By L. Randall Wray, Professor of Economics at the University of Missouri-Kansas City, Research Director with the Center for Full Employment and Price Stability and Senior Research Scholar at The Levy Economics Institute. Originally published at New Economic Perspectives
Sorry that it has taken me a while to get back to my multi-part series on debt-free money. This is the third part of the current series, although I had previously written several other blogs on the related topics of debt-free money, positive money, and 100% money. See links at the bottom.
This post will focus on the concept of “redemption” as the most fundamental requirement of indebtedness. This seems to confuse readers. For example, Eric Lonergan calls this a “fantastic linguistic contortion”, a “pure semantic confusion”, a “hidden definition slipped in between dashes”.
I’ll demonstrate that my use of the term redemption is consistent with the use both in scholarship and American law. I note that Lonergan has written his own book on Money, so it is surprising that he is unfamiliar with the proper use of the terms debt and redemption—which even predate religion and civilization. See, for example, the great book Margaret Atwood, Payback: Debt and the shadow side of wealth for a short history of the subject (and serious scholars should of course read David Graeber’s Debt: the first 5000 years.)
The most important point is that the debtor must redeem himself. I suppose Lonergan does not get out much—at least not enough to have ever “redeemed” his airline’s debt to him in the form of frequent flyer miles. He claims that the issuer of debt does not need to accept his own debt in order for that debt to have value. Really? Would he accumulate airline miles debt if the airlines refused to redeem it for miles?
He goes on to argue that we’d still use the government’s currency even if it could not be “redeemed” (in my sense of the term).
Well, as P.T. Barnum says, there’s a sucker born every minute. It adds up. But it is not going to drive a currency. Besides, the dopes already have debt-free bitcoins. They don’t need debt-free, non-redeemable frequent flyer miles or currency. The “fair value” of non-redeemable frequent flyer miles or debt-free bitcoin currency is zero, as Eric Tymoigne has demonstrated.
Yes, suckers and speculators can cause prices to deviate from fair value. For a while.
Lonergan’s website is titled Philosophy of Money. Philosophy is beyond my paygrade—I’ve read Simmel, who wrote the book on the topic, but won’t pretend to have fully digested it. I have instead relied heavily on the work of the autodidactic, A. Mitchell Innes, who wrote what I consider to be the best two articles ever written on the “nature” of money (in 1913 and 1914). His speculation on the history of money has largely been confirmed over the century that followed publication of his articles.
I also adopted his use of terms like redemption and debt—which conformed to their use through history from Babylonian times. And, as I’ll show, scholars of the history of currency still use the terms in the same manner. It is not me who is “contorting linguistics” in some fantastic way. Our nation’s founding fathers (and mothers) would have no problem following my arguments.
But let me first recount the exposition I have offered before on this site. In Part Four I’ll get to the nitty gritty history. Don’t worry, it will be posted close on the heels of this one. However, since the previous expositions are strung across blogs written since 2014, I want to provide a few extracts (with very minor editing) to remind readers of the position MMT takes on the topics of debt, redemption, and currency.
Background Extract #1. The Basics of MMT
Source: http://neweconomicperspectives.org/2014/06/modern-money-theory-basics.html:
For the past four thousand years (“at least”, as John Maynard Keynes put it—modern scholarship pushes it back at least 6000 years), our monetary system has been a “state money system”. To simplify, that is one in which the authorities choose the money of account, impose obligations denominated in that money unit, and issue a currency accepted in payment of those obligations. While a variety of types of obligations have been imposed (tribute, tithes, fines, and fees), today taxes are the most important monetary obligations payable to the state in its own currency….
For most people, the greatest challenge to near-and-dear convictions is MMT’s claim that a sovereign government’s finances are nothing like those of households and firms. While we hear all the time the statement that “if I ran my household budget the way that the Federal Government runs its budget, I’d go broke”, followed by the claim “therefore, we need to get the government deficit under control”, MMT argues this is a false analogy. A sovereign, currency-issuing government is NOTHING like a currency-using household or firm. The sovereign government cannot become insolvent in its own currency; it can always make all payments as they come due in its own currency.
Indeed, if government spends currency into existence, it clearly does not need tax revenue before it can spend. Further, if taxpayers pay their taxes using currency, then government must first spend before taxes can be paid. All of this was obvious two hundred years ago when kings literally stamped coins in order to spend, and then received their own coins in tax payment. Or cut tally sticks; or printed paper notes. Then spent them before they received them back in tax payments. (Ditto the American colonies, as I’ll demonstrate.)
