile, the deadly innocent fraud of Social Security takes its toll on both our present and our future well-being.

Modern Money Theory: Deadly Innocent Fraud #3: Federal Government budget deficits take away savings – Warren Mosler. 

Fact: Federal Government budget deficits ADD to savings.

Government deficits equal increased “monetary savings” for the rest of us, to the penny.

Simply put, government deficits ADD to our savings (to the penny). This is an accounting fact, not theory or philosophy. There is no dispute. It is basic national income accounting. For example, if the government deficit last year was $ 1 trillion, it means that the net increase in savings of financial assets for everyone else combined was exactly, to the penny, $ 1 trillion. (For those who took some economics courses, you might remember that net savings of financial assets is held as some combination of actual cash, Treasury securities and member bank deposits at the Federal Reserve.)

This is Economics 101 and first year money banking. It is beyond dispute. It’s an accounting identity. Yet it’s misrepresented continuously, and at the highest levels of political authority. They are just plain wrong.

When the government account goes down, some other account goes up, by exactly the same amount.

Deficit spending doesn’t just shift financial assets (U.S. dollars and Treasury securities) outside of the government. Instead, deficit spending directly adds exactly that amount of savings of financial assets to the non-government sector. And likewise, a federal budget surplus directly subtracts exactly that much from our savings. And the media and politicians and even top economists all have it BACKWARDS!

The last six periods of surplus in the more than two hundred-year US history have been followed by the only six depressions in our history.

And after the sub-prime debt-driven bubble burst, we again fell apart due to a deficit that was and remains far too small for the circumstances. For the current level of government spending, we are being over-taxed and we don’t have enough after-tax income to buy what’s for sale in that big department store called the economy.

When the January 2009 savings report was released, and the press noted that the rise in savings to 5% of GDP was the highest since 1995, they failed to note the current budget deficit passed 5% of GDP, which also happens to be the highest it’s been since 1995.

The only source of “net $U.S. monetary savings”(financial assets) for the non-government sectors combined (both residents and non-residents) is U.S. government deficit spending.

But watch how the very people who want us to save more, at the same time want to “balance the budget” by taking away our savings, either through spending cuts or tax increases. They are all talking out of both sides of their mouths. They are part of the problem, not part of the solution. And they are at the very highest levels.

The government deficit equals the savings of financial assets of the other sectors combined .

So now we know: – Federal deficits are not the “awful things” that the mainstream believes them to be. Yes, deficits do matter. Excess spending can cause inflation. But the government isn’t going to go broke. – Federal deficits won’t burden our children. – Federal deficits don’t just shift funds from one person to another. – Federal deficits add to our savings.

The right-sized deficit is the one that gets us to where we want to be with regards to output and employment, as well as the size of government we want, no matter how large or how small a deficit that might be.

Modern Money Theory: Deadly Innocent Fraud #2: With government deficits, we are leaving our debt burden to our children. – Warren Mosler. 

Fact: Collectively, in real terms, there is no such burden possible. Debt or no debt, our children get to consume whatever they can produce.

Professional economists call this the “intergenerational” debt issue. It is thought that if the federal government deficit spends, it is somehow leaving the real burden of today’s expenditures to be paid for by future generations.

The idea of our children being somehow necessarily deprived of real goods and services in the future because of what’s called the national debt is nothing less than ridiculous.

Nor is the financing of deficit spending anything of any consequence. When government spends, it just changes numbers up in our bank accounts.

The entire $13 trillion national debt is nothing more than the economy’s total holdings of savings accounts at the Fed. And what happens when the Treasury securities come due, and that “debt” has to be paid back?

Yes, you guessed it, the Fed merely shifts the dollar balances from the savings accounts (Treasury securities) at the Fed to the appropriate checking accounts at the Fed (reserve accounts).

Nor is this anything new. It’s been done exactly like this for a very long time, and no one seems to understand how simple it is and that it never will be a problem.

When I look at today’s economy, it’s screaming at me that the problem is that people don’t have enough money to spend. It’s not telling me they have too much spending power and are overspending.

When we operate at less than our potential – at less than full employment – then we are depriving our children of the real goods and services we could be producing on their behalf. Likewise, when we cut back on our support of higher education, we are depriving our children of the knowledge they’ll need to be the very best they can be in their future. So also, when we cut back on basic research and space exploration, we are depriving our children of all the fruits of that labor that instead we are transferring to the unemployment lines.

A U.S. Treasury security is nothing more than a fancy name for a savings account at the Fed. The buyer gives the Fed money, and gets it back later with interest. That’s what a savings account is – you give a bank money and you get it back later with interest.

It’s all a tragic misunderstanding.

China knows we don’t need them for “financing our deficits” and is playing us for fools. Today, that includes Geithner, Clinton, Obama, Summers and the rest of the administration. It also includes Congress and the media.

Paying off the entire U.S. national debt is but a matter of subtracting the value of the maturing securities from one account at the Fed, and adding that value to another account at the Fed. These transfers are non-events for the real economy and not the source of dire stress presumed by mainstream economists, politicians, businesspeople, and the media.

The deadly innocent fraud of leaving the national debt to our children continues to drive policy, and keeps us from optimizing output and employment. The lost output and depreciated human capital is the real price we and our children are paying now that diminishes both the present and the future. We make do with less than what we can produce and sustain high levels of unemployment (along with all the associated crime, family problems and medical issues) while our children are deprived of the real investments that would have been made on their behalf if we knew how to keep our human resources fully employed and productive.