By Dan Kervick, a PhD in Philosophy and an active independent scholar specializing in the philosophy of David Hume who also does research in decision theory and analytic metaphysics. Cross posted from New Economics Perspectives
Reflections on Modern Money
Before considering what it would mean to make our monetary system more democratic, let’s begin by calling to mind a few familiar features of money and modern monetary systems in general, features we all intuitively understand as users of money in a modern monetary economy.
First, money obviously comes in very different forms. Not only are there different currency systems – the dollar system, the euro system, the renminbi system, etc. – but even within a single system, money can take significantly different forms. There is all of that familiar paper and metal currency, consisting of tangible objects that can be physically transported from one hand to another, and that are denominated with different face values. But money might also exist simply as “points” electronically credited to someone’s digital monetary scorecard at a bank. These points are debited from and credited to various accounts, and need never be exchanged for physical currency. We can already see a near future in which the traditional material currency of metal coins and paper notes will no longer be used. In thinking about our modern monetary system, then, it is useful to think of it as a network of such monetary scorecards. And we can think of the exchange of physical paper and metal currency as just one among several ways of adding and subtracting points from the monetary scorecards of those who exchange the money. Each individual possess such a scorecard, but so do businesses, governments and other organizations.
Conceiving of our monetary transactions in this way is compatible with the intellectual framework developed by Hyman Minsky, who said, “A capitalist economy can be described by a set of interrelated balance sheets and income statements.” However, the world of balance sheets Minsky asked us to describe contains more than just money. These balance sheets record the ownership of other financial assets – that is, promises or commitments of money rather than money itself. And they also contain accounts of real assets – items of positive value to their owners, like cars or buildings or a book collection – that are not financial assets. Finally, the balance sheets are also accounts of liabilities – things that represent negative value to their owners, such as debts that legally commit the owner of the debt to an outflow of wealth over time.
A second thing to note about modern monetary systems is that the market value of these exchangeable monetary points lies, for all of their users, purely in their exchange value. That is, the only value that attaches to the acquisition and possession of money comes from the knowledge that money can be exchanged for other things. It is true that people also seek to acquire money as a “store of value” that they save for indefinite periods and have no definite plans to spend. But the only reason one can be successful in storing value when one saves money is that other things continue to happen out in society that preserve the use of that money as a medium of exchange. If at any time people became unwilling to accept that form of money in exchange, the saver would no longer be storing value when they saved their money, but valueless points on a meaningless scorecard.
The fact that the value of modern money is purely based on its acceptance in exchange makes money different from all of the non-monetary items that we accumulate and exchange. Non-monetary items of value always have a direct practical utility, for at least some significant number of people, a utility that is not dependent on the prior exchange of those items for something else. The utility might be realized in consumption, as it is with a bar of chocolate, or in the production of some other product or service, as with a block of iron. It is true that for some specific people, the entire value of some non-monetary object might derive from the prospect of exchanging that object for something else. So, for example, I might be a philistine art collector who buys paintings only to store value over time and perhaps exchange them later for the things I really want. For me, paintings function as something like money. But I can use paintings in this purely mercenary way, as merely something to exchange for something else, only because there are other people who love paintings for their own sake.
Similarly, I might be a prisoner who trades goods for cigarettes, even though I don’t smoke, but only because some other prisoners do smoke, and are willing to give something up for the cigarettes. But money is different altogether. What makes a certain good a form of money is that its value for pretty much everyone lies entirely in the fact that others will accept it in exchange. There is no non-monetary, non-instrumental foundation for the exchange value of money. There might be a few demented misers with a perverse love for paper bills and metal coins themselves, and a few numismatic hobbyists who collect these bits of money as cultural curiosities and works of art in themselves. But the exchange value of money does not depend in any significant way of the existence of this relatively small number of people.
Thirdly and finally, it is clear that governments play a very important role in the regulation of contemporary monetary systems, and in the creation and destruction of the monetary units in that system. The monies we use have an official, legally institutionalized role in our economies, an official status that is advertized to us by the markings and declarations on the physical currency itself. Almost all money in actual widespread use is some government’s money. The government is central in preserving the value and stability of the government’s money over time. And we know that while we all have a great deal of liberty to exchange the money we personally possess for other good and services, and to exchange goods and services for money, the legal authority to create and destroy the official government money is tightly regulated and protected. It is to such official, government administered monetary systems – at least when they exist in democratic societies – that I refer when I describe a monetary system such as the dollar system as “the public’s money.”
But how do those governmental monetary processes happen? How is the monetary system stabilized over time? How is money actually created and destroyed in a modern monetary economy? The full answer to these questions is not simple. Governments are complex entities, consisting of many separate branches, divisions, departments and agencies, each with its own assigned powers and authorities, and many distinct operational centers have their hands on different aspects of the monetary system. The private sector plays a key role as well. My focus will primarily be on the processes that create and destroy money. We can put off the precise details of government monetary operations for now, and start instead with a simplified model. I will call the government in this simple model a “monetarily sovereign government”, or just a “monetary sovereign”.
Monetary sovereigns can come in different forms, but in a democracy the people as a whole are supposed to be the ultimate seat and source of the government’s sovereignty, including its sovereignty over monetary operations. Think of the monetary sovereign, no matter what individual or group of individuals constitute and exercise that sovereignty, as possessing a single monetary account of its own – a single unified monetary scorecard. Initially, the monetary sovereign’s scorecard can be thought of as very much like anyone else’s monetary scorecard. When the monetary sovereign spends, and either buys something from someone in the private sector or transfers money outright to the private sector, some monetary points are deducted from the monetary sovereign’s scorecard and an equal number of points are added to that private sector scorecard. And going in the other direction, when the monetary sovereign taxes, or when someone purchases some good or service from a government agency, some monetary points are deducted from the private sector scorecard and an equal number of points are added to the monetary sovereign’s scorecard.
But there are two wrinkles, two special circumstances that make the monetary sovereign’s scorecard very different from private sector scorecards.
First, the monetary sovereign is the seat of government, and hence the ultimate administrator of its own scorecard. If you and I exchange money, and the exchange takes place via our bank accounts, the banks that oversee these accounts administer the adjustment of the monetary points on our scorecards. And if two banks exchange money, the government, which operates a central bank that serves as a sort of bank for bankers, administers the adjustment of monetary points between the two bank scorecards. But when a monetary exchange takes place between the monetary sovereign and any other person or entity in the private sector, the monetary sovereign is the ultimate administrator or arbiter of the monetary adjustment. The monetary sovereign’s scorecard is not administered by some third party, but by the monetary sovereign itself.
It is true that the scorecard of some agency within the government might be administered by some other agency of the government. In the US system, for example, the Treasury Department’s monetary transactions are administered by the Federal Reserve System, which holds the Treasury Department’s accounts. But the Fed is ultimately part of the government, which means that the US government as a whole is the ultimate administrator of the government’s own accounts.
The other way in which the monetary sovereign’s monetary scorecard is different from a private sector scorecard is connected with the first difference: A monetarily sovereign government reserves for itself the power of adding or deleting monetary points on its own scorecard or any other scorecard, at its own discretion, without any requirement that an equal number of monetary points are debited from any other scorecard or credited to any other scorecard. And the monetary sovereign uses its power to guarantee that it is the sole entity in the monetary system that possesses such power. The monetary sovereign, in other words, wields the exclusive power to create and destroy money in the monetary system it controls. Currency users in the private sector, on the other hand, can only exchange monetary points in ways that make the books balance. To the extent that agents other than the monetary sovereign are permitted to engage in money-creating and money-destroying operations, these operations take place only with the permission of the monetary sovereign, and under the guidance or supervision of the monetary sovereign.
There might appear to be one partial exception to the above restriction, however. Private sector banks are also permitted, within certain limits, to create new monetary points in the monetary system. When a bank decides to give a loan to some new borrower, it creates a deposit account for that borrower and credits the loaned amount of dollars to that account. In effect, it creates a new monetary scorecard for the borrower and puts some monetary points on it. As the economists Basil Moore, Scott Fullwiler, Marc Lavoie and many others have emphasized, those points need not come from anywhere. They need not be the result of a transfer of points from some other account to the borrower’s account. Although the bank might be subject to central bank reserve requirements that mandate the bank hold a certain percentage of money against its deposits, in its reserve account at the central bank, the bank typically has several weeks to meet these requirements, and can acquire the reserves after making the initial loan, either from other banks or from the central bank itself.
So bank lending can in some sense create additional money. However, in a very strict sense, what the bank borrower receives is not monetary points, but a promise of monetary points to be delivered in the future. That promise is a liability of the bank – something it now owes the borrower and that the borrower can convert into money on demand. If the borrower decides to withdraw the promised money in the form of material currency, the bank must take cash from its vault and give it to the borrower. At this point, we can see an actual transfer of money from the bank to the borrower. But the bank’s vault cash has to be acquired from the monetary sovereign, and it has to pay for that cash.
Now since bank deposits can be exchanged just about as freely as money in any form, they can be legitimately defined as one form of money itself. There is perhaps no strict line that can be drawn between liabilities for money or promises of money, on the one hand, and money itself, on the other hand. But ultimately, however we define “money”, all of these banking operations are administered and regulated by the monetary sovereign, and so the monetary sovereign’s decisions are ultimately responsible for which lending operations a bank is permitted to conduct, and whether the bank’s lending results in a net increase in money in the monetary system. The monetary system is under the ultimate control of the monetary sovereign, even if the sovereign chooses not to be very assertive in exercising that control, and passively allows banks to create money as they see fit.
So let’s return to the operations of the monetary sovereign itself. In order to bring the nature and ultimate capacities of monetary sovereignty into sharper relief, let’s consider three distinct models or mental pictures of the monetary sovereign’s monetary operations. These mental pictures are designed only to provide a more vivid imaginative understanding of monetary sovereignty. And initially at least, they might appear to be dramatically different pictures. But we will see that in the end the pictures are, somewhat surprisingly, fully equivalent in everything that is really essential and important about the monetary sovereign’s operations.
The first picture can be called the infinite account model. Think of the monetary sovereign as possessing an account or monetary scorecard that holds an infinite quantity of dollars. When it spends in its unit of currency, it credits some amount of units X to some private sector account, but debits X units from its own account. When it taxes, it debits X units from some private sector account, but credits X units from its own account. But since it possesses infinitely many units of the currency in the first place, these operations have no effect on its own balances. Currency units come in and go out, but the addition or subtraction of a finite number of units from an infinite stock of units never makes any difference. The same infinite number of units exists on the monetary sovereign’s scorecard at all times.
A second picture is the empty account model. In this case, think of the monetarily sovereign government as possessing an account that contains no money whatsoever. Its scorecard always stands at zero. When it spends, it credits X units to some private sector account, but makes no change at all in its own account. When it taxes, it debits X units from some private sector account, but again makes no changes at all to its own account. Since it never possesses any money on its books, the monetary sovereign’s basic monetary operations of taxing and spending can be viewed as simply creating private sector monetary points out of thin air and destroying private sector money, not transferring that money back and forth between the private sector and the government. On the empty account model, only private sector monetary scorecards are marked up with monetary balances, and the monetary sovereign never possesses money of its own.
Finally, there is the quotidien account model. The monetarily sovereign government is seen on this model as always possessing a finite amount of currency units – just like a private sector entity. At all times, some finite number of monetary units are on its monetary scorecard, and the monetary sovereign running a quotidien account is scrupulous about balancing the books on its monetary operations. When it spends, it credits X units to some private sector scorecard, but scrupulously debits X units from its own scorecard. When it taxes, it debits X units from some private sector scorecard, but again carefully credits X units to its own account. Since it possesses only finitely many units in the first place, these operations do have an effect on its balances. However, there is one added wrinkle: the monetary sovereign is, as before, legally entitled to create or destroy currency units on its scorecard as a separate operation. So in the end, while there are always some finite number of units on its scorecard, the monetarily sovereign government ultimately chooses exactly how many units that is, since it can add or subtract units from its own scorecard at any time. Even though the sovereign’s bookkeepers are scrupulously balancing the books when it comes to recording exchanges to and from the private sector, the fact that the government can at any time credit or debit some additional amount makes the bookkeeper’s care somewhat absurd or meaningless, at least with regard to the monetary sovereign’s own account.
Recognizing that degree of meaninglessness in the quotidien account model is the key to grasping a very fundamental fact about monetary sovereignty. When it comes to understanding the real economic effects of the monetary sovereign’s operations, it really makes no difference whatsoever which picture one employs. The three pictures are all equivalent. If the monetary sovereign is entitled to create or destroy currency units at will, it really doesn’t matter whether we imagine the sovereign as possessing infinitely many units, zero units or some finite number of units of its own choosing. All that matters is what happens to the accounts in the non-governmental sector. The monetary sovereign administers the monetary system of the real economy, and that real economy consists of the sphere of goods and services that are produced and exchanged by the world outside of the government, a world in which the government’s money plays the role of facilitating exchange, accounting for value in a standard unit of measure and making payments. Since those people and entities in the private sector economy are not permitted to create currency units at will, unless such power has been delegated to them by the monetary sovereign, their spending and savings decisions are constrained at any time by the number of units they possess at that time. And the rate at which money is exchanged for goods and services depends ultimately on the amount and distribution of money that exists out in the private sector. What ultimately matters, then, is whether some government operation has the effect of adding monetary points to some private, non-governmental sector scorecard, or deleting monetary points from some private, non-governmental sector scorecard. What happens to the sovereign’s own scorecard is insignificant with regard to the creation and destruction of value in the real economy, that is, with regard to all of the things we really care about.
Going forward, then, it will be good to use neutral terms to describe the effects of the fundamental monetary operations of the monetary sovereign, terms which do not depend on which of the three models we use to conceive of these operations. We will say, then, that taxes “remove” money from the non-governmental sector, and that government spending “inserts” money into the non-governmental sector. The monetary sovereign possesses the power of a government to make these things happen, and the insertion and removal of money from various places in the private sector can have profound effects. But what happens behind the accounting wall separating the monetary sovereign’s scorecard for all of the other scorecards makes no real difference to anybody. Whether one chooses to regard the insertion of money into the economy as a transfer of money – in accordance with either the infinite account model or the quotidian account model – or as the creation of money from nothing – in accordance with the empty account model – really makes no difference to the effects of these operations in the private sector economy.
So far, I have discussed only two main kinds of government monetary operations: taxing and spending. But I have neglected to discuss borrowing, another significant government financial operation. How should we understand the borrowing operations of a monetarily sovereign government?
To answer this question, we should begin by asking what we mean by “borrowing” and “lending”, in the financial senses of those words. What does it mean to say someone has borrowed money from some bank lender? Well it is clear that we don’t mean quite the same thing that we mean when we talk about other non-monetary acts of borrowing and lending in the everyday world. If my neighbor borrows my lawnmower from me, and I lend it to him, I simply hand over my lawnmower to him for some more-or-less agreed amount of time. He uses it for a while, and then gives it back to me. End of story. The value of the lawnmower has probably depreciated just a tiny bit as a result of the use, and my neighbor has derived some value from the lawnmower for which he did not pay me. But if, instead of agreeing to lend him the lawnmower, I am only willing to hand over the lawnmower for some more-or-less agreed payment from my neighbor, we would probably say that my neighbor has then rented my lawnmower from me, not borrowed it. So in essence, my act of lending constitutes a modest neighborly gift on my part. I give the gift and my neighbor receives it. That’s all.
But clearly, that is not at all the way we are using the terms “borrowing” and “lending” when we apply these terms in the usual way to the borrowing and lending of money. As we all know, a bank loan is no gift! In the case of money, we are talking about an exchange or trade. When people borrow money, they acquire some money in exchange for a promise, a promise to pay some other amount of money in the future – almost always a greater amount. The promise then represents a financial asset for the lender, and a financial liability to the borrower: it represents something the lender is slated to gain and the borrower is slated to lose. The financial instrument, the promise, represents a cash flow. From the point of view of the lender, it represents an inflow of monetary payments, generally associated with a fixed payment schedule. From the point of view of the borrower on the other hand, the financial instrument represents an outflow of money on the same more-or-less fixed payment schedule. A bond – such as the bonds sold by businesses and governments – are essentially financial instruments formalizing promises of this kind. In terms of a monetary scorecard, we can think of a financial asset like a bond as something like some marks on the scorecard corresponding to a schedule of pre-determined point increases. The lender’s scorecard contains the bond as well as any previously existing monetary points the lender possessed. As any one of the various times indicated on the schedule transpire, some marks indicating a scheduled payment of currency units at that time are erased, and the appropriate numbers of actual currency units are added to the scorecard. Gradually what begins as a mere schedule of monetary points to be received in the future is transformed into some quantity of actual monetary points.