Another shocking truth is that a sovereign government does not need to “borrow” its own currency in order to spend. Indeed, it cannot borrow currency that it has not already spent! This is why MMT sees the sale of government bonds as something quite different from borrowing.
When government sells bonds, banks buy them by offering reserves they hold at the central bank. The central bank debits the buying bank’s reserve deposits and credits the bank’s account with treasury securities. Rather than seeing this as borrowing by treasury, it is more akin to shifting deposits out of a checking account and into a saving account in order to earn more interest. And, indeed, treasury securities really are nothing more than a saving account at the Fed that pay more interest than do reserve deposits (bank “checking accounts”) at the Fed.
MMT recognizes that bond sales by sovereign government are really part of monetary policy operations. While this gets a bit technical, the operational purpose of such bond sales is to help the central bank hit its overnight interest rate target (called the fed funds rate in the US). Sales of treasury bonds reduce bank reserves and are used to remove excess reserves that would place downward pressure on overnight rates. Purchases of bonds (called an open market purchase) by the Fed add reserves to the banking system, preventing overnight rates from rising. Hence, the Fed and Treasury cooperate using bond sales/bond purchases to enable the Fed to keep the fed funds rate on target.
You don’t need to understand all of that to get the main point: sovereign governments don’t need to borrow their own currency in order to spend! They offer interest-paying treasury securities as an instrument on which banks, firms, households, and foreigners can earn interest. This is a policy choice, not a necessity. Government never needs to sell bonds before spending, and indeed cannot sell bonds unless it has first provided the currency and reserves that banks need to buy the bonds.
So, much like the relation between taxes and spending—with tax collection coming after spending–we should think of bond sales as occurring after government has already spent the currency and reserves
Background Extract #2. Creation and Redemption
In this instalment I will examine three analogous questions (each of which has the same answer):
- Does the government need to receive tax revenue before it can spend?
- Does the central bank need to receive reserve deposits before it can lend?
- Do private banks need to receive demand deposits before they can lend?
As we’ll see, these are reducible to the question: which comes first, Creation or Redemption?
…. It has long been believed that we accept currency because it is either made of precious metal or redeemable for same—we accept it for its “thing-ness”. In truth, coined precious metal almost always circulated well beyond the value of embodied metal (at least domestically); and redeemability of currency for gold at a fixed rate has been the exception not the rule. Hence, most economists recognize that currency is today (and often was in the past) “fiat”.
Further, and importantly, law going back to Roman times has typically adopted a “nominalist” perspective: the legal value of coins was determined by nominal value. For example, if one deposited coins with a bank one could expect only to receive on withdrawal currency of the same nominal value. In other words, even if the currency consisted of stamped gold coins, they were still “fiat” in the sense that their legal value would be set nominally.
The argument of Adam Smith, Knapp, Innes, Keynes, Grierson, and Lerner is that currency will be accepted if there is an enforceable obligation to make payments to its issuer in that same currency. Hence, MMT has adopted the phrase “taxes drive money” in the sense that the state can impose tax liabilities and issue the means of paying those liabilities in the form of its own liabilities.
Here there is an institution, or a set of institutions, that we can identify as “sovereignty”. As Keynes said, the sovereign has the power to declare what will be the unit of account—the Dollar, the Lira, the Pound, the Yen. The sovereign also has the power to impose fees, fines, and taxes, and to name what it will accept in payment. When the fees, fines, and taxes are paid, the currency is “redeemed”—accepted by the sovereign.
While sovereigns also sometimes agree to “redeem” their currency for precious metal or for foreign currency, that is not necessary. The agreement to “redeem” currency in payment of taxes, fees, tithes and fines is sufficient to “drive” the currency—that is to create a demand for it. I will say more about this other kind of redemption in Part Four.
Note we also do not need an infinite regress argument. While it could be true that I am more willing to accept the state’s IOUs if I know I can dupe some dope, I will definitely accept it if I have a tax liability and know I must pay that liability with the state’s currency. This is the sense in which MMT claims “taxes are sufficient to create a demand for the currency”. It is not necessary for everyone to have such an obligation—so long as the tax base is broad, the currency will be widely accepted.
There are other reasons to accept a currency—maybe I can exchange it for gold or foreign currency, maybe I can hold it as a store of value. These supplement taxes—or, better, derive from the obligations that need to be settled using currency (such as taxes, fees, tithes, and fines).
