Presenting at PFA – Principal and Interest – Why I Fell Out with Positive Money

pfa

Photo courtesy of Corinne Price

I had a great time presenting on the philosophy of money at Philosophy for All, and I learned a lot. Yes, I noticed the artwork. I’m not going to post the audio of the talk because it was my first time speaking on this; and, frankly, I made several mistakes that I’d be embarrassed to have out in public.

If you’d like me to send you the audio file for your PRIVATE use, drop me your contact details and I’ll consider it.

I found the audience generally receptive to the exercise of trying to think about money in a different way from what we’re usually taught. This bodes well. While I may have been speaking largely to a London elite, the generally sympathetic reception I got makes me wonder why some version of austerity is still the common ideological element uniting all the major UK parties. I didn’t watch the leader’s debate, but I saw enough on Twitter to get the ugly picture.

Some audience members, however, seemed to agree with my general conclusion – that capitalist production requires it to be the case that almost all the time at least one sector is running a deficit* – but for what I believe to be the wrong reason. Their reason is that in order for both the principal and the interest on a loan to be repaid, new debt must always be issued. The idea is that if the whole economy borrows £100 at 5% interest then it owes a total of £105 but only has £100. The ‘extra’ £5 has to come from somewhere, and this can only be from more borrowing. I’ll call this the Treadmill of Debt notion.

Steve Keen expressed some frustration at the prevalence of the Treadmill of Debt notion, and wrote a piece on Forbes explaining why it’s wrong. But his explanation is pretty hard going for the average non-accountant. He points out that it involves a confusion of stocks with flows. That is right, but a simpler way of pointing out the mistake is just to say that interest can also get spent. I think I can make the relevant point with an oversimplified model.

Suppose I borrow £100 from the bank at 5% interest. I use £5 of this borrowed money to pay off my interest, leaving me with £95. The banker takes this £5 profit and spends it buying stuff from me (a friend suggested I could also earn the £5 by working for the banker – mowing her lawn or something). I now have £100, and I pay off the principal. This is enough to show that it’s perfectly possible for both the principal and the interest to be repaid on a loan without anybody taking on more debt. All you need is for the interest to be spent.

Why is this important? After all, I also think that capitalism effectively depends on a continuous growth of debt. But it’s dangerous to think that this is needed just to repay the interest on existing loans. My point is that capitalists produce in order to accumulate money, not all of which they spend. The Treadmill of Debt notion, by contrast, makes it seem as though a permanent expansion of debt is necessary only because of the way the monetary system works. Thus the resulting policy recommendations differ.

One view (the one I think is correct) entails that the government should maintain a permanent deficit in order to sustain production at the highest possible level and increase the deficit during periods of recession.

The other – the Treadmill of Debt view – entails that the monetary system is ludicrous and should be overhauled. I blame Positive Money UK for the preponderance of that view. If you read their literature carefully, they don’t quite fall into the Treadmill of Debt fallacy. But they seem to target their promotional material at people who do fall into it.

There is a lot wrong with the way that banks are regulated. But the monetary system isn’t broken. It does not guarantee ever-expanding debt. On the contrary, it allows for periods of underproduction in which debt doesn’t expand enough for capitalists to realize a monetary surplus and therefore do not undertake production.

As I said, Positive Money don’t fall into the Treadmill of Debt fallacy, but there is one myth they propound that is in serious need of debunking. This is the myth that governments (with floating fx) currently have to borrow from private banks in order to spend. This is an illusion. When the government spends, the central bank credits bank reserves to the recipient of government spending. It looks like the government has to raise this revenue by selling bonds. But there is the illusion. Bond sales are a reserve drain, aimed at maintaining interest rates. Yes, most of the bonds are bought by private banks. The central bank then buys up some of those bonds or sells more out of its own stock, in order to maintain its target interest rate. This is all for the sake of maintaining the rate; it doesn’t finance government spending. If the central bank left the rates at zero there would be no point to the bonds at all, and the illusion that the government spends by borrowing from the private banks would be shattered.

Positive Money types say that we need to switch to a completely different Sovereign Money system, so that the government can create money ‘debt free’ instead of going into debt with the private banks. J. Huber even recommends a revolