Why Banks Must Be Allowed to Create Money

Ann Pettifor has penned an effective rebuttal of the Chicago Plan, which has been taken up in the UK as “Positive Money”. Its advocates call for private banks to have their ability to create money taken from them, and put in the hands of a committee, independent of the state, that would decide on the level of money creation. Banks would be restricted to lending money that they already have on deposit.

Pettifor explains how the enthusiasm for the Chicago Plan rests on a fundamental misunderstanding of the nature of money and confusion about its relationship to credit. While readers may not like the notion that credit, and therefore money creation, is best left in the hands of banks, the problem is much like the one that Churchill articulated about democracy: it looks like the worst possible system until you consider the alternatives.

Pettifor points out that banks’ ability to create money out of thin air dates from 1694 in England. In addition to helping lower the cost of financing wars, an objective was to reduce interest rates to help facilitate commerce and end usury. If you read the works of early economists, one of their favorite topics was the need to end usurious lending, since businesses could not afford to borrow at those rates and survive, and so the money typically went to the most unproductive activities imaginable, namely, financing gambling by aristocrats.

Pettifor also stresses that she is no fan of banks and would support nationalizing them. But she points out that “…nationalising banks is a different proposition from nationalising (and centralising) money creation in the hands of a small ‘independent committee’.”

Here is the core of Pettifor’s article, which I strongly urge you to read in full:

In a recent paper, ‘Money creation in the modern economy’[2] Bank of England staff explained that: ‘[B]anks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits … Commercial banks create money, in the form of bank deposits, by making new loans.’ Because there is widespread confusion about the role of banks in creating money, it did not take long for the Bank of England’s report to ignite debate on the comment pages of the Financial Times. In his regular column, Martin Wolf called for private banks to be stripped of their power to create money….

Indeed, the notion to my mind is preposterous. It is an approach reminiscent of the misguided and failed monetarist policy prescriptions for controlling the money supply in the 1980s. Second, the proposal that only money already saved should be made available for lending assumes that money exists as a consequence of economic activity, and equals savings. But that is to get things the wrong way around. Rather, it is credit that functions as money, and it is credit that creates economic activity and employment. Deposits and/or savings are the consequence of the creation of credit and its role in stimulating investment and employment. Employment, as we all know from our own experience, generates income – wages, salaries, profits and tax revenues. A share of this income can then be set aside as savings. To restrict all economic activity to savings would be to contract economic activity to an ever-diminishing sum of existing savings. Furthermore, the restriction of all lending to existing savings would lead to higher rates of interest, because the level of savings is much lower than the level of potential economic activity and employment. Savers would be in a position to demand a higher return on the loan of their savings. This would return society to the dark ages, when investment and economic activity was subject to the whims of great feudal landowners, putting the financial elite in control of society’s surpluses or ‘savings’….

A return to a system based on existing savings would cause rates to rise, and once again harm both commercial activity and employment. And this is not to mention the role that high rates play in stratifying the imbalance of power between creditors and debtors, and with it poverty and inequality. Society’s long struggle to evolve away from dependence for economic life on the savings of the few (the ‘robber barons’) was precisely the point of the development of a sound monetary system. It called for a financial system that could provide the whole spectrum of society – individuals, farmers, entrepreneurs and the state – with affordable finance for the achievement of personal and public economic and social goals. If directed at productive activity, affordable finance can be used to meet society’s essential needs. In countries without sound monetary systems, there literally is no money. In these countries, only the savings of the fortunate are made available for lending at, invariably, usurious rates of interest. The result is that poverty is deeply entrenched, investment negligible and unemployment high.

Pettifor also stresses (without using this term) that the credit creation process results from demand for loans. We’ve seen in the US and in Japan how banks aren’t lending to small and medium-sized businesses, not due to miserly impulses, but lack of loan demand. Pettifor elaborates:

Without applications for loans, there would be no deposits. In other words, while the banker or bank clerk plays a critical risk assessment role in the ‘creation of money out of thin air’, and while the state plays an equally critical role in transforming that private loan into public fiat money, it is the myriad numbers of Britain’s borrowers who are the real spur for the creation of money. When entrepreneurs and other borrowers apply for loans, they help create money (deposits) ‘out of thin air’. If entrepreneurs and other borrowers do not apply for loans (because interest rates are too high, terms too tough, confidence low or business slack) the money supply shrinks, as now, and deflation may ensue. If the demand for and supply of loans exceeds the economy’s real potential then the money supply expands and inflation (of assets as well as wages and prices) is an inevitable consequence. In a well-managed monetary system, private bankers should be regulated by the central bank to ensure that applications for loans are carefully assessed as both affordable and repayable, and that loans are aimed at facilitating transactions between economic actors engaged in productive, income-generating activity. Lending or borrowing for gambling and speculation would be restrained or even prohibited. Speculation, after all, does not increase an economy’s productive capacity, but speculative fevers increase both the risk that borrowers will not make the capital gains needed to repay debts and wider systemic risk.

Readers may argue that there are no good regulators to be found these days. So pray tell why should we believe that we’ll be able to create what Lambert calls a “magic board,” a new body of wise men to whom we can safely entrust the power to create money? In a system with widespread corruption, a power node like that is an invitation to abuse. And that’s before you consider the much bigger issue that Pettifor raises, that relying on savings as the source for lending will inevitably send the economy down the path of greatly higher interest rates, more unemployment, and even greater inequality.

While banks have gotten such a bad name that it’s understandable that many want to reduce their role, the Chicago Plan would only give more power to the wealthy at the expense of ordinary citizens. Lending per se isn’t the problem, it’s letting banks not suffer the consequences of their recklessness and not being willing to restructure bad debts that should be the focus of reform efforts.

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184 comments

  1. skippy

    Yves you bloody edgy hot thing, lassie, in more ways than one imo…. yes… its all about behavioral modification e.g. to which ends do we [humanity] modify our selves as a society… in order to advance it… for the betterment of all… with out blowing up the planet or our species. All in the full acknowledgement of our past [increasing granularity on that topic].

    If people could only understand it was and has not been a matter of institutional failure, but, of ideological origins i.e. some compounds can both save life and take it, its just a matter of diagnosis and dosages to remedy the illness, balance matters[!!!].

    skippy… rolling back ignorance has to be the most laborious task our species has toiled upon….

    1. Moneta

      It’s hard to be enlightened when you are stuck on a treadmill. Even the Dalai Lama depends on the ignorant for his food. I fact, throughout history most of the enlightened ‘sages’ depended on the toil of slaves.

    2. ewmayer

      How about simply restoring – and actually enforcing – sane leverage limits and capitalization rules? How novel that would be!

      The Fed could also do something useful for once, on the “lending standards” front, the role they utterly ignored during the blowing of the last housing bubble.

      I know, I know, “It’s hard to get someone to understand something when his job depends on not understanding it.” [Approximation of the original quote, which I believe is due to Upton Sinclair].

      For the Fed the quote would read, “It’s hard to get a FedHead to not blow bubbles when he believes his job is the blowing of bubbles”. (In the vain hope that ‘the next one will surely stick’.

      1. Ben Johannson

        This man or woman deserves the most magic-est cookie in the whole world for making far too much sense.

  2. Jose

    What if “committees with the ability to create money” were to be made fully accountable to the electorate instead of “independent”, as currently proposed by the likes of “Positive Money” and Martin Wolf?

    This obsession with “independence” seems misplaced in regimes that define themselves as “democracies”.

    Today we have a situation in which deposit-creating commercial banks are unaccountable private bodies – and reserve-creating Central Banks are unaccountable public bodies.

    Transferring those powers to another unaccountable committee that would replace those institutions in the ability to create “money” doesn’t seem much of an improvement. And since this system has never been tested in real life we could be in for a nasty surprise. A bit like what happened with that recent technocratic experiment drawn up by “brilliant” eggheads – the euro.

    1. Yves Smith Post author

      Huh? Look at how elections work in the US. Even before Citizens United, the US has had an election system where election outcomes are determined by well-funded interest groups, mainly business. Tom Ferguson has done meticulous work on electoral spending and can show that back to the 1980s with detailed data sets, and archival work shows this pattern goes back for decades before that. The idea that you can have “accountability to the electorate” is a fantasy. If we had that, we’d have effective regulators too.

      Moreover, the issue with independence is a second-order problem. The first order problem is that restricting lending to savings assures that the rentiers will make even more since interests rates will be at usury levels. That means more unemployment and more inequality. Tougher oversight and making lenders bear the consequences of bad lending decisions is a much better check on the tendency of banks to get run off the cliff together (at best) and engage in predatory lending (at worst). The solution posed by the Chicago Plan is a poisoned chalice.

      1. Jose

        the issue with independence is a second order problem

        In the eurozone it´s certainly a first order problem. The manager of the whole system is a totally unaccountable body (the ECB) whose powers may only be changed by a revision of the Treaties, a quite unrealistic if not impossible scenario.

        Also, dismissing “independence from the public” as “secondary” is tantamount to a dismissal of democracy. Yes, elections may have been captured by plutocratic interests, especially in the U.S., but the fact that the Fed is accountable to Congress and that its chairperson may be submitted to harsh questioning there is certainly preferable to the autocratic powers bestowed on the central bank of the eurozone.

        And it´s also incorrect to associate high interest rates with inequality and low interest rates with economic prosperity. For instance, Brazil has made important steps towards reducing inequality under a high interest rate regime – and low yields in Europe and the U.S. have done great damage to the financial position of middle class retirees.

        1. Yves Smith Post author

          Brazil has a high underlying inflation rate, so real interest rates are comparatively low. And the issue in the US is not low interest rates per se but a DECLINE in yields from what they had anticipated when they invested. The Fed acknowledges that this is supposed to be a temporary measure but they look to have painted themselves in a corner.

          1. Jose

            Brazil has real interest rates of 4.5% – overnight. And one can buy riskless government bonds with real yields close to 6%.

            Also, the decline in yields was not the problem in the U.S. or Europe. This favored investors, including middle class pensioners who benefitted from the rise in the market value of their previous investments. The problem is the persistence of zero yields – this will pose a long term problem for savers, including millions of retirees.

      2. Moneta

        The thing is that easy money and lenders bearing consequences are contradicotry.

        I look at our economy and think that half of it should not exist; that we are producing the wrong goods and services to support healthy social ties and lifestyle.

        However, throughout my entire life my ideas have always been shot down. Most people like the world as it is for the top 10%… if only they were in that group.

        So who is going to decide what is good and sustainable or not? IMO, the printing machine fails for the masses when we can’t agree on what gets financed and what does not.

        1. EoinW

          Sodom and Gomorah before the fire and brimstone fell? I wonder how good they all thought their society was right up to the end.

      3. diptherio

        The problem that I see that is unaddressed by Pettifor is that allowing private banks to create money through their loans means that it is private bankers who are deciding how our social resources should be invested. Why should we allow that, or expect that they will make investment decisions that benefit society-at-large as opposed to, say, their own personal financial interests?

        The problem with allowing private banks this kind of control over the money supply and its deployment, is that bankers, even in the best case scenario, are handing out loans on the basis of repayment probability, not what society actually needs.

        Private banks should be nationalized and all bank employees made into public employees with standard wage and benefit packages. Loan funds should be handed out on the basis of many factors (social desirability, environmental sustainability, etc.), not just ability to repay. One can imagine that citizens might come up with a list of things that they want funded in their community. The (public) bankers job, at that point, would be to determine which loan seekers have the best odds of fulfilling the public purpose and repaying their loan (this is somewhat akin to public budgeting proceedures).

        One of the major contradictions in our society is that we allow private individuals (bankers and loan officers) to make decisions about the deployment of public resources (new currency issue) while having no accountability to the public for those decisions. Hence, our private bankers can create new US currency to loan to a foreign company whose goal is to undercut US manufacturers (for instance) and there is nothing we can do about it, as a society.

        How is new currency created and deployed and who gets to decide how that happens (and what are their incentives)? These questions have gone unexamined for far too long–it’s good that they are finally seeing the light of day and getting a little public debate.

        1. skippy

          Because of balance Dip ergo humans are largely stoopid i.e consumers are not very good voters… or masters of destiny… whomever made that template?

        2. Moneta

          People want what the rich have. Since the bankers are currently the rich, their lifestyle is what the general population aspires to… take it all away from the bankers and the general population will be lost.

            1. Moneta

              A lot of people in the middle class will say that their lives today are better than those of kings a couple of hundred years ago. They’ll look at how the rich live today and unconsciously think that, over time, technology will give them the life the rich currently enjoy.

              Maybe not all but a significant percentage wants the life of the rich and famous. A group large enough to ruin the party for those who don’t.

              1. jrs

                Pretty much the ONLY thing I really want that the rich have is leisure time. If technology was capable of producing that regardless of social structure we should have passed that threshold quite awhile ago.

              2. LifelongLib

                It’s true in some ways. Two hundred years ago, kings died of causes that you or I (sadly not everyone) could handle with a trip to the clinic. Of course they also enjoyed a degree of education and personal freedom that you and I can only dream of. I’d still rather be alive now than then.

        3. Joe Firestone (LetsGetitDone)

          I agree with some of this comment, but will also point out that it doesn’t contradict the post’s central point, which is that the primary issue isn’t private vs. public, but rather whether the creation of money should be a decentralized, localized process or a centralized high-level committee driven process. I think, generally speaking, it is better to have a decentralized process driven by loan demand from businesses and consumers, and that Yves and Ann Pettifor are right that we need money creation by the banks.

          That said, I prefer public banks staffed by civil servants to private ones staffed by business people motivated primarily by economic gain. I also prefer banks with very narrow economic functions excluding speculative investments and creative financing, for the purpose of minimizing systemic risk. I also think that this point, while a very useful and cautionary one, is overdrawn:

          . . . allowing private banks to create money through their loans means that it is private bankers who are deciding how our social resources should be invested. Why should we allow that, or expect that they will make investment decisions that benefit society-at-large as opposed to, say, their own personal financial interests?

          The problem with allowing private banks this kind of control over the money supply and its deployment, is that bankers, even in the best case scenario, are handing out loans on the basis of repayment probability, not what society actually needs.

          I think this because, first, I think the comment above ignores the possibility of Treasury money creation through fiscal policy and deficit spending. This goes on primarily today through creation of securities as net financial assets created by deficit spending. Eventually however, when securities holdings become extensive enough to disturb the Fed’s interest rate targets, then the Fed exchanges reserves for securities in open market operations increasing the money supply. Also, if the Treasury ever decides, in the future, to use its full coin seigniorage authority to deficit spend then that too would directly increase the money supply in the private sector without mediation of private bank loans.

          And, second, if we narrow banking functions appropriately, regulate them strictly relative to speculation, provide appropriate performance criteria for loan officers, and charter some banks specifically for the purpose of meeting community development, environmental sustainability, renewable energy, and other key public purposes, then it need not be the case that loans would be made solely on the basis of repayment probability. We could also reinforce the primacy of public purpose, even in loans made by private banks, by requiring hiring of loan officers with backgrounds in the social need areas we want to emphasize in addition to having basic finance backgrounds. Indeed, even making the financial aspects of banking dull again can reinforce the tendency to try to fund projects reflecting social needs since these types of loan applications will often be a lot more interesting to process and fund than conventional business projects for the loan officers involved.

          Finally, this question:

          Why should we allow that, or expect that they will make investment decisions that benefit society-at-large as opposed to, say, their own personal financial interests?

          is partly answered just above, but also answered by a political consideration, namely that nationalizing all the banks may be a bridge too far politically, while reforms nationalizing and breaking up the biggest banks, establishing some public banks, and establishing banks specializing in loans for fulfilling social and urgent policy needs, may be easier to pass, and nearly as effective as total bank nationalization would be. Remember, that the biggest issue is centralization vs. decentralization of money creation, and not public vs. private.

        4. susan the other

          Diptherio, I do think you have just summarized Ann Pettifor’s position. I’ve followed her on NC and a few other places and she says what you just said. She thinks there is no reason for the cost of money, interest rates, to be much above zirp since money is created by the financial system itself. Allowing banksters to get high interest rates for the money they pull out of a hat is like allowing gold miners to decorate tungsten bars with gold leaf. The creation of money should be controlled. But money should be cheap. Maybe a committee for the proper creation of money is scary since we know how corrupt everything is, but the committee itself would have to follow legislated rules. aka laws. I’ve always liked her every word. I sometimes wonder if our problem lies in the oil and water conflict. That Debt is Water and Profit is Oil and they just don’t mix. So when they eventually clog each other up it’s a big plumbing problem if we cannot produce enough growth – which we cannot today because we will devastate the environment, etc. I’m beginning to wonder if we can have one or the other for an economic system, but not both.

      4. Ralph Musgrave

        Yves, you say, “The first order problem is that restricting lending to savings assures that the rentiers will make even more since interests rates will be at usury levels.” Really? So how do you explain the fact that in the middle of the recent crises, the private banking system in the UK was giving us no or very little increase in the money supply, i.e. new loans effectively came from old loans being repaid, yet interest rates were at record lows? (And that’s normal BTW: that is, private banks (assisted by their customers) tend to suddenly expand the money supply in boom and then contract it, or leave it stable in a bust.)

        Moreover, full reserve banking does not forbid any net increase in lending. What happens is that if the economy needs stimulus, more central bank money is created and spent into the economy (exactly what most MMTers advocate, by the way). As to how the private sector USES that new money, that’s left entirely to market forces. If private sector entities want to use the new money to expand loans, then OK. Or if the private sector chooses to use the money to expand primarily non-lending based forms of economic activity, then OK.

        And finally, the above “create and spend new money” policy is exactly what we’ve experienced recently in that fiscal stimulus followed by QE equals the latter “create and spend” policy. Far as I know, the sky has not fallen in as a result.

        1. Wat Tyler

          Very good !
          Creating new money by loaning it into existence with interest obligations is a scam.
          Jim

        2. Yves Smith Post author

          Huh? What does the recent crisis have to do with “restricting lending to savings”? We aren’t under that regime. Your example is irrelevant.

        3. Fiver

          “Far as I know, the sky has not fallen in as a result.”

          Actually, its fallen on a great number of people around the world due to major strains on weaker economies which are far more vulnerable to the policy on-off effects of volatile hot money flows. Each large round of QE has been a factor in toppled regimes, further weakening of numerous weak economies, furthering instability and so on. In addition, it has forced major trading nations also to serially devalue in what is, effectively, as well as descriptively, a race to the bottom for the great majority of employees everywhere – in developed countries entirely captured by domestic and global capital where existing rights and obligations are under constant attack, and in ‘developing’ countries with feeble to non-existent labour, environmental, legal, political and other rights or protections.

          From my perch I see a sky pocked with holes and not much in the way of holder-uppers on the drawing board.

      5. Grumby

        “The solution posed by the Chicago Plan is a poisoned chalice.” Yves, the vessel with the pestle has the potion that is poisoned. Where is Danny Kaye/Sylvia Fine when we most need them?

      6. Carla

        Ann Pettifor: “In a well-managed monetary system, private bankers should be regulated by the central bank to ensure that applications for loans are carefully assessed as both affordable and repayable, and that loans are aimed at facilitating transactions between economic actors engaged in productive, income-generating activity. Lending or borrowing for gambling and speculation would be restrained or even prohibited.”

        If the monetary system and banking had worked this way, I doubt Naked Capitalism would exist. We would all be the poorer for not having the benefit of Yves’ insights and the collective wisdom of the commenteriat here, but some of us would still have jobs, homes, pensions, savings, and investments that have been lost.

        My understanding, and please correct me if I’m wrong, is that the debt-based money system has led to frequent booms, busts, speculative bubbles and crashes since its inception. Furthermore, it seems to me to be based firmly on the growth imperative, which as many here seem to agree, has no realistic future on this planet. Again, please set me straight if I am mistaken.

  3. Bobbo

    “This would return society to the dark ages, when investment and economic activity was subject to the whims of great feudal landowners, putting the financial elite in control of society’s surpluses or ‘savings’”

    Cmon, you’re kidding me, aren’t you? Haven’t the financial elite always been in control of society’s surpluses or savings, even (and especially?) in modern times? Can anyone really make an argument with a straight face that our modern monetary system is more democratic and more equitable than during those fearsome and mythical “dark” ages? As we have moved towards easy money the wealth gap has grown, not narrowed. The only reason things are better for the serfs is because of cheap oil, not modern money. The modern monetary system is so opaque and counter-intuitive that even intelligent and educated people are shocked when they finally grasp how modern money creation works. How can that be a good thing if you are a champion of democracy and equality? 99% of the people will never grasp it no matter how many times you explain it.

    “Great feudal landowners” of old have simply been replaced with the modern equivalent: debt servitude to those money-creating creditors. And we have lost something along the way: It has become impossible for the average person to be a saver and to save for retirement. The average person now MUST be an investor, swimming in a sea of overvalued assets, chasing yield that does not compensate for the risks. These days nobody in the middle class can ever retire because they have no assurance what they future expenses will be or whether the whole system will collapse.

        1. skippy

          Conditioning is something you should look into beardo…. if one observes a ballistic weapon without knowlage of its potential… its a curiosity.

          Now if you constantly reinforce that its death incarnate via endless fear campaigning from birth… wellie… now you have an inanimate object that has an agency of its own…. seemingly.

          The gun kills via the mental precept used to condition the uniformed mind… eh.

          skippy… I thought bye now you would be living large in one of your utopias, ME, Somalia, or Zimbabwe, times a wasting….

    1. lolcar

      People don’t fail to grasp the modern monetary system because it’s so complicated and opaque. They fail to grasp it because they are repeatedly told simplistic fairytales by competing propagandists. It’s the rare person who doesn’t have to be dragged kicked and streaming to a new understanding when told something that conflicts with everything they thought they knew, even if what they thought they knew was only passively absorbed listening to media talking heads bloviating about the economy.

      1. LifelongLib

        You mean, like how a government that controls its own currency can create any amount of it at any time, so no such government can plead “lack of money” as a reason things aren’t getting done if the economy is capable of doing them? That’s a widespread “failure to grasp”.

    2. EoinW

      It shall be interesting to see what happens next. In medieval Europe citizens could be forgiven for being serfs and peasants because that was all they had ever known. There wasn’t yet an Information Age to inform nor an Enlightenment to embrace. Today one would think modern man is more educated and not willing to accept being at the bottom of a neo-feudal society. Yet, as correctly pointed out, fairy tales seem to be effective. Thus we’ll soon be put to the test and find out if the 21st century citizen is any smarter than his Dark Age forerunner.

    3. Moneta

      It used to be that when you grew old, you passed the torch to your children. They got to sit in at the head of the table and they supported you in your old age. Now, our society is upside down. The older generation clings to its wealth for dear life as their kids become basement dwellers.

      If you think in terms of family unit, you don’t need millions to retire. You need a fortune when your modus operandi is based on individualism.

      1. jrs

        If you don’t have kids: STARVE! You deserve it for not breeding. Couln’t you have plopped out some kids? Oh you don’t think you’d be a good parent? Noone cares, just breed. NOW DIE OLD CHILDLESS PERSON. On the ice flow … (opps forgot about climate change)

        1. Moneta

          I would house a childless aunt if she’s a good person.

          Like I said, too many ore stuck on individualism.

        2. Carla

          Segment on NPR tonight about aging in Japan, where some folks say they will commit suicide when they become elderly rather than depend upon someone else to take care of them. (This resonates with me, BTW.) Apparently there’s an ancient tradition there of taking grandma up on a mountain and abandoning her there to die.

    4. MyLessThanPrimeBeef

      It doesn’t have to be that way (usurious lending) if we have money creation via the people spending it into existence (which was not talked about in the 17th Century, perhaps, but this is the 21st century).

      1. LifelongLib

        I’m not clear on how the people (as opposed to a sovereign currency issuer) can spend money into existence. How would you differentiate legitimate from illegitimate money creation? Spending into existence legally from counterfeiting?

  4. charles 2

    With all due respect Yves, have you read the contributions from your MMters friends before posting them ? I say this because they provide a very effective rebuttal of Mrs Pettifor’s argument. There is no need for a “magic board”. The democratic body with the power of the purse (in the US, the Congress) fulfils this function by legislating the respective levels of expenses, taxes and bond issuance. In a Chicago system money creation = expenses minus taxes minus bond borrowing (assuming the Fed doesn’t do QE, in which case the formula becomes expenses minus taxes minus bond borrowing plus bond purchase by the Fed).
    Comparing the present situation where the Public expenses amount between 25% and 50% of GDP in modern countries to the Dark Ages where the sovereign was just a marginal spender is just irrelevant. The Sovereign, through his mere spending mass, is able to generate enough money so that viable economic ventures (including the ones that are initiated by the sovereign, such as public infrastructure) are financed by EQUITY instead of DEBT, which effectively solves the problem of restructuring if the projects happen to be stupid : for private investment, the equity denominated in that money is just written off, for public investment, money is actually what functions as equity in the public balance sheet and the “write-off” simply occurs through the inflation rate at some point (which can take a long time to materialise)
    Indeed the problem of MMT is not that it cannot generate enough money for equity financing of viable economic projects, but that it actually generate more than is actually needed for that purpose and therefore leads to misallocation of real resources.

    1. skippy

      Its not about the object [commodity] its about its purpose [ideological bias] and whomever purpose that condition serves.

      skippu… how do you commodify a whim [desired out come]? Its a social political observation from antiquity for gawd sake and not a mangling of dubious metrics.

    2. Benedict@Large

      MMT does what? MMT doesn’t DO anything. MMT doesn’t not do anything. MMT is an operational description of how money is created and destroyed. Your suggestion that MMT does or doesn’t do something only shows that you don’t know what you are talking about.

      1. MyLessThanPrimeBeef

        How does the description (of money, specifically the Dollar) from Wiki on the term Petrodollar compare with MMT’s:

        In the existing system all transactions actually be settled in U.S. dollars creating a world-wide demand for dollars. The petrodollar system also meant that the U.S., the largest consumer of oil in the world, gained the power to buy oil with a currency it can print at will.[citation needed]

        No citation to this assertion, thus it is indicated ‘citation needed.’ Nevertheless, it makes sense to me.
        The Dollar is backed by Black Gold.

        It doesn’t exactly use MMT terminology that taxation gives value to money, but it says the Petrodollar agreement creates a worldwide ‘demand’ for dollars. If you believe demand leads to value, then you may say it is that Petrodollar agreement that gives value to the dollar…because, again from the Wiki entry:

        In 1971 Richard Nixon was forced to close the gold window taking the U.S. off the gold standard and setting into motion a massive devaluation of the U.S. dollar. In an effort to prop up the value of the dollar Nixon negotiated a deal with Saudi Arabia that in exchange for arms and protection they would denominate all future oil sales in U.S. dollars.

        That is, before the agreement (or the deal), we were looking at a ‘massive devaluation.’ With that agreement, ‘value’ returned (that is to say, devaluation no more).

    3. Yves Smith Post author

      Wow, you could not be more off base. I pinged MMT people before I ran this post to ask them to help out in comments because I anticipated an uninformed backlash. They had all read the Pettifor piece already and were delighted to help.

    4. Joe Firestone (LetsGetitDone)

      There is no need for a “magic board”. The democratic body with the power of the purse (in the US, the Congress) fulfils this function by legislating the respective levels of expenses, taxes and bond issuance. . . .

      But the fact is that Martin Wolf’s proposal is for 100% reserve banking along with a “magic board” to determine the supply of money. So, Ann is addressing the proposal in question, while you are criticizing her view based on your own interpretation of what the Chicago school entails . . . .

      Also, what is “this function”? If it is the supply of credit needed by the private sector, then 100% reserve banking won’t supply the needed credit, but will be deflationary. As Bill Mitchell says in stating the MMT position on this:

      Note that the current practice is that loans create deposits. Clearly, under a 100-percent reserve system, all credit granting institutions would have to acquire the funds in advance of their lending.

      There would be the equivalent of a gold standard imposed on private banking which could invoke harsh deflationary forces. Further, the 100-percent reserve banking system does not eliminate credit risk so that crises could still occur if there were significant defaults under the “fixed-term” variation.

  5. Francesco

    The debate about what is money is getting more and more worthless by the day. It seems to me that is all about WHO has the control to create money. The real debate should be about capital but capital is not money. Capital is basic natural resources to transform and all what the ancient greeks called téchne. The natural resources pool is shrinking fast and we’re not investing in téchne, on the contrary we’re cutting investments on the main pillar, education, all over in the western world. Spending tonns of words about credit money will not change this a single iota.

    1. lolcar

      The credit money system is the primary determinant of who gets access to resources in the modern world. As such spending tons of words on it is vital. Particularly since as a means of control it is so much more veiled and hands-off than straight force.

      1. Francesco

        You’re living in fantasy land. The primary determinant of who gets access to energy resources are nuclear weapons, stealth bombers and the will to use them, even against your former allies interests. Come on boy wake up, finance is just a tool, powerless without weapons and bombers, and power is what really matters !

  6. John Merryman

    If we began to understand that money functions as a contract, rather than a commodity, then the notion of ‘creating’ money would be much more logical. It is a promise of a relative value, not the actual value, which could be determined by any number of issues.

    1. Ben Johannson

      I think that’s broadly correct. Money, and by extension credit, is not a discrete “thing” or commodity. It’s a social dynamic consisting of relationships that intermediates the many transactions we conduct with each other and settles our social obligations to each other. It’s from those relationships (including our relationship with the IRS) that credit gains its value.

      There’s a growing line of thought that seems to view credit as a form of black magic used by banks to curse the tribe, that debt is an evil which must be disposed of and that accomplishing this goal will destroy the Bad People tormenting us. But this is a delusion. Because credit and debt are social relationships in which you owe me and I owe you, societies cannot exist without them. Positive Money-ists object to social arrangements which have been in existence for at least six thousand years and characterize every culture of which we are aware. Certainly they argue that it is only the modern “usurious” aspect they wish to eradicate, but their plan is incoherent: the call to dispense with the current monetary system to eliminate its abuse implicitly acknowledges the problem lay not with the institution but with those we have allowed to abuse it by creating debt without constraint. The fault for our current state does not lay in our stars but in ourselves.

      Furthermore we have vast historical evidence that fixed-rate banking (which is effectively what they wish to implement) is more prone to misuse and instability. Prior to the current Federal Reserve system financial panics happened roughly every four to six years, in a system where loans = savings as called for by Irving and as called for by the Chicago Plan. Economic contractions in the range of twenty-five to thirty percent happened roughly every fifteen years. There has been no effective response to this point, no document or revelation which lays out for us the superiority of 19th Century banking, only a curiously myopic faith that it must in some way “be better”.

      Frankly I find it rather childish, this call for some way of life which requires no oversight, no effort to protect and no informed decision-making on behalf of citizens. And that’s all the Chicago Plan is, the creation of a mystical council of enlightened elders who will absolve us from the eternal penance of paying attention to what is going on, allowing us to live our lives in blissful ignorance while those above decide what is best for us while control of interest rates is turned over to the financial markets which have worked so very well in the public interest over the last two decades. I promise that you have not seen a capitalist system in the truest sense of the term until you make firms and households dependent upon the savings of them what got it. The capitalist class won’t have to bother with lobbyists any more, they can simply withhold their savings from society and blackmail an entire nation.

      Under those conditions, who do you think will do the choosing of our monetary committee?

      1. Ralph Musgrave

        It’s not just Pos Money that objects to the existing banking system. Mervyn King, recently retired governor of the Bank of England said, “Of all the many ways of organising banking, the worst is the one we have today.” (Not of course that that proves PM is right.)

        Re your 3rd paragraph, you seem to be saying that “Prior to the current Federal Reserve system” there was a system where “loans = savings”. Actually, prior to the Fed, the private banking system was free to increase the total money supply, just as now: i.e. it could lend without there being any “money in the kitty”. In that sense, loans did not equals savings all the time. Indeed, that system increased the supply in booms and cut the supply in slumps: exactly what we don’t need. I.e. the private banking system tends to exacerbate booms and slumps.

        As for your claim that the “Chicago Plan involves . . . . no informed decision-making on behalf of citizens.”, I assume you mean “by citizens”. If so, that is not true: that is “citizens” would deposit money, and borrow very much as they do now.

        However, if you’re really referring to “decision-making on behalf of citizens”, then one form that would take under Pos Money’s system would be a committee deciding on stimulus. Now that’s virtually the same as EXISTING central bank committees which decide on stimulus (i.e. interest rate adjustments, QE, etc).

        1. John Merryman

          One way is simply having government spend it into existence, but this essentially give politicians the power to create money out of thin air, so there would have to be a fairly sturdy mechanism. When the basis of the currency is government debt, there is an inherent bias
          toward creating a lot of public debt. The current system is effectively designed to do so.
          Budgeting is to list priorities and spend according to ability. Instead the legislative
          leadership bundles up these enormous bills, then adds whatever necessary to collect
          enough votes. Which the president can only pass or veto in whole. The result naturally
          leads to overspending. If the government actually wanted to budget, these bills could be
          broken into all their various items and have every legislator assign a percentage value
          to each one. Then reassemble them in order of preference and have the president draw
          the line at what is to be funded. As Truman might have put it, “The Buck Stops Here.”
          This would create a system of actual budgeting, as well as distributing more power over
          the entire legislature, rather than having most of it accumulate at the top. The
          percentage voting would also allow legislators to tune their responses to various
          constituencies and other pressures, better than does a simple yes/no system.
          This would result in far less national money going to local projects, but if there was a
          public community banking system, which funneled its profits back into public projects
          within its own community, rather than having it siphoned off by big banks, to be lent
          back to the various governments, it would be result in a more stable and sustainable
          civic foundation. These local banks would then pool resources for larger, regional projects, in a bottom up system.

          1. F. Beard

            One way is simply having government spend it into existence, but this essentially give politicians the power to create money out of thin air, so there would have to be a fairly sturdy mechanism. John Merryman

            The ethical solution is for money created by government (fiat) to be legal tender for government debts only and to allow genuine private currencies to compete with fiat for the payment of private debts only.

            It all goes back to ethics: Government is force and the private sector is or should be voluntary cooperation only. Therefor a single money supply is not sufficient for both sectors (cf. Matthew 22:16-22).

            1. John Merryman

              FB,
              “The ethical solution is for money created by government (fiat) to be legal tender for government debts only and to allow genuine private currencies to compete with fiat for the payment of private debts only.”
              Very true. This also goes back to understanding it as a contract, rather than a commodity. We could devise any number of methods of reciprocity, if we appreciate them as such. Rather than treating it as a commodity to be collected, which necessarily emphasizes those currencies with the strongest enforcement powers, over those based on faith in the counterparty. Families, communities, churches, stores, etc could all form various sorts of credit unions.

              1. F. Beard

                Families, communities, churches, stores, etc could all form various sorts of credit unions. John Merryman

                Or common stock companies with the common stock accepted back by the company for the goods and services (but not the assets*) of the company.

                *Since the purpose of a common stock company is to consolidate, not dissipate, capital for economies of scale.

                1. John Merryman

                  The possibilities are endless, when the purpose is to create real value and not just the illusion of wealth.

          2. MyLessThanPrimeBeef

            Another way is for the people, instead of the government, to spend it into existence.

            1. Lil'D

              You can! You are freely able to buy any goods or services with your IOU, as long as your counterparty will take it. It becomes a negotiable instrument, spending “just like cash”.

        2. MyLessThanPrimeBeef

          Actually, prior to the Fed, the private banking system was free to increase the total money supply, just as now: i.e. it could lend without there being any “money in the kitty…

          When there was a bank run, could the banks have lend to themselves to come up with the money?

          Jimmie Stewart to banker: I want my $50 in my account.

          Banker: Let me lend you $50 instead, and I will throw in a toaster. Now, you have $100 in your account.

          Jimmie: You have no money. I don’t trust you. Give me my $50.

          Banker: Remember that $200 loan you asked for last month. We will do it now.

          Jimme: You have no money.

          Banker: How can I possible lend you money if I don’t have any money.

          Jimmie: Well, I was told you could just create money. That’d be how you would do it.

          Banker: That’s right. So, how can I ever run out of money? Go home and relax. And spread the ‘education.’

        3. Yves Smith Post author

          Did you not read the post? It CLEARLY states that this is the system that was in effect in the UK since 1694. I make no reference to the Fed nor did I insinuate any.

          In the US, the first central bank was modeled on the Bank of England, the Bank of the United States, chartered in 1791. Its charter was not renewed in 1816. A new Bank of the United States replaced it. Its charter was allowed to lapse in 1836. By all accounts, they had done a good job as central banks, but the specter of its being controlled by wealthy individuals, including foreigners, was seen as incompatible with democratic principles. From 1836 until the creation of the Fed, the US Treasury served as the central bank.

        4. Joe Firestone (LetsGetitDone)

          Ralph, is that really a defense of positive money? Please, don’t make me laugh. The idea that stimulus would be in the hands of an unaccountable committee, is not something I or other MMT writers favor. We want stimulus to be in the hands of democratically accountable political actors.

          1. JuneTown

            Ralph’s use of the term ‘stimulus’ to state what the Monetary Authority would be determining was ill-advised, as the only thing they would be determining would be the amount of money needed in circulation to achieve GDP-potential.
            GDP-potential is the maximum level that the economy can achieve given its economic parameters, esp. including labor, resources and the state of production.
            Sorry, but it’s amazing that y’all claim a progressive mantle, while complaining ad-nauseum of the travesty of the modern day bankers in the system, and then defend, totally unnecessarily, the private banking and money-creation system.
            It’s as if regulation does not lead to deregulation, or stability to instability.

            1. Ralph Musgrave

              “the only thing they would be determining would be the amount of money needed in circulation to achieve GDP-potential.” Bingo! Quite right! You’ve got it. I.e. the committee determines the amount of stimulus needed to “achieve GDP-potential”.

              Couldn’t have put it better myself.

            2. Joe Firestone (LetsGetitDone)

              I’m not defending the private banking system, only the idea that a decentralized system of banks ought to be able to create money. My own preference is that all of these banks be owned by Governments, and staffed by Civil Servants. I see no reason why private companies ought to profit from performing a public function enabled by delegation to the Federal Reserve of Congress’s power to create fiat money.

              1. F. Beard

                My own preference is that all of these banks be owned by Governments, and staffed by Civil Servants. Joe

                And what shall be the basis of qualifying for a loan? So-called creditworthiness? Who is worthy of their neighbor’s and especially the poor’s legally stolen purchasing power?

          2. Ralph Musgrave

            “Democratically accountable political actors”? That’s the bunch of economic illiterates who are more interested in squabbling with each other than doing anything about recessions (as pointed out by Robert Gates, former US defence secretary).

            Moreover, the “unaccountable committee” that would exist under full reserve and decided on stimulus would come to almost exactly the same thing as those dreadful “unaccountable committees” in central banks who CURRENTLY decide on stimulus (e.g. the Bank of England’s Monetary Policy Committee). Plus they’d be appointed in the same way. I didn’t know that every other MMTer objected to the latter sort of committee. That really is news to me.

      2. John Merryman

        The problem with the system as it is now, is that we have come to view money as a commodity in itself, essentially another form of widget, which we can ‘manufacture,’ if we ignore the viability of the other side of the contract. So now capitalism has gradually evolved from a system to make economic exchange more efficient, to the production of capital as an end in itself. The result now is massive amounts of debt, public and private, as the other side of the ledger to this ‘wealth.’ So if we start to understand it is not some ‘magical’ form of value, but a bookkeeping entry, then more attention will be paid to those debts being relatively viable and less emotional attraction toward acquiring them and selling one’s soul, community and environmental resources in order to do so. Then the community, the environment and one’s peace of mind become stores of value in and of themselves. Then such needs as elder and child care, primary education, local public works, etc, become much more community transactions and not requiring some global currency in order to function. Leaving both those international banks and national governments out of the transaction.
        As it is, with the basis of the money as public debt and the assets largely pooling in the private sector, the only way to keep it circulating , is for the public to keep borrowing it back and building up ever more unsustainable debt.

  7. Ben Johannson

    Typically, advocates of the Chicago Plan have not read it. They hear some confused comment about “debt-free money” and like dogs in Pavlov’s kennel they bark on queue. In fact I’ll go further: the Chicago Plan/Positive Money is for people who don’t want to make an effort toward understanding how things work.

    1. Ralph Musgrave

      Typically, opponents of the Chicago Plan have not read it. They hear some confused comment about “debt-free money” and like dogs in Pavlov’s kennel they bark on queue. In fact I’ll go further: opponents of the Chicago Plan/Positive Money is for people who don’t want to make an effort toward understanding how things work.

      See: I can do silly comments too. However you do have the beginnings of a valid point: your point about “debt free” money. What’s referred to there is normally called “base money” or “high powered money”, or “central bank created” money and that money is in a sense debt free. However, it is naïve to think that if “debt encumbered money” (i.e. commercial bank created money) were banned that there’d be a HUGE REDUCTION in debts. As Ann Pettifor said, there’d be a FINITE reduction in debts / loans, but my guess is it wouldn’t be a huge reduction.

        1. JuneTown

          The IMF’s research paper that revisited the Chicago Plan is certainly evidence in print deserving criticism if you care to address this
          https://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf

          but this work merely confirmed (using standard IMF DSGE modeling ENHANCED by the IMF authors to include banks, money and debt)
          the work of Dr. Kaoru Yamaguchi which modeled his construct of a public money administration,
          http://monetary.org/wp-content/uploads/2011/11/DesignOpenMacro.pdf

          Dr. Yamaguchi uses Systems Dynamics macro-economic modeling, a system Dr. Steve Keen described as the most sophisticated he had ever seen a couple of years ago, and which appears the basis for his MINSKY model.

          There’s more than plenty of evidence.

          1. Joe Firestone (LetsGetitDone)

            Simulations use reasoning; but they’re not a source of empirical evidence. In fact, they’re often used when data is lacking and empirical tests of policy proposals aren’t available.

            On this:

            Dr. Yamaguchi uses Systems Dynamics macro-economic modeling, a system Dr. Steve Keen described as the most sophisticated he had ever seen a couple of years ago, and which appears the basis for his MINSKY model.

            I like system dynamics, and have worked with it occasionally since the 1960s. System Dynamics was originated in the mid 1950s by Jay Forrester, so it’s nearly 60 years old now. Also, it’s not the “most sophisticated” form of modeling available, Steve Keen notwithstanding.

            Complex Adaptive Systems-based simulations are one form of modeling that is more “sophisticated.” And there are also other forms such as “Fuzzy Systems Modeling, “rough sets modeling,” neural network modeling, Genetic Algorithms, and other forms that are far more “sophisticated,” if by that we mean systems that have more complex epistemological bases, and underlying assumptions than system dynamics.

            My objection to the Chicago Plan is based on its centralization of decision making about the money supply in a Committee of technocrats, along with the proposal that the primary criterion for its decisions would be price stability. I think this is sure to be deflationary, since 1) the idea that there are non-partisan, unbiased technocrats is a fable of progressivism popular in the early 20th century; 2) all of our history since then shows that everyone has an axe to grind, 3) I think such a committee is very likely to be biased against full employment and unconcerned about the impact of its actions on growing inequality in the United States, and 4) such an “independent” committee, would be insulated from popular pressure to create full employment, and widespread prosperity in the economy.

            Now, please note, I agree that we would be better off with a system of public finance that prevented bubbles and eliminated the public debt from the political considerations of legislators, and I do like these aspects of the Chicago plan. But a) we already can eliminate the public debt in a painless way; and (b) there are other ways to minimize bubbles through regulations and outright prohibitions of certain kinds of behaviors.

            So, why do we need a centralized committee for controlling the money supply, and a plan that accepts the bankrupt theory of the money multiplier as a basis of policy? I just don’t see it.

      1. MyLessThanPrimeBeef

        Whatever reduction in debts can be made up for with equity money that comes into existence when the people take it (that newly created equity money) and spend it.

  8. Johann Sebastian Schminson

    It would much safer, affordable, and sound to simply allow me to create money for everyone. I’ll only keep a .05% management fee. You won’t get that deal anywhere else. In addition to my other, sterling qualifications, I have a lifetime supply of zeros at my disposal.

    1. MyLessThanPrimeBeef

      It’s dangerous for one guy to do it (vote for who will be the vote or how to spend money).

      Together, it’s OK.

      Let the people elect their leader. It’s called democracy.

      Let the people decide how to spend the money the people will put into existence when the people spend it.

      You may think it’s the worst scheme (Money Creation via the People), leaving it to stoopid humans, until you contemplate the alternatives.

  9. Marko

    “Its important to note that under the specific policy choices outlined in Modernising Money, the amount of credit (lending) available to businesses is not limited to people’s savings, as Ann claims. Indeed, Martin Wolf’s summary above makes this clear: in fact the quantity of bank lending would be limited to peoples savings plus the amount that the Bank of England made available to banks to on lend into the economy. ”

    http://www.positivemoney.org/2014/04/ann-pettifor-there-will-be-no-shortage-of-money/

    1. Yves Smith Post author

      Pettifor did address this but you missed it. Efforts to control the money supply were abject failures. Both the US and the UK attempted it in the early 1980s. In both cases, the result was that trying to fix the rate of money supply growth showed it had no connection to any macroeconomic measure of activity. Controlling or focusing on controlling money supply directly is widely recognized among economists as an ineffective and potentially destructive approach, which is why it was shocking to see Wolf take it up. This is a discredited monetarist idea that somehow refuses to die.

      1. JuneTown

        Those pseudo-‘monetarist’ approaches should have been more than adequate for the intelligencia to realize that the “supply” of money cannot be controlled via the interest rate string which merely controls the ‘cost’ of money.
        For those incapable of seeing the difference between direct control via issuance and no control via interest rates, the wild ass notion of MMT that the Guv NOW creates the money by spending should remain to the fore of the mind’s eye.
        Do they, or don’t they?
        Nobody seems to know for sure.

  10. spooz

    I have been a fan of TCP since I read Kumhof’s IMF paper on it in 2012. I thought Dennis Kucinich’s NEED Act (HR 2990) did a good job fleshing it out.

    These are the bullet points

    1) End the private creation and destruction of money through fractional reserve banking, and replace it with full-reserve banking.
    2) Replace money supply with debt-free US dollars issued by the treasury, in an amount specified by an independent monetary commission.
    3) Incorporate the Federal Reserve into the US Treasury for supervisory and regulatory expertise. Fed is no longer privately owned.

    It also contains provisions for funding of universal health care, a citizens dividend and monetary grants to states, among others.

    I hope to make it to the American Monetary Institute conference this fall to hear Jamie Walton, who worked with Kucinich’s office to put the bill together, describe how its various elements would work. Joseph Huber will also be speaking, on debt free fiat. Other speakers include Michael Hudson and Steven Keen.

    It is good to see it getting any discussion at all. I was saddened to see even the Wikipedia entry for the NEED Act was removed this month. But I am feeling hopeful these days after the Supreme Court ruling on cell phone privacy. If we can reign in the NSA, perhaps we can have real monetary reform.

      1. JuneTown

        Actually, some of Bill’s worst work.
        I saw this video on YouTube about it.
        https://www.youtube.com/watch?v=HLg2hEtjtq8

        He deals with full-reserve banking, as does Mosler, as part of the gold-standard, totally ignorant on their parts.
        Full reserve banking has nothing to do with the gold standard, it was proposed as a REPLACEMENT for the gold standard … the standard of stable buying power…..as in this recent work by Atif and Amir can prove to anyone….posted at MikeNorman’s blog
        http://houseofdebt.org/2014/04/26/100-reserve-banking-the-history.html

        1. Joe Firestone (LetsGetitDone)

          You miss Bill’s point, which is that is the supply of money is constrained by Executive decision instead of being allowed to float according to the needs of the economy determined in a bottom-up way then this will create the same kind of inflexibility as existed under the gold standard.

          Of course, it will be a bit more flexible than that since the independent committee will be able to inject more money into it, when it thinks that’s necessary. But, still such decisions will be subject to the likely conservative anti-inflation biases of the committee members who may well tolerate much more unemployment and damage to the economy than we need to have due to their overweening concern about inflation. A lot of damage can be done to the economy, if committee decisions, out of an abundance of caution delay a needed expansion of the money supply by 6 months to a year. The tendency of partisans of the plan to quote the quantity theory of money when they want to refer to inflation isn’t comforting in this regard, either.

          I have to say, I’m afraid that I don’t see the charm of relying on a centralized independent committee to make this kind of decision rather than the Secretary of the Treasury in consultation with the President, when we look at the history of the FOMC and the Fed, the performance of Eurozone technocrats, or the technocrats at the IMF, the World Bank, the CBO, and other financial and financial analysis organizations. Technocrats at such organizations get paid too well, they nearly always side with the neoliberal elite and they nearly always visit unnecessary hardship in the form of economic austerity on the 99%. They just don’t feel the pain of most people leaving in a stagnant economy, which is remaining so in large part due to their owned flawed advice and recommendations based on false models. And yet now you and others propose to give them even more power by giving them direct control of the money supply?

          Sorry, but I don’t think so.

        2. Joe Firestone (LetsGetitDone)

          Also, after reading the House of Debt post, I want to add this. The most attractive thing about the Chicago Plan since the 1930s has been its cure for problem caused by the money multiplier in previous times. By getting rid of fractional reserve banking altogether. However, since the 1930s, we’ve gone off the gold standard entirely, and with the way money and banking work today we know that bank capacity to lend is no longer dependent on the money multiplier, simply because the banks lend first without reference to whether their reserves meet requirements and then add reserves by borrowing afterward. The constraint on their lending is their own decision making and the credit worthiness of their buyers, not their reserve levels. So the 100% reserve cure for the money multiplier isn’t relevant any longer to bank lending. It’s a solution to a money multiplier source of instability that doesn’t exist.

          Atif and Amir didn’t even note that the break in the monetary system occurring in 1971 when the world went off the gold standard constraint and ended commodity-based money systems changed the problem context of bank lending radically. That’s an egregious error undermining their case for the Chicago Plan.

  11. Charlton Butler Jr

    What amazes me is you people talk as if there is such a thing as interest. It is an accounting fact that you create the loan but not the interest. Someone has to fail, in direct relation and proportion, to the amount of interest on your loan. Yes for you to even pay off a simple loan someone has to fail to do that. There is no such thing as interest only freaking organic things are alive and can build or accrue interest. God I live in a world of morons who never once consider the impossibility of interest and money.

    1. Ben Johannson

      Repaying a loan is not made possible by failure of another loab because the bank still has to write off the non-performer out of capital. Besides which, you qould be hard prressed to explain how 90%+ of loans typically perform if they were reliant upon the failure of the other 10%; the numbers don’t add up.

      1. Nell

        I saw a lecture by Steve Keen a couple of years ago that debunked the ‘ need a treadmill of loans to pay of the interest’ myth. Essentially it is about flow of money, whereas those worried about interest are focused on the stock of money. They forget that spending the loan creates income for someone else, who then spends this income and creates more spending etc (the multiplier effect). Keen showed how this works mathematically when you model the flow of a loan through a series of economic transactions. Basically the spending and income generated by the transactions cover the interest. I imagine there has to be a balance between the number of loans created and the interest charged at the aggregate level to keep things humming along.

        1. F. Beard

          Except the recycling of credit most often has banks in the loop and they always add on interest to get the credit back into circulation.

        2. EconCCX

          @Nell I saw a lecture by Steve Keen a couple of years ago that debunked the ‘ need a treadmill of loans to pay of the interest’ myth. Essentially it is about flow of money, whereas those worried about interest are focused on the stock of money.

          Keen ever so quietly fessed up to his error in March, at long last.

          Because if you admit the reality that banks create money by lending, and that money is destroyed by debt repayment (a point I have to admit that I took some time to appreciate), all the simple equilibrium parables of conventional economics fly out the window. In particular, the level of economic activity now depends on the lending decisions of banks (and the repayment decisions of borrowers). If banks lend more rapidly, or if borrowers repay more slowly, there will be a boom; if the reverse, there will be a slump.

          http://www.ideaeconomics.org/blog/2014/3/25/the-boes-sharp-shock-to-monetary-illusions

          I’d like to believe that this example, with some help from the NY Fed, was especially persuasive.

    2. Ralph Musgrave

      That tired old argument about bank loans supplying capital but not the money to pay interest is popular with advocates of full reserve. One flaw in it is thus. Banks don’t burn or hoard the money paid to them by way of interest: they spend it on employees’ salaries, shareholder dividends, interest paid to depositors, maintaining their offices and computer systems, etc etc. In short, every dollar flowing into banks flows out again back into the non-bank private sector. There is thus no obvious reason why borrowers cannot get hold of the money needed to pay interest.

    1. Benedict@Large

      Positive money doesn’t deserve the time of day. It’s nonsense created by tin foil hat versions of what money is.

      1. spooz

        Will Steve Keen and Michael Hudson be wearing their tin foil hats to the American Monetary Institute conference? Shocking they would associate with such fringe types.

          1. spooz

            Nice to see that they are willing to have a discussion with the “children”, at least. From the mouths of babes and all.

        1. Ben Johannson

          Michael Hudson is not a Positive Money-ist, nor is Steve Keen a card-carrying member.

      2. JuneTown

        Have you read “Modernizing Money” by Dyson and Jackson?
        Or the various extensive responses made to Ann Pettifor’s article.
        Seem pretty strong and reasonable to me.
        Regardless, would you care to make some specific observations on what is wrong with their work?
        Positive Money was not only promoted by Martin Wolf in his April FT posting, but also is often cited by Lord Adair Turner, former Chief of the Financial Services Authority in the UK, in the advancement of his Permanent Overt Money Financing(POMF) solution to the crisis of debt-contract based money in this Volcker Group publication.
        http://www.group30.org/images/PDF/ReportPDFs/OP%2087.pdf
        And the BoE’s recent “guess how money is created…banks do it(97 percent) out of thin air” has finally confirmed Positive Money’s stance.
        That “tinfoil hat” charge might turn out to be in the ‘eye of the beholder” when this conversation is done.
        Anything of substance on Positive Money’s faults?

  12. William Neil

    So many suns and planets and sub-orbits here. Can I ask some basic questions to try to straighten out the confusions, some of which may turn out to be my own?
    First, let’s separate the quality of loans from the quantity made by banks. Countrywide before being taken over by BoA was the prime suspect on that score, were they not, among many others: declining loan quality with all the bad abbreviations we’ve come to know? Isn’t traditional bank auditing supposed to detect that? (Not in the age of new disguises and a many decades long de-regulatory atmosphere I answer myself) And don’t existing bank regulations have standards for the ratio of loans to “capital” (yes, yes, I know how much is crammed into that “word” and its acceptable definitions), so that when a certain ratio is exceeded – too many loans compared to too little “capital” to back it up – the bank is deemed unsound and the next morning there are signs for new owners on the door, sometimes with Federal initials and a reminder that your deposits are still safe***with footnotes.

    And now on to MMTers world. What I have just said is deeply qualified, if not entirely overridden, by the ability of the central bank – the FED – to, by electronic strokes, create/deposit/invent new capital so that the old limiting ratios of loans to “capital” are now no longer limits? This can be a rescue device in times of panic; when it becomes institutionalized to create loans but not, for example, public jobs, infrastructure banks, green or what have you….you end up with the very biased and unhealthy quantitative easing…which as Michael Hudson never tires of pointing out, in as likely – more than likely to end up in real estate speculation, a variation of the famous carry trades – or perhaps a not so surprising hybrid: loans for productive investments outside the home country of the money creating central bank. But most of the time, end up in financial tail chasing and not “productive economic activity,” which itself is a phrase whose solid definition has been stretched, bent and involuted to accommodate all the new twists of a new age, mostly non-productive ones, according to Hudson again. But it becomes a tautology, doesn’t it?

    1. Ben Johannson

      The Fed cannot issue capital to banks; barring the odd TARP here and there they must raise it for themselves, typically through stock issuance and valuation.

      As for speculation, yes the system is being abused. I would argue the answer is to exercise prudential oversight with things like enforced underwriting standards.

      1. JuneTown

        SAVED !!
        By another Macroprudential Regulation round of the regulation-deregulation cycle.
        Yeah, that’ll undo regulatory capture.
        Like this is about a few men behaving badly.

        1. Ben Johannson

          Your desire to absolve the guilty of any responsibility is touching, but unnecessary. You have a whole government and corporate structure behind your position.

  13. Ralph Musgrave

    Ann Pettifor’s article is nonsense. I left a 750 word comment after it pointing numerous flaws. That was two days ago. And no one has answered my points.

    Now that’s odd because she wrote a similar article a few weeks back which attracted a large number of comments from me and others, and we all got involved in a lively discussion.

    1. skippy

      I refuted the article with many words, yet protest here, with a few of the former and an assemblage of projections.

    2. William Neil

      Interest on deposits. What century is that from? What a quaint custom. Too bad we can’t adjust the rates on our “loans” to suit our economic circumstances. And how about the endlessly revolving, rolled-over commercial real estate loans. In American dreamland, we’re all going to be earning much more come some unspecified day in the future; it’s called permanent upward mobility, or used to be. But it is not so easily leveraged when you’re behind the creditor’s bills. Applies only to certain categories of borrowers. Different classes of borrowers, different classes of citizens.

    3. lambert strether

      Next time, limit yourself to 749 words, and your comment won’t be a conversation stopper? [rimshot. laughter]

    4. JuneTown

      Me too.
      Yet, for some reason, she restates her position anew and leaves the original article and comments in the dark.
      If you could post a link to the original….which I can’t seem to find….it would edify the MMT intellectuate here.

  14. Larry Headlund

    As luck would have it I am reading Walter Bagehot’s Lombard Street (1873) where he explains banking so clearly even bankers can understand it. In an early chapter* he points out that as a matter of real history, not conjectural stories, banks were ‘creating money’ decades before they thought of taking deposits. In fact, it was based on their reputation of creating money that led to deposits, not the other way around. It could be centuries before deposits were any considerable part of their business and deposits never were more than a fraction ( 1/6 to 1/10) of the money out on demand.

    *Chapter III for those interested.

    1. Jim Haygood

      ‘… deposits never were more than a fraction ( 1/6 to 1/10) of the money out on demand …’

      Thank you. Lending any amount beyond savings presumes fractional reserve banking.

      If fractional reserve lending is allowed at all, what is a prudent level of reserves to guard against bank runs? As Bagehot’s quote indicates, 10% to 16% was considered prudent in the late 19th century.

      Today, thanks to the Greenspandian subterfuge of overnight sweeps, reserves are miniscule. Current Federal Reserve data shows required reserves of $82.9 billion versus an M1 money supply of $2,791 billion — a reserve ratio of 3 percent at the commercial banks. Bagehot would be bloody appalled.

      Meanwhile, at the central bank, the Federal Reserve’s own capital is a skinny 1.5% of its assets.

      Prudent? It’s about as prudent as downing a fifth of gin while crossing the Grand Canyon on a high wire. Today’s fractional reserve banking system is better described as a ‘death wish.’

    2. financial matters

      We would be much better off if the Fed would have followed Bagehot’s advice in response to the crisis.

      “It has been recognized for well over a century that the central bank must intervene as “lender of last resort” in a crisis. Walter Bagehot explained this as a policy of stopping a run on banks by lending without limit, against good collateral, at a penalty interest rate. This would allow the banks to cover withdrawals so the run would stop. Once deposit insurance was added to the assurance of emergency lending, runs on demand deposits virtually stopped.

      — However, banks have increasingly financed their positions in assets by issuing a combination of uninsured deposits plus very short-term non-deposit liabilities. Hence, the GFC actually began as a run on these non-deposit liabilities, which were largely held by other financial institutions. —

      Suspicions about insolvency led to refusal to roll over short- term liabilities, which then forced institutions to sell assets. In truth, it was not simply a liquidity crisis but rather a solvency crisis brought on by risky and, in many cases, fraudulent practices.””

      and understanding these dynamics for the near future can be very important..

      “”These “too big to fail” institutions are seen by some as “systemically dangerous institutions”—often engaged in risky and even fraudulent practices that endanger the entire financial system.””

      “”If we are correct in our analysis, because the response last time simply propped up a deeply flawed financial structure and because financial system reform will do little to prevent financial institutions from continuing risky practices, another crisis is inevitable—and indeed will likely occur far sooner than most analysts expect.””

      http://www.levyinstitute.org/pubs/rpr_4_13.pdf

      The above also alludes to the unresolved problem of money markets feeding into the tri-party repo system. (Very short-term non-deposit liabilities)

      The Fed as a creation of Congress has power because of it’s close relationship to the Treasury. It is the Treasury’s bank as well as providing backing and clearing for private banks. It is just a tool but one that needs to be used responsibly.

      http://neweconomicperspectives.org/2014/06/consolidate-consolidate-question-maybe-isnt.html

      1. alan page

        Use of the word “fraud” and compound interest (without restraint) in the same sentence constitutes FRAUD! THERE IS NO NATURAL SYSTEM (existing ON A FINITE RESOURCE) THAT CAN GROW WITOUT RESTRAINT FOR VERY LONG! The whole notion of wealth concentration must be rethought. Given the lack of restraint that process must begin NOW because we are in the time of the last doubling. When any group has half of anything, allowing them to double their holdings in a finite environment guarantees that everyone else will have NOTHING!

  15. CMA (@CmaMonetary)

    “Second, the proposal that only money already saved should be made available for lending assumes that money exists as a consequence of economic activity, and equals savings. But that is to get things the wrong way around. Rather, it is credit that functions as money”

    Money can be anything, credit or equity. Gold was money. The gov could create money and recognize it as equity.

    “Furthermore, the restriction of all lending to existing savings would lead to higher rates of interest,”

    The gov can just expand the money supply at this point to bring down the rate like now.

    “This would return society to the dark ages, when investment and economic activity was subject to the whims of great feudal landowner”

    “Savers would be in a position to demand a higher return on the loan of their savings.”

    Returns on savings lending to banks would depend on how abundant savings are. If too scarce then rates will be too high but the gov can create more money which will increase supply of savings and bring down the interest rate.

    Supply and demand.

    1. JuneTown

      Sorry.
      Way too rational for this discussion, which, as Dyson points out in his comments thereon, confuses money and credit willy-nilly, or, better said, as convenient misinformation.

  16. Ralph Musgrave

    Yves,

    You say “Readers may argue that there are no good regulators to be found these days. So pray tell why should we believe that we’ll be able to create what Lambert calls a “magic board,” a new body of wise men to whom we can safely entrust the power to create money? In a system with widespread corruption, a power node like that is an invitation to abuse.”

    My answer to your question (second sentence just above) is that full reserve is VASTLY SIMPLER than the Byzantine complexity that is Dodd-Frank and the similarly incompetent set of rules governing banks that are being set up in other countries. In fact the head of the Dallas Fed (Fisher I think) said that Dodd-Frank has done more harm than good. In short, full reserve doesn’t have a desperately high bar to get over if it’s to improve on the existing system.

    Thus all else equal, the “wise men” governing banks under full reserve ought to be able to do a better job than the “wise men” wrestling to make sense of Dodd-Frank while bank lawyers run rings round them.

    As to your claim that Positive Money’s “Money Creation Committee” would involve an “invitation to abuse”, that committee’s job, as is clearly explained in PM literature is simply to decide on how much stimulus is suitable. And that function is near identical to EXISTING central bank committees which decide on stimulus (i.e. interest rate adjustments, QE, etc). The Bank of England’s “Monetary Policy Committee” is an example.

    1. JuneTown

      Ralph,
      We do not rationally discuss those tinfoil hat notions like full-reserve banking here………way too sophisticated for Moslerian notion that full reserve banking is a gold standard proposal (See his response to Wolf’s paper at The Center)
      But this recent posting by Princeton and U-Chicago’s Amir and Atif at the House of Debt site has again reinvigorated a discussion of same.
      http://houseofdebt.org/2014/04/26/100-reserve-banking-the-history.html
      They cite the strength of the Fisher et al 1939 Program for Monetary Reform.
      Fellow tinfoil-hattters in these parts.

  17. docG

    Will someone please explain exactly how banks are able to create money? If I apply for a loan and am accepted, then a certain amount of money will appear in my account, or in the form of a check. So you’re saying the bank just created that amount from thin air? I thought only the federal govt. was legally able to create fiat money. And if you’re saying the bank had to borrow that money from the Federal Reserve, then it’s the Fed that’s creating the money, not the bank. And if not, then where does it come from? And what is to prevent that bank from creating trillions of dollars by lending it to its own officers or their families? Or setting up dummy accounts into which huge amounts of brand new money could flow? And if that were the case, then wouldn’t inflation be continually soaring out of control?

    Sorry, but I don’t get it.

    1. financial matters

      The Fed backs up that money which is why it’s also supposed to be in the regulatory business.

    2. Blurtman

      There are supposedly controls on how much money a bank can create out of thin air, so it is not unlimited. But think about it. You go to your bank to take out a mortgage to buy a house. The bank “lends you” $500,000. You take a check for that amount and hand it over to the person from whom you are buying the house. He deposits the check in his bank, and now has $500,000 in his account. Does your bank put $500,000 in cash in an armored card and drive it over to his bank? No. It is all digital credits. The “money” does not exist. The banks have the ability to create digital credits, within limits. Now you must pay back the loan, with interest, typically from the sweat of your brow. You, however, may not create digital credits out of thin air.

      1. Moneta

        That’s why there are all kinds of rules of thumb like max debt-to-income and debt to GDP. These are not perfect but they give an indication if debt levels are too high for the productive capacity of the nation. We know that more than 3x is pushing it for individuals. Countries enter the danger zone at 200%

        And now, people want to forget about the debt side and just print. It makes me think of the south American who bought my house and called me in July to ask about the pipes in the basement. They were ugly and he wanted to pull them out. I told him he’d regret it at the end of October.

    3. washunate

      Don’t over think it. Currency comes from the government. The ‘from thin air’ viewpoint is primarily used to justify bailing out insolvent and/or criminal enterprises with public money.

    4. Nathanael

      When you write a check, and that check gets endorsed to the next person, and that check gets endorsed to the next person, and so on, the check IS MONEY. The money was created when you wrote the check. It is destroyed when the check is deposited & cancelled.

      If you understand this, you understand money creation. This is why bonds can be money.

      1. Nathanael

        (Please note that as long as the check is circulating, it does not matter how much money you have in your account.)

      2. washunate

        Ah, I agree, a check is money. But it’s not new money.

        Writing a check is an exchange. It doesn’t create anything that didn’t previously exist; rather, it transforms one kind of existence into another.

        A check is the conversion of general creditworthiness, of having a general claim on currency units *somewhere* to the specific creditworthiness of having a specific claim on currency units at a specific bank. Indeed, the very phrase ‘bill of exchange’ captures this essence in its name. When someone writes a check (drawer), they are transferring the claim of ownership of the specified amount of currency units in the specified account (drawee) to the specified recipient (payee).

        If checks created money, then someone with $1,000 in their bank account could buy a house by writing a check for $200,000. There are words for such activities, of course, but they tend to be unlawful acts like kiting, fraud, forgery, and counterfeiting.

        1. Calgacus

          No. Checks are “new” money. In fact all new money, all money is (loosely) checks. An amusing illustration is the fact that Albert Einstein became monetarily sovereign in his later years. People wouldn’t cash his checks, which he paid for real goods and services with, but collected them.
          If checks created money, then someone with $1,000 in their bank account could buy a house by writing a check for $200,000.

          This happens all the time. It’s the usual way houses are bought and sold in the modern USA, and creates a large proportion of the money in the country and the world. It is called “mortgages” or real estate finance. When you sign a mortgage, you are essentially writing a whole checkbook full of mostly postdated checks, drawn on the Bank of You, to your bank. The one check that is not post-dated is called “the down payment”, and that is what is usually counted against the $1,000 immediately. The bank keeps the others. In return, they let you write the check for $200,000. All of these are “new money”, new relationships.

          All money is created this way, by somebody writing a check, and always was. Dollar bills are the same as government checks. There are no “currency units” which are not relationships, which are not checks from somebody to somebody else. As Mitchell-Innes said, one of the most important statements of the many important things in his great papers – “There is no medium of exchange.”

          Of course, one should make formal definitions accord as well as one can with common usage. That is what MMT does: “Money” there usually means any credit/debt relationship that is widely used in commerce. This includes bank money & state money. “Currency” is used for “state money”. Some authors differ and can call bank money “currency”. Benedict@large here unusually – imho confusingly – is calling only state money “money” & bank money “credit”.But the key point, so simple it repels many minds, though that is how everybody really understands it, is that everything is just credit = debt, an immaterial relationship. The main thing is to consistently use terminology, get the abstract relations between them right & make sure to understand other people’s usages.

          On the most common usages, banks certainly do create money, bank money, bank credit. Of course they do not create currency/state money, state credit.

          1. washunate

            “Of course they do not create currency/state money, state credit.”

            So we are saying the same thing.

            When banks make crappy mortgage loans, only two things can happen: 1) banks go bankrupt, or 2) banks get bailed out by the government.

            1. Nathanael

              No, no. The banks can float the money forever if they can keep the trust going. It’s really all about psychology.

              Look, we had a local currency around here — Ithaca Hours. It wasn’t technically backed by anything. It *was money*. It stayed in circulation as long as its charismatic backer was in town promoting it, and then it started to decline in circulation.

              Money is really a confidence game. Which is OK. Someone who is generally well-trusted by everyone — like Albert Einstein — can just create money and people will take it. Period.

              This is why I’ve said that the biggest risk to our government currency is nothing economic, but stuff like the 2000 election theft and the lies which got us into the Iraq war. Those are the sorts of things which cause people to repudiate a currency — trust issues.

          2. ChrisPacific

            OK, so:

            Bank money = a number in a deposit account with the bank, or a check drawn on that bank
            State money or coin of the realm = physical currency, or money in the above sense from a government source, such as a refund check from the IRS

            You could say that money is a deferred promise that is tradable and broadly accepted. In that sense, a check made out to cash from an individual falls short of being money. If you offer it to me as a debt settlement I’ll probably refuse if I don’t know the name on the account, because I can’t be sure whether I’ll be able to cash it. A bank check from the People’s Collective Bank of Lower West Shady Elms, Florida, would probably be considered money in Lower West Shady Elms, but maybe not in New York City. A bank check from Bank of America would probably be considered money anywhere in the US, except maybe right after the London Whale story broke.

            It seems odd to me that banks can simply create deposits in an account without obtaining that money from somewhere else (like the rest of us have to do) but given that they are typically leveraged 10:1 or more and all those loans end up as deposits in somebody’s account, obviously it has to come from somewhere. Of course, part of the deal is that banks promise to exchange it all for state money on a 1 for 1 basis any time we ask them to, which helps preserve the fiction that bank money and state money are one and the same thing. This is a promise that they cannot possibly keep if enough people all call them to fulfil it at once. In that sense, bank money is a bit like religion in that it derives its power from the collective belief of a large number of people. No more belief, no more religion (or bank).

            1. Ben Johannson

              Faith in the soundness of the banking system is certainly a requirement. A critical flaw of the pre-Fed era was that banks could never be fully trusted by depositors to have the deposits on hand nor trusted by other banks to make payments in a timely fashion. The Federal Reserve was created specifically to remedy these deficiencies by standing ready to ensure the liquidity necessary for banks to perform their functions.

              A bank check from the People’s Collective Bank of Lower West Shady Elms, Florida, would probably be considered money in Lower West Shady Elms, but maybe not in New York City. A bank check from Bank of America would probably be considered money anywhere in the US, except maybe right after the London Whale story broke.

              This was the situation in the 19th Century, with big established banks commanding betters terms and more depositors because they were considered more reliable than smaller banks, as they usually were. Even so they did sometimes fail and financial panics were a regular feature of American life.

    5. Another Gordon

      Only the Fed can legally create notes and coins but the banks can create all the credit they want subject to certain prudential and regulatory constraints – capital and (in some countries but not all) reserve ratios. You don’t even need to be a bank to play this game on a small scale; I once bought a business in large part with a private loan granted to me by the vendor who thought I was good for it – correctly as it turned out! That was pure private credit creation.

      In recent years the banks have too often ignored the prudential constraints in a race to the bottom (highly profitable until it isn’t) and regulation has been marginalised by wrong-headed politics, including even the usual legal sanctions against ordinary theft and fraud (which are, of course, a form of regulation) – see multiple posts by Bill Black. Hence the financial crisis. Hence also the fact it’s not yet fixed.

    6. Mel

      At the Khan Academy (online) “Jay” has a good series of chalk-talks on Banking and Finance that cover this topic.

    7. Ben Johannson

      Here’s the thing: banks don’t actually loan you anything when they extend you credit. They agree to clear a big payment with another bank in exchange for a series of little payments from you in the future.

      Let’s say you apply for a $10,000 car loan at your bank. They like your credit history so they approve the application and write a check. So far you’ve got a little slip of paper which acts a bank IOU, which you then hand to the dealer. He takes it to his bank where the teller hits some keys on his keyboard, and suddenly an additional $10,000 is in the dealer’s account. Those digits didn’t come from anywhere, they weren’t a transfer, they were just keystroked into the computer.

      Later that night your bank, the one that issued the IOU, will determine whether it has enough reserves to transfer to the bank where the deposit was created. By doing this the payment is said to be “cleared”; after all your bank just saddled the dealer’s bank with a liability (the new deposit) and therefore must ensure the dealer’s bank receives an offsetting asset (the reserves). If your bank doesn’t have enough reserves to clear the payment then it will borrow them from another bank or even from the Federal Reserve. To be clear, the reserves your bank sends do not become the dealer’s deposit, they just end up as an asset on the bank’s balance sheet in addition to the deposit.

      So the dealer’s bank created money when it accepted your check and the money supply expanded. As you pay the loan back the money supply will contract and the $10,000 which came from nowhere will cease to exist.

      1. washunate

        Ben, that’s not considering the system as a whole, though. The car dealer’s bank doesn’t create money. Yes, they created digits within the banking system. But those digits didn’t come from thin air. They came from the borrower, via the borrower’s bank!

        $10,000 in the form of “I’ll pay you back later, I swear” and $10,000 in “Dead Presidents” and $10,000 in “1s and 0s” are certainly different kinds of money, but they are all money in the broad, systemic sense of the word. Exchanging IOUs for keystrokes doesn’t increase the amount of money in the economy as a whole.

        It merely monetizes credit, transferring money from the informal economy to the formal economy (or, from the nonfinancial economy to the financial economy).

        There are two easy, independent ways of seeing that banks don’t create money. First, if banks could create money, then they would own everything. Second, if banks could create money, then they wouldn’t ever need to be bailed out.

            1. Ben Johannson

              Given my original comment, to which you objected, said the same thing I have to question whether your response is given in good faith.

    8. JuneTown

      Please google The Credit River Decision.
      No, the banks do not lend money.
      They create and issue money in the process of lending……..something you thought the Guv could do…..but they can’t (except coins in the US).
      But the Judge in that case said only God can ‘create’ something (purchasing power) out of nothing.
      An informative bit on money-ness.

  18. jgordon

    People must be able to meet their basic living needs without money, and without aid or interference from centralized corporate/government systems. Money should be a nice thing to have, but not something people need to get by. The problem with the industrialized world today is that people have extrapolated uses of money that should never have come about, and thus we have created an insatiable, pernicious, and domineering system that will utterly collapse when it runs short of the (ever-expanding) human and mineral resources required to sustain it.

    1. F. Beard

      People must be able to meet their basic living needs without money,

      Yep. A family farm should be the norm in the West and not the exception.

      They’re coming again – for those who survive the Second Coming.

  19. William Hunter Duncan

    “If you read the works of early economists, one of their favorite topics was the need to end usurious lending, since businesses could not afford to borrow at those rates and survive, and so the money typically went to the most unproductive activities imaginable, namely, financing gambling by aristocrats.”

    Which is exactly what is happening right now, with the lowest interest rates possible. Massive cultural transformation is absolutely necessary right now, and yet all the excess money is flowing to mostly useless aristoctrats, all about maintaining the status quo.

    Why can’t we have a currency that isn’t about debt? I think if I were emperor of the world, I would arrest all the aristocrats, put them to work washing public toilets, and let people experiment with currency. Be responsible about it, or find yourself working with the incontinent.

    WHD

  20. washunate

    Hmm, interesting. I would say quite simply that banks don’t create money. Currency only comes from the government. What banks do is exchange the credit of a borrower (the promise to obtain currency in the future) for government-issued currency today.

    If banks give up more currency than the borrower’s credit is worth, they go bankrupt as borrowers are unable to fulfill the promise to obtain currency in the future. Unless the government bails out the bank. In which case, the bank still isn’t creating the money. The government is.

    1. Benedict@Large

      At least SOMEONE else here understands that banks don’t create money. I have no idea why so many others simply stick their heads in the sand when they are asked to confront this.

      If banks created money, their books would not balance. If banks can create money, why do some banks go broke?

      1. washunate

        I believe the words you are looking for are cognitive dissonance…

        But seriously, I think the reason is a yearning to have money be complicated, a desire for gatekeepers and experts and so forth to look out for the masses. I don’t think that’s unique to money, either.

        The way I see it, it doesn’t really matter if we nationalized commercial banking or let individual banks that are poorly run go bankrupt. Both outcomes would be superior to the muddling public/private GMO hybrid that is our present system.

        Which I think is why discussion about finance and political economy tends to be so obtuse, because those two options can be explained in about 20 words. Normal people can decide which kind of system is their personal preference. What takes thousands of words – and highly paid academics – is trying to make it sound more complicated than that.

        1. JuneTown

          Here’s a clue.
          No need to nationalize banks or banking.
          Nationalize the money system…..because it is the nation’s money system, and let the banks do the banking.
          Having government banks is of peculiarly limited benefit, if at all.
          Banking is properly a private activity which should, as you say, include the ability to take risks and fail, which is what would happen in the public-money, private-banking scenario.

          This “they’re trying to make it more complicated than our fantasy’ meme” is overdone here.
          Private fractional-reserve banking and money is unnecessarily complicated, but it’s the system we have.

      2. washunate

        P.S., this quote in particular is a good example of what I see:

        “In a well-managed monetary system, private bankers should be regulated by the central bank…”

        That makes no sense to me. Either private bankers should be regulated by their ability to make a profit to sustain operations (if you make bad decisions, you go out of business) or they’re not really private bankers.

      3. Ben Johannson

        They go broke because they issue more bad debt than can be covered by their capital. That banks create money is a fact. If you choose to deny a fact then fine, but you are behaving irrationally by doing so.

      4. Ben Johannson

        If banks can create money, why do some banks go broke?

        Bank money is temporary. It expands the money supply when the loan is extended and contracts it as the loan is paid back. Bank IOUs must always return to the aether from whence they came, that is why they can run out of capital. This is also why MMT says government issued dollars are net financial assets, because they are permanent unless taxed out of existence. They are, to the penny, the net savings of the non-government sector because bank issued money always goes away.

    2. JuneTown

      You would say that, but you would be wrong.
      The power of money is the creation of “purchasing power” via its issuance.
      That’s what banks do.
      “. Currency only comes from the government.”
      Currency? Like we don’t operate on a digital currency created by ledger-entry at the banks by which they first create a marketable debt-contract which is the bank’s asset and never enters government hands.
      “What banks do is exchange the credit of a borrower (the promise to obtain currency in the future) for government-issued currency today.”
      So, you believe that the banks are merely exchanging already existing government ‘currency’, and not ex-nihilo issuing that money into existence?

      I would say that is a belief system not backed by either facts, science or empirical evidence.

      First there is no money, then banks make a loan and there is.
      Government has less than nothing to do with it, unless you have a public CB issuing settlement media to make the debt-based system work.

  21. TedWa

    The Chicago plan seems fine to me. “To restrict all economic activity to savings would be to contract economic activity to an ever-diminishing sum of existing savings. Furthermore, the restriction of all lending to existing savings would lead to higher rates of interest, because the level of savings is much lower than the level of potential economic activity and employment.”
    Solution – credit is created by the interest paid on savings. Incentivize savings by the populous and the populous will have control over the money supply and how it’s spent. Why are they claiming that only the plutocrats will benefit in such a system when everyone will? Of course miminum wage will have to increase so the plutocrats will not have total control of that system.
    Typical economist, their profession, career and welfare depends on defending banksters – that is the fact of the matter. That’s what they’re taught in school. Everything they say is tainted by their learned biases.
    Interesting topic. Thanks Yves.

    1. Ben Johannson

      Where would the interest come from? If you plan to depend on interest income to expand the money supply then someone has to produce it.

  22. Pelham

    Question: Let’s say a bank lends money to someone to set up a business and the borrower puts up his house as collateral. But then the business soon fails, and the bank takes possession of the house. How does this benefit anyone? The borrower is homeless, and the bank has a house for nothing.

    Of course, you could say that requiring collateral for a loan reduces moral hazard associated with the borrower. But doesn’t the no-risk situation for the bank — either a lucrative payback from a successful business or getting a house for nothing — create moral hazard on the other side of the loan?

    If I’m right, this is an intolerable situation. I don’t know what the answer might be, but an answer is required.

  23. Nathanael

    This piece misses the main point: it’s *impossible to stop companies from creating money*.

    If you prevent banks from creating money, “shadow banks” will pop up to create money. Look at money market funds, which were *exactly this*.

    It doesn’t matter whether you want to prevent banks from creating money. When there’s a demand for money, money *will* be created to meet the demand — legal or illegal. There’s no point in trying to ban it.

    What you need to do is to create as much “government money” as necessary for the economy, so that people don’t need to depend on bank-created money.

    1. MyLessThanPrimeBeef

      I’m not comfortable with the first part of the post.

      It’s like fraud is inevitable so let’s accommodate that.

      As for government money, I think it’s a good idea, provided, it’s the people who spend it into existence.

      1. Nathanael

        Think about it hard and look at the history. Have you ever given someone an IOU?

        …have they ever given it to someone else and said “MyLessThanPrimeBeef will pay you back, I’m giving you his marker”?

        That’s money.

        Money is a social construct. THAT’S OK. It’s not “fraud”.

        Money is like… a promise of “a favor” from the issuer of the money. (A somewhat unspecific promise, rather than a promise of “my cow Millie”.) This is the fundamental root and origin of money, historically, too. Everything else is complications layered onto it.

    2. JuneTown

      I could be wrong, but the ‘buck’ of money market funds indicates to me that this is a market in already-existing bank-created money that is being risked. Not a money problem there, but an economic one….that MMFs do little for the real economy.
      Agree on the government-money-creation solution.

      1. Nathanael

        No, no, MMFs created money. What they did was to buy long-dated bonds and sell “extremely liquid” money backed by it, keeping only a tiny percentage of cash to handle withdrawals.

        Roughtly the same thing banks did with deposits, only without Federal Reserve or FDIC backing. “Breaking the buck” was the equivalent of discovering that the bank was insolvent (before FDIC backing) and suspending withdrawals was the equivalent of, uh, suspending withdrawals.

        While people *believed* in the money market funds, however, they were used for large financial transactions as if they were money. T-bills are also used as if they are money for large financial transactions.

  24. beene

    Any form of debt based currency has always bankrupted the nation it was created.
    The correction is simple end fractional reserve banking, and all bonds backed by the government.
    The government simply spends money into the economy and that amount is bound by the average of the gdp of the past ten years, that limit may only be violated in times of world wars.

    1. JuneTown

      But ! But!
      Beene !
      Haven’t you heard that MMT has discovered that this is how money gets created now?
      Nothing to fix or reform with their belief system.

  25. Steven

    Ms. Pettifore’s critique of the Chicago Plan in its modern incarnations rightly exposes the dangers of relying upon a “small ‘independent committee'” to make economic decisions that determine the fate of nations. She also exposes the weaknesses and dangers of a Positive Money system under which credit could be extended only by those who already have money in the bank. Regrettably, however, when it comes to her defense of a reformed status quo, what Irving Fisher called the creation of money by “thousands of private mints”, Pettimore appears to derive her conclusions from the assumptions that governed a by-gone world of entrepreneurs and hustlers with big plans and no money. It is a poor, pre-industrial world populated by “individuals, farmers, entrepreneurs”, not “The New Industrial State” about which Galbraith wrote so many years ago.

    Before dismissing the Chicago Plan out of hand, Ms. Pettifore should explore its etiology a little further, specifically Frederick Soddy’s “Wealth, Virtual Wealth and Debt” (2nd edition). Writing in the 1930s Soddy describes a world vastly different than the one Pettifore assumes as the basis for her defense of (private?) localized credit creation. It is a world where wealth is created by machines powered from inanimate energy source with “individuals, farmers, entrepreneurs” just looking on to supervise the process. Ms. Pettifore, on the contrary, apparently assumes the primacy of money in the wealth creation process. Today’s giant corporations don’t need credit to fund their operations (or at least they didn’t when their CEOs weren’t busy buying up stock and their competitors to push up the value of the stock options they hold).

    What is missing from this discussion is a definition of ‘wealth’, of what constitutes “productive” investment. Ms. Pettifore apparently believes the primary criteria is that any investment must be “income-generating”, i.e. profitable. If short term profit is indeed the sole criteria that should guide investment, then we live in the best of all possible worlds right now. But that, of course, is not the case. (If it were, we wouldn’t be having this discussion.) More or less completely missing is the consumption side of the equation. “From each according to his ability, to each according to his needs” may not work very well when the state owns the means of production. But neither does the “Everyone for himself. The devil take the hindmost.” mentality that governs production for profit.

    It was ‘profitable’ for Europe’s landed nobility to rob the commons and dispossess the peasantry to whom it had a centuries’ old obligation to provide enough land and protection to support themselves and their families. It was ‘profitable’ for industrial capitalists to mechanize the jobs by which the working classes in their countries supported themselves – and to off-shore the jobs that remained to lower cost workers in other countries. This is what Goldman Chief Executive Lloyd Blankfein meant when he said he and other bankers were “Doing God’s work”, i.e. conducting a ‘race to the bottom’ in which the world’s most desperately poor (and bankers like himself) would be better off.

    What is missing from the debate over who should create money is the issue of ‘for what purposes?; more generally, the question of ‘what is wealth?’ Soddy and his contemporaries in the energetics movement which surfaced in the 1930s before being smothered by internal rivalries are much closer to the truth than those who believe it is money created by bankers. For a more contemporary take on this, see Dr. Michael Hudson’s “America’s Protectionist Takeoff 1815 – 1914″. Hudson is one of the world’s great living economists. His secret in this volume and much of his other work (aside from being in the right place at the right time – see ” Super Imperialism – New Edition: The Origin and Fundamentals of U.S. World Dominance”) is simply paying attention to the hard-won economic wisdom acquired by previous generations, wisdom which for various reasons more recognized members of his profession disparage and dismiss as irrelevant.

    1. JuneTown

      WOW !
      A suggestion for reading Soddy’s “Wealth, Virtual Wealth and Debt.’
      Left ON !
      Sorry, these pages, as well as Pettifor’s modern iteration, are incapable of differentiating between wealth and debt because wealth (monetary assets) are created for the one percent while debt (IOUs) are created for the Ninety-Nine percent. And as long as a balance sheet is in balance, that’s all that matters to the Accountancy here.
      While I don’t agree about the powers of the national monetary authority, I very much appreciate the depth of your comment.
      Thanks.

      1. JuneTown

        OOPs, meant to say that ‘virtual wealth’ is created in monetary assets, not real wealth.

  26. alex morfesis

    this issue of banks creating capital by loan distribution which translates into money is the reason that bank charters are handed out to those who can make the argument they can handle the responsibility.

    The problem today is one of confusion. The idea that small and medium businesses are not asking for loans is a red herring. It has always been the game of bankers to claim that the thing they don’t want to do, nobody wants.
    Bankers have two real sets of rules. One for those they went to grad school with and others for the rest who dare disturb their mammonite chanting. Many a small business is being told that the berp that happened in 2007-2008 that dinged their credit is a problem, meanwhile, almost every PE firm has bankrupted an enterprise and made their regular lenders and prime brokers eat losses…yet somehow, they are allowed to continue borrowing funds.

    The issue is the elmer fudds at the top of the food chain who have fallen in love with computer screen capitalism. The idea, neigh the audacity, of one to suggest that loans be made to those who would create non electronic assets is an affront to the current mindset of the congregation.

    egads, next someone will suggest that 100 dollar shoes could actually be made in the US for a profit and all the carbon used up to bring them from overseas could be saved. reality, what a precept.

  27. dannyb2b

    “Second, the proposal that only money already saved should be made available for lending assumes that money exists as a consequence of economic activity, and equals savings. But that is to get things the wrong way around. Rather, it is credit that functions as money”

    Money can be anything, credit or equity. Gold was money. The gov could create money and recognize it as equity.

    “Furthermore, the restriction of all lending to existing savings would lead to higher rates of interest,”

    The gov can just expand the money supply at this point to bring down the rate like now.

    “This would return society to the dark ages, when investment and economic activity was subject to the whims of great feudal landowner”

    “Savers would be in a position to demand a higher return on the loan of their savings.”

    Returns on savings lending to banks would depend on how abundant savings are. If too scarce then rates will be too high but the gov can create more money which will increase supply of savings and bring down the interest rate.

    Supply and demand.

    1. JuneTown

      I see you’ve done some reading, some learning and become informed.
      Please move on.
      TIC.

  28. Benedict@Large

    Credit is not money. It does not turn into money. Banks create credit. They do not create money. If you do not know the difference (and apparently most of you do not), you probably shouldn’t be embarrassing yourself playing like you know macroeconomics. You don’t.

    Positive money is complete crap. It defines a “reality” where banks create money, and then argues that this is bad. I suppose it would be, except that banks don’t. It doesn’t matter how many times you point this error out to the positive money crowd. It doesn’t matter to them that their “world” is not consistent with basic rules of accounting which all banks must adhere to (but apparently not the economics profession). They “know” better because some moron passing himself off as an economics professor told them so. As for Pettifor, she then argues against positive money’s recommendations, which means she too is under the erroneous illusion that banks create money. Her rebuttal is thus nonsense responding to nonsense.

    Sorry, but this whole thing is people who don’t know what they are talking about pretending to be experts with new ideas. As long as the left dallies with crap like this, it will insure its irrelevance on macroeconomic issues.

    1. F. Beard

      Credit is not money Large Ben

      Then what is money since the MMT crowd calls fiat “tax credits”?

      Are you a closet gold-bug?

    2. JuneTown

      Have you missed the memo where the Bank of England completely supports the Positive Money construct, and if you’ve never read the quotes to exactly that effect from the head of the Bank of Canada, Bank of England and the Fed that banks create money……maybe you should take up another subject.
      You’re so far behind the curve as to be irrelevant.
      But thanks for the specific that Positive Money is wrong that banks create the money…….because the theme of Ann Pettifor’s posting is that banks SHOULD continue to create the money, and not turn it over to government.

    3. Nathanael

      Look up “banknote”. I suppose you’ll claim that the Bank of England (originally a private institution!) ddin’t create money.

      Banks create money. There was actually a long period when governments didn’t.

  29. cebepe

    It cannot be true that banks, or anyone else, should be allowed to or can create money “out of thin air.” If it was true, then there would be no problems in the world. So there is something missing in the argument, something critical.

    1. JuneTown

      Banks create money via a debt-contract that must be satisfied by the lender’s security, beyond which banks assume losses that destroy their own capital.(in theory)
      That’s the problem with pro-cyclical fractional-reserve lending, were it not for the FDIC,banks would be losing the depositors money as well, and the system could not exist.
      Yes, there is something wrong with this picture.
      The higher the focus, the more is obviously wrong.

      1. Ben Johannson

        Fractional reserve banking plays no role in the problems you seem concerned with. It enables banks to do nothing they could not do with a 100% reserve requirement because they are not reserve constrained. They can always get what they need to extend a loan or the Fed loses control of the short-term interest rate.

  30. Paul Tioxon

    Once again, the need to accept and understand the contribution of Marx and those have built on his contribution would stop a lot of needless argumentation. Money has a dual nature and the mechanism that turns it into the political power to control is the comodification process. The logical fallacy of turning a unit of currency into a commodity that can be bought, with what else, the same unit of currency creates within the logic of capitalism a reductio ad absurdem RAA in logic. Money is assigned units of 1, 5, 10….. and so on to enable the market economy to work today over far flung distances. But when money is bought and sold as a commodity, $1 to the debtor becomes $1.015 per month to the lender. This unequal exchange, demanding more for $1 than its face value is a result of demanding a profit from all exchanges in the marketplace. The alternative is to have equal exchanges, where total cost is the price and nothing more.

    Money is created out of thin air by capitalism during the exchange process due to the profit function. It is not only finance that makes money out of thin air, all for profit enterprises strive to do the same and many successfully meet this goal. Once the profits are pulled out the marketplace, they re-enter as private property for the most part in the form of investment to gain further profits. The leakage of profits in the form of wages or taxes paid are of course recovered in the consumer buying and in the regulatory capture and lobbying by profit seeking capitalists.

    The creation of money also occurs at the creation of profits, because profits only exist in the form of money under the market based economy that we see operating today and for the past few hundred years. Governments could make money out of thin air under this system due to the non for profit production of goods and services that come from the government. Under privatization, value is unlocked from former public property. The sale of innumerable assets large and small are monetized from parking meter revenues to the Philadelphia Gas Works, recently auctioned for $1.86Bil. I see no reason why the US Government does not declare Imputed Public Profits of its operations and issue currency as a deposit in a National Infrastructure Bank which in turn can deposit capital in state public banks that will also make loans for economic development.

    A sound finance system built on non profit enterprise can make loans at cost and not for a profit.

  31. cebepe

    Desperate humans think: “if only God could manage the show…”; when God doesn’t take up the offer, they think: “perhaps we can trust a small, independent Committee to replace our confusion and uncertainty.” Plato thought this way too – let’s find someone above the fray, someone free of this world’s desires, who will act for the common good always. No, Daddy will not take care of things always and neither would the Chicago committee. But neither can banks create money out of thin air. Banks, or any and all of us, are continuously engaging in complex calculations relating to the reliability of the borrower, the odds of obtaining a return, etc. People and institutions always take greater risk if someone else is bearing the risk, and the effort of any person is always to “lay off the risk.” If this is an accurate statement of the way things are, because it’s the way humans behave, we continuously have to find ways to live with it. It’s the same with all animals: they can stay still and not eat, or move to eat and risk being eaten. We use money in the same way.

  32. johm33

    Perhaps the most egalitarian way is for the GOV to issue money equally to citizens at whatever rate could be considered subsistence+ and charge them the same rate of interest as the banks pay, and have occasional jubilees where debt cancellation occurs or a bounty is given again equal ‘credit’ to all. GOV rakes it back with a turnover tax.

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