The Fundamental “Law” of Credit: Redeemability
Innes posed a fundamental “law” of credit: the issuer of an IOU must accept it back for payment.
We can call this the principle of redeemability: the holder of an IOU can present it to the issuer for payment. Note that the holder need not be the person who originally received the IOU—it can be a third party. If that third party owes the issuer, the IOU can be returned to cancel the third party’s debt; indeed, the clearing cancels both debts (the issuer’s debt and the third party’s debt).
If one reasonably expects that she will need to make payments to some entity, she will want to obtain the IOUs of that entity. This goes part way to explaining why the IOUs of nonsovereign issuers can be widely accepted: as Minsky said, part of the reason that bank demand deposits are accepted is because we—at least, a lot of us—have liabilities to the banks, payable in bank deposits.
Background Extract #3. Creation and Redemption
Before the sovereign can issue tallies or coins, he must put taxpayers in sinful debt by imposing a tax obligation payable in his tally stick or coin. This creates a demand for his tally or coin.
When the central bank lends reserves to a private bank, it puts that bank in sinful debt, crediting its account at the central bank with reserves, but the bank simultaneously issues a liability to the central bank.
When the private bank lends demand deposits to the borrower, it credits the deposit account but the borrower records a liability to the bank.
So each “redemption” simultaneously wipes out the sinful debt of both parties. The slate is wiped clean. Hallelujah!
You see, folks, it’s all debits and credits. Keystrokes. That record bonds of indebtedness, with both parties united in the awful sinfulness.
Until Redemption Day, when the IOUs find their ways back to the issuers.
- Those who think a sovereign must first get tax revenue before spending;
- Those who believe a central bank must first obtain reserves before lending them;
- And those who believe a private bank must first obtain deposits before lending them
- Have all confused Redemption with Creation.
Receipt of taxes, receipt of reserve deposits, and receipt of demand deposits are all Acts of Redemption.
Creation must precede Redemption.
Conclusion
When the sovereign issues currency, she/he becomes a debtor. The sovereign’s currency is debt. The holder of the currency is the creditor. The most fundamental promise made by any debtor is the promise to redeem, by acknowledging his/her debt and accepting it. Those who themselves have debts to the sovereign can submit the sovereign’s debt in payment. Refusal by the sovereign to accept his/her own debt is a default. This will have implications for future acceptance of that sovereign’s debt.
Acceptance by the sovereign of his/her own debt is redemption. Airlines also redeem their frequent flyer miles by accepting them in payment for actual flights. Redemption “wipes the slate clean”. It eliminates the debt. Keystrokes take away the frequent flyer miles from the accounts of passengers. In the old days—as I’ll demonstrate in the next piece—sovereigns burned their debts on redemption. Homeowners commonly used to have mortgage burning parties when they redeemed themselves by paying off their homes. Probably no one lives long enough any more to do that.
We have argued that the sovereign imposes debts—tithes, fees, fines, and taxes—on the population. Those with tax debts can redeem themselves and wipe clean their tax debt by delivering back to the sovereign her/his tallies, coins, or paper notes. Today it is actually done with keystrokes—debits to private bank deposits and the bank reserves at the central bank.
Note that tax payment redeems both taxpayer and sovereign. Isn’t that nice? The sovereign’s currency is burned, and the taxpayer can burn her tax bill. Hallelujah!
Arguing that we should not see the sovereign’s currency as debt, and arguing that the sovereign needn’t redeem her/his debt reflects a fundamental misunderstanding. I think it probably derives from the impulse to focus solely on the use of money as a medium of exchange. This was Friedman’s mistake, who used to argue we can just assume money falls from helicopters. Right! If it did, it would be debt-free and have a fair value of zero. It would be as valuable as the leaves that fall from trees.
Currency must be debt and it must be redeemed to have a determinant nominal value in terms of the domestic money of account.
The sovereign might make other promises when she/he issues debt. There could be a promise to pay interest over time. There could be a promise to redeem her/his debts for the debts of other sovereigns. While uncommon in history, the sovereign could also promise to redeem for precious metal bullion. I do agree that gold coins or paper notes redeemable for gold would have a fair value above zero, although their nominal value would be indeterminant. I’ll say more about this in Part Four.
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‘Bond sales by sovereign government are really part of monetary policy operations. The operational purpose of such bond sales is to help the central bank hit its overnight interest rate target.’
Probably ‘bond’ is being used in a generic sense in this sentence, to mean ‘Treasury security.’ Since the Fed’s policy rate is an overnight rate, the term wanted is ‘bills.’
Bills comprise only about 15% of Treasury debt outstanding. Schedules of note and bond issuance (much of which is rollover rather than new debt) are set without the slightest regard to ‘helping the central bank hit its overnight interest rate target.’
So what is the operational purpose of note and bond sales? To finance the fiscal deficit (same as it ever was). At times during the 19th century, the federal government had almost no debt outstanding. Monetary policy remained entirely unruffled.
The rest of the yield curve just acts as an extension of the overnight rate. A 2-year note trades at a value that is not far off where “the market” expects for the average of the overnight rate over the next two years. Etc.
One could debate the exact wording that Wray uses, but pretty well all schools of thought which believe that interest rates matter agree that you need to look beyond just the overnight maturity when judging the effect of monetary policy. Bond sales create that curve.
Not that I disagree, but this is not what Jim was arguing.
I’d say the secondary market creates the yield curve. Although implied forward rates can be derived from the yield curve, it’s quoted in nominal yields to maturity, because that’s what investors care about.
Since Federal debt was minimal in the 19th century, municipal and railroad bonds serve as the best bond indexes for the period. Treasury issues were so few and far between that it’s impossible to derive a term structure from them. T-bills weren’t regularly issued till 1929, so commercial paper and bankers acceptances were the commonly quoted short rates before then.
Certainly there’s an investment demand for high quality debt. But various issuers of highly-rated debt can supply that demand.
High quality commercial paper is still much weaker than sovereign debt and sovereign debt a better instrument of central banks to use to manage rates. During a broad crisis, even AAA paper can go poof.
(There has been a few comments; this is in response to Jim Haygood’s reply.)
The secondary market prices Treasury bonds based on expectations of the path of the overnight rate. The point of bond issuance is to create that curve.
As for your discussion of 19th century policy, the Fed did not exist, and “monetary policy” bears little resemblance to how it works now. In those days, the Treasury had to juggle how it kept deposits in the banking system in order to support money flows.
Randy Wray is referring to a modern system in which the currency floats and is not convertible. In a currency which is convertible, the government has fixed borrowing constraints. There is a huge structural difference between the post-1973 system and the pre-World War II system.
From this post yesterday:
As for the relationship between short and long-term interest rates, Perry Mehrling (and I believe others) have examined the “expectations” hypothesis of the yield curve and found that it is empirically false. Instead, according to Mehrling, the Fed’s manipulation of the short term rate is transmitted to longer dated maturities via raising or lowering the actual costs of dealers in buying/selling securities, both government and otherwise.
Further, in Jim Haygood’s response, I do not see a refutation of the logic of the argument that the currency has to be issued first prior to either taxation or borrowing, references to the gold standard era, aside.
“At times during the 19th century, the federal government had almost no debt outstanding. Monetary policy remained entirely unruffled.”
You are referring, OC, to the depression of 1837 – 43, after Jackson nearly paid off the federal debt in 1835. The US then had no central bank, and thus no monetary policy to ruffle or unruffle.
Operational purpose of note and bond sales? Social welfare for the financial community? Paying off the sociopaths so they won’t cause trouble elsewhere in society?
Most likely–and I would love Dr. Wray to comment on this–we have most of our T-Bill sales because of having a history of borrowing when we had deficits. There is likely no practical reason to continue to insist that a running count of our deficits from 1837 to today (yes, that was the last time we had a zero balance) need to be held as bonds by somebody. We should probably cancel the “National Debt” and simply realize that we need deficits in order to expand an economy and surpluses to curb out-of-control inflation. Good luck convincing a Republican Congress of that, though.
Stg. Stephanie Kelton said: she was asked what would happen if MMT policies created too much money, would our money still be accepted? She answered that (for international trade purposes) that all we had to do was produce things other countries wanted to buy…. So why then do we mess around with monetary tricks to keep the overnight rate from falling too low? Do we want our dollar to be the most liquid currency in the world so we are willing to raise the cost of living here for bank profits? And isn’t that the very definition of inflation?