People can also sell bonds that they have already purchased from some other party. Suppose A has purchased a bond – a schedule of monetary payments – from B. But suppose A no longer wants to wait for the promised money to be credited to her scorecard on schedule, and prefers some money now. Then A might be able to find some third party C who is willing to buy the remaining schedule of payments from A. A receives some money from C – that is, A’s monetary scorecard is credited by some amount and C’s monetary scorecard is debited by some amount. Now B still owes the remaining schedule of monetary points, but B now owes them to C. In accordance with the remaining schedule of payments, C’s scorecard will be marked up with additional monetary points and B’s schedule will be debited by that amount of points concurrently.
So, borrowing and lending money in financial markets does not involve any kind of gift. It is an exchange in which each party gives something up and each party receives something in return. The borrower receives present money and in return gives up money in the future. The lender gives up present money and in return receives money in the future. Generally, people are only willing to make such an exchange if it is mutually beneficial. It is important to keep the mutually beneficial nature of credit relationships in mind. There is an unfortunate tendency in contemporary discourse about credit to regard the lender as a person who has bestowed some favor, gift or act of grace on the borrower. But that is not the case. Rather, two people have made a simple mutually beneficial exchange. One party to the exchange receives from the other some money in the present; the other party to the exchange receives from the other some money in the future.
But let’s return now to the case of a monetary sovereign, and look at these borrowing and lending processes from the perspective of a monetary sovereign’s operations, in line with any one of the three models we described before. Start with borrowing. What are the effects of government borrowing from the non-government sector, at positive interest? Well, first, the private sector lender buys a bond from the monetary sovereign. At the time of the purchase, some monetary points are removed from the lender’s monetary scorecard, and a schedule of pre-determined monetary points is added to that scorecard. Then over time, some of the marks representing pre-scheduled monetary points are removed and the appropriate number of monetary points are added. These operations are likely to be very important to the private sector lender. But remember that from the standpoint of the monetary sovereign it makes no difference what happens to the monetary sovereign’s own scorecard. All that is important is what happens to the private sector scorecard: some money is first subtracted from the scorecard, and then some greater amount of money is added to the scorecard over time. And since that lender is part of the private sector, the government in this case first removes money from the private sector and then inserts money into the private sector over time, on a pre-determined schedule.
Now what if, instead of borrowing from the private sector, the monetary sovereign lends to the private sector? We can understand the effects of this operation by just reversing the time order and direction of the previously described borrowing operation. When the government lends to a private sector entity, some money is first added to that entity’s scorecard, and then some greater amount of money is subtracted from the scorecard over time. The government in this case first inserts money into the private sector and then removes money from the private sector over time, on a pre-determined schedule. But remember again that from the standpoint of the monetary sovereign it makes no difference what happens to the monetary sovereign’s own scorecard. All that is important is what happens to the private sector scorecard: some money is in this case first added to the scorecard, and then some greater amount of money is subtracted from the scorecard over time.
Now consider the monetary effects of several of these monetary operations together: taxing, transfer spending, borrowing and lending. Both money and official promises of money represent assets to the party that hold them. So the effect of these government monetary operations is the swapping around of government-issued financial assets on private sector balance sheets. In each case, the monetary sovereign is mainly adjusting the schedules on which it will insert and remove money from the private sector, and the accounts on which it will make these changes. In some cases it adjusts a schedule of money removals and money insertions forward in time toward the present; in some cases it adjusts a schedule further off in time toward the future. It is likely engaging in a large and complex combination of such adjustment operations at any time. All of these adjustments help regulate the flow of additional money into and out of the private sector.
Think of it this way: The private sector can be imagined as a collection of wells, and each well is outfitted with a collection of nozzles to which one can attach hoses. Each hose either draws water out of a well and into the monetary sovereign’s well, or draws water out of the monetary sovereign’s well and into the private sector well. Some of the hoses carry a steady flow whenever they are hooked up. Other hoses are outfitted with valves that deliver their water flow in bursts, on a set time schedule. The monetary sovereign’s various monetary operations can then be seen to consist in detaching some hoses and attaching others, sometimes swapping out one hose for another.
But just as before, remember that it doesn’t really matter what happens to the monetary sovereign’s own well. This is perhaps easiest to imagine if we think of the monetary sovereign’s well as infinitely deep – as in the infinite account model. Water flows into and out of the monetary sovereign’s well. But these flows make no difference from the standpoint of the monetary sovereign itself, since the sovereign’s well is always infinitely deep and filled with an infinite amount of water. But the flows of water make quite a bit of difference indeed to the owners of the many ordinary wells out in the private sector.
This is Part Two of a six-part series. Part One is here.