ZEN and the Art of Modern Money, Part 3 (MMT)

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By J. D. Alt, author of The Architect Who Couldn’t Sing, available at Amazon.com or iBooks. Originally published at New Economic Perspectives. Please read Part One here and Part Two here

OPERATION #2—The federal government buys something big for the collective good.

NOTE: A much appreciated comment at Naked Capitalism re: Post#1 suggested that the term “Combustion Chamber” was misleading since the “fuel” (money) put into the chamber is not burned as in a motorcycle engine but is redistributed to other accounts. I was planning to point this out further into the narrative but the comment showed that would be too late. So, beginning now, I’ve changed the name “Combustion Chamber” to “Production/Consumption (P/C) Chamber,” of which we have two: a Public P/C Chamber and a Private P/C Chamber.

OPERATION #1 looked at a transaction in private commerce—an exchange of money occurring in the Private P/C Chamber of our diagram-machine. OPERATION #2 will observe a transaction in the Public P/C Chamber. Before we start, this is a good time to address a question you may already have asked: Why does our diagram-machine have twoProduction/Combustion Chambers? Why can’t all the Production and Consumption that American citizens need take place in just one?

The answer is this: The Private P/C Chamber that we just observed, by its very nature, will only produce certain kinds of goods and services—namely, those goods and services that can be produced—and marketed—for financial profit. The money-issuing mechanism for the Private P/C Chamber is driven exclusively by a profit formula requiring there to be a marketwilling and able to pay a price (in U.S. dollars) for what is produced that will cover the cost, overhead, and profits of the production. When that condition is met, the diagram-machine can produce the required fuel by the mechanism of exchanging Promissory Notes for new bank-dollars, as we’ve just observed. If that condition cannot be met, the goods or services will simply not be produced.

There are, however, many non-marketable goods and services required for people to lead safe, healthy, lives in the pursuit of happiness and relative comfort. These are goods and services for which there is no market either willing or able to pay the cost (in U.S. dollars) required to produce them—yet which are necessary or highly desirable for the collective good of American society. These “non-marketable” goods and services fall into two categories, depending on how they are produced:

  1. Goods and services produced by a state-owned or managed enterprise. The state produces them “at cost,” i.e. there is no overhead or profit. An example would be law-enforcement and the court system.
  1. Goods and services produced by private enterprise but paid for by the state. The private enterprise charges the state overhead and profit—the same as if the state were a buyer in the private market. An example would be B-1 bombers built by Lockheed.

The distinction between these two categories is extremely important so far as capitalism-versus-socialism arguments are concerned (which we can explore later). As far as our machine-diagram is concerned, however, it doesn’t matter if it’s producing fuel for a state-owned enterprise (like the court system) or a state-paid private business (like Lockheed). All that matters to us, at the moment, is to see why producing these kinds of goods and services requires a second P/C Chamber with a different formula for producing fuel (money).

To observe this different formula in OPERATION #2 let’s imagine a very large non-marketable challenge that collective society might confront: engineering and deploying a Satellite Laser-Cannon to destroy incoming asteroids larger than a football field. (This is the size that could vaporize a major city.) Clearly, private commerce is not going to generate the money (fuel) necessary to build and deploy the asteroid-blasting weapon for the simple reason there is no market willing or able to pay for it. It will have to be undertaken and accomplished in the Public P/C Chamber.

STEP #1: Congress appropriates U.S. dollars and directs the Treasury to spend them to cause a Satellite Laser-Cannon to be engineered, deployed, and operated.

  • To get the satellite laser-cannon built and deployed, Congress (which, let’s don’t forget, represents all of us collectively) appropriates $100 that the Treasury is directed to spend to pay American businesses to accomplish the job. What exactly does “appropriate” mean? It means that Congress makes a claim on $100 Reserves at the Central Bank and directs the Treasury to spend them for a specific purpose.
  • Right off the bat, we have a problem, right? In our diagram-machine, Treasury doesn’t have $100 Reserves in its spending account at the Central Bank! Looking at the fuel-meter status of our diagram-machine, we see that the Treasury Reserve account only contains $10. How can our diagram-machine handle this situation? Can it do a “tax-collecting” operation to transfer Reserves into the Treasury’s account?
  • If we test that scenario, we quickly observe that bank accounts#1 and #2, together, cannot be taxed enough to meet the Treasury’s spending needs. Even if they were taxed 100% and drained completely (which would be a political catastrophe for the elected government dictating the tax-rate) only $40 would be credited to the Treasury’s Reserve account—leaving it still $50 short of its spending mandate to get the Satellite Laser-Cannon built.
  • It would appear our diagram-machine is not capable of producing something that might, just maybe, result in averting the annihilation of a major American city! That’s a discouraging thought. But “fiscal analysis” seems to indicate it’s simply a reality: Our machine just doesn’t have enough fuel to produce something big (but non-marketable) that American society has decided it really needs. So, are we just stuck?

NO!! We are not stuck!

 Imagining we are stuck sells our diagram-machine short—far short of what it’s capable of accomplishing. As we’ll now see, if the labor, expertise, technology, and materials necessary to build the Satellite Laser-Cannon exist—and can be purchased with U.S. dollars—our diagram-machine is fully capable of producing the fuel necessary to marshal those resources to accomplish the task. Let’s observe now how our machine does it.

STEP #2: The Treasury issues future Reserves.

  • As we’ve already noted (and explained in the inset on page__) future Reserves are commonly called “treasury bonds” because they pay interest. Because Reserve dollars normally do not pay interest, banks would much rather hold future Reserves (that do pay interest) in order to increase their revenues and profits. A bank therefore readily (even greedily) exchanges Reserves in its Reserve account for the future Reserves issued by the Treasury.
  • Looking again at our diagram-machine, the Treasury issues $100 in future Reserves @ 3% interest.
  • Bank#1 decides it would like to trade its Reserves for the future Reserves plus interest. But its Reserve account only has $10! How does it get the other $90?

(MOVE ONE)

  • Bank#1 exchanges $90 collateral with the FED for $90 in new Reserves. (The collateral might be the deed to the bank’s office building on Main Street.)

(MOVE TWO)

  • Bank#1 now has $100 in its Reserve account—which it trades to the Treasury for the $100 in future Reserves.

(MOVE THREE)

  • Bank#1 trades $90 of its newly acquired future Reserves to the FED in exchange for the collateral the FED was holding. This exchange was planned in advance and is called a “Repo-Agreement.”
  • Bank#1 now has its collateral back, plus $10 future Reserves (+ 3% interest) in its Reserve account. The FED has added $90 future Reserves to its Balance Sheet.

(MOVE FOUR)

  • The Treasury now has $110 Reserves in its account—enough to fulfill Congress’s spending directive.
  • The Treasury writes two checks for $50 each—one to New Jersey Satellites, and one to San Diego Laser Technology—to pay for the building and deployment of the Satellite Laser-Cannon.
  • These two companies are now the holders of bank accounts #1 & #2 in our diagram-machine. They deposit the received Treasury checks in their bank accounts.
  • The two checks from the Treasury are presented at the Central Bank for “clearing.” $100 Reserves are debited from the Treasury Reserve account. $50 Reserves are credited to Bank #1 Reserve account, and $50 Reserves are credited to Bank #2 Reserve account.
  • Bank accounts #1 and #2 are each credited with $50 bank-dollars.

That’s the conclusion of OPERATION #2. The net result of all the accounting operations is that a Satellite Laser-Cannon is built and deployed—and now stands ready to deflect the course of any dangerously large asteroid that might threaten an American city. That, and the peace-of-mind it provides American society, is a big accomplishment!

There are several important things we should consider now about the operations we’ve just observed—but first let’s allow the diagram-machine to run a bit longer before we hit the pause button. (You will have noted that, since it is self-fueling, unless someone or some thinghits the kill switch, it will run on and on forever.) We want to look at two more quick operations in the next Post:

OPERATION #3—Promissory Note to Bank#1 is cancelled.

OPERATION #4—Promissory Note from Bank#1 to the FED is cancelled.

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10 comments

  1. UserFriendly

    Honestly as someone with a rather solid grasp of MMT I find this whole metaphor perplexing, but I’m sure it helps some people.

    I noticed this new group (Our Money) that just started to promote MMT. While they accept MMT’s description on the mechanics of the economy, they also appear to be trying to salvage some ideas from Positive Money. Specifically they want to have some form of capital controls and underwriting standards to limit banks ability to create private debt, but only after a Job Guarantee and expansive fiscal policy are in place. I can sympathize with their goal of decreasing household debt and their frustration that private banks get to profit by creating money and lending it out, but I’m not quite sold that this is how to do it.

    IMO they look like they might just push a lot current of regulated banking into shadow banking, which they find less offensive because it doesn’t have a reserve account with the fed and thus can only lend out actual deposits.

    I wonder if reenacting glass steagall and making FDIC banks boring again would do the same sort of thing with less fuss.

    Reply
    1. Grebo

      You don’t need a reserve account to create credit, just a banking licence. The key trick is to be able to take customer deposits onto your own balance sheet. This allows accounts payable items to be reclassified as customer deposits.

      Positive Money is aware of this and I don’t get the impression they approve of shadow banking at all.

      MMT seems to think that private credit creation is not important because it does not change the Net Financial Assets of the private sector (Bill Mitchell said as much just the other day). I share Positive Money’s suspicion that if you divide the private sector into financial and real sectors something interesting might emerge.

      Reply
      1. skippy

        You do understand the fundamental underpinnings of the PM group I hope e.g. they don’t care about the shadow sector because in their view its more free market [tm] and all live or die by the market [win – lose paradigm]. MMT with Social Democratic administration is an anathema to its core ideological tenets [tm].

        Concur on the evolution of the PM groups stance or like bastard Keynesians the blending of old and new to keep a finger in the pie.

        The “Science” of Money term is about as PR as is Positive Money, you can smell the ideology from around the corner, not that PM has a lingering olfactory signal of precious metals or the free banking period of the 1800s.

        Always found it perplexing that some bemoan the status of banks, yet are completely blissfully ignorant of what sociopolitical-economic views that set that stage, so its back to screwing around with EHM and QTM – if their in charge ….

        Reply
        1. Grebo

          I’ve been reading PM’s output for several years now and they have not set off my quite sensitive Neoliberalism detector yet. Nationalising money and regulating the banks is contrary to the Neoliberal agenda.

          There seems to be a kneejerk reaction in some quarters to any talk of money in economics:—Monetarism!

          You seem to be in that quarter, if I understand you correctly.

          positivemoney.org/2014/12/possible-stop-banks-creating-money-shadow-banks-just-take/

          Reply
          1. skippy

            I’ve been engaging them since the GFC, quite aware of its core members and broader socioeconomic views. Some were quite fond of Milton Friedman and the Chicago plan, not to mention anti democratic tendencies.

            Reply
    2. Male Colium

      Yeah, I don’t think this is MMT at all. Sovereign Governments don’t need to issue bonds and no permission from Congress is needed. These are just conditions put in place by politicians who think other politicians can’t control their spending desires when they discover the power of fiat.

      Reply
  2. Matthew G. Saroff

    One of these days, I’d like to see an analysis of cyanide gold extraction in the 1890s in the end of the long depression from an MMT perspective.

    Obviously, gold is not fiat currency, but an exansion of the money supply is an expansion of the money supply.

    Reply
  3. Susan the other`

    Accounting is important. Unfortunately for me. I just go catatonic at the first sentence. But Alt has woven a simple cloth of money going up and down and in and out. And even I can see that it is intrinsic to the use of fiat. It has finally dawned on me that “fiat” is accounting. At every stage. Spending priorities are the fiscal decisions, accounting organizes and controls it. This simple tapestry can even take on some diagonal threads and for certain needs, isolated patterns with complex stitches. But the more complex it gets, the more regulation we must have to keep the entire piece for warping and twisting. That’s my two cents :-).

    Reply
  4. JEHR

    For me, I have been reading about MMT for some time now and to introduce a new analogy just means another layer of complexity that I can no longer deal with. The analogy might have worked in the initial stages of my learning, but, unfortunately, not now.

    Reply
  5. Mael Colium

    This has been entertaining, but I think the whole purpose of MMT has been lost within the web of colourful explanations, which to entertain, have really just created more confusion. The principles of MMT are much more simple than these explanations – at least to me!

    The point being that MMT is simply a lens to view the operations of a modern monetary system, which enables us to view the potential of a currency sovereign with a floating exchange. Combined with the sectoral balances equations of an economy, we are able to reliably predict and plan the operations of an economy devoid of the arbitrary and often politically based rules imposed by laws and regulations which in face pervert the true capability of Governments to manage economic affairs. MMT is not a rules based system but an observation mechanism.

    Reply

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