Wray just elaborated that the value of sovereign debt (money) rests in its acceptance and use. I think he says that the nominal value of our sovereign unit of account is tweaked by our Treasury with interest paying bonds…. because otherwise, like gold, the nominal value of the dollar “would be indeterminate” and thus (?) unredeemable with consistency. So it all boils down to cooperation and faith in the fairness of the whole monetary scheme and the use of interest. “Full faith and credit” as the dollar bill says. And nowhere in our official regulations or our vast code of law and regulation does it forbid the use of sovereign money to be used for social purposes – so how did this whole thing get so mixed up that we don’t even understand cooperation anymore?
so… the bigger the population using your currency/debt, the more valuable it is…. until you reach the outer limits of our third level of atmosphere where the weight of all that bribery becomes a heavy cloud that keeps in too much heat…
Susan, you may be interested in that the Minneapolis Fed is of Bernies’ opinion that the NY Fed is to close to the NY banks it’s supposed to supervise.
“Kashkari has even gone one step beyond Sanders. In a speech yesterday at the Brookings Institution, Kashkari said a bold range of options should include:
◾Breaking up large banks into smaller, less connected, less important entities;
◾Turning large banks into public utilities by forcing them to hold so much capital that they virtually can’t fail (with regulation akin to that of a nuclear power plant);
◾Taxing leverage throughout the financial system to reduce systemic risks wherever they lie.”
More……….http://wallstreetonparade.com/2016/02/former-goldman-sachs-guy-is-channeling-bernie-sanders/
I thought that was understood here at NC, at least in historical context for the last 100 years and more so the last 60ish wrt MPS.
Skippy…. sorta like the confusion over an ad hoc religion became the mythos of empire….
this is one of the all-time greatest posts that this website has ever hosted. it is also perfect for clearly and briefly explaining the way our monetary system works. it is what ideally should be read and understood by all people who hold the now defunct label of “citizen” in the U.S.
I have a sincere question.
What happens if there is no redemption? Is it possible that a quadrillion in derivatives cannot be redeemed?
Derivatives are not debt and hence not relevant. For instance, most options simply expire, with no value at the expiration date.
Derivatives are a wager on some underlying instrument.
I think that’s a good question and it could be problematic if these clearing functions run into trouble.
http://us.practicallaw.com/3-502-8950
“”Statutory Construction: How Are Derivatives Regulated under the Dodd-Frank Act?
The regulation of OTC derivatives, commonly referred to as swaps, under Title VII of the Dodd-Frank Act is broken down by:
Type of swap (see Types of Swaps under Title VII).
Type of swaps-trading entity (see Types of Swaps-trading Entities under Title VII).
As detailed in this Note, certain Title VII requirements, such as clearing and exchange trading, are applicable on a swap-by-swap basis, while other requirements are applicable based on the type of party entering into the swap. Uncleared swaps are also subject to a variety of enhanced requirements under the Dodd-Frank Act. Swap data reporting requirements apply to all swaps.””
What happens when no taxes are paid (deliberate tax avoidance), wouldn’t this mean there is no longer anything to redeem?
My problem with MMT isn’t the theory. My problem with it is that it solves no problems. It is not even intended as an instrument to be used to solve any problems.
It does demonstrate that ‘to a point’ the sovereign can spend as much as desired, by in effect issuing debt it owes only itself. That “point’ would be based on negative effects of that spending on the macro economy, not the amount of ‘debt’ per se. In that sense it can be a Keynesian uber-sovereign for creating jobs (directly or indirectly) so long as the point of negative effects isn’t reached. That is the best it can do.
On the other hand, there is an alternative monetary model available that would eliminate unemployment, poverty, and using taxes to fund government. It is not “helicopter money” because the size of the supply of money is limited in it by demographics–but nothing else. The central bank would still exist as the bankers’ bank, but would not participate in the funding of government (which would be funded in total–including local, state, and federal spending–at the current per capita rate as part of the operation of the monetary system).
Neither would the central bank participate in ‘managing’ the economy. For that matter, the means would not exist for either monetary or fiscal policies to that end. The market-based economy would become the self-regulating thing it is supposed to be in theory.
Legally, the money would rest on the other pillar of “legal tender:” the only form of payment lenders can demand for repayment of debts.
If curious, the model is available for consideration at http://www.ajustsolution.com. (Though it was arrived at via a quest for a more just economy, the model can stand as strictly economic proposal.) Actually, the best place to start would be “How the Fix the Central-bank System, Improve the Economy, and Charge Taxpayers Nothing To Do It” at IVN (Independent Voter Network: ivn.us: . [An editor’s clunky title, by the way; my title was “Re-forming the Central-bank System.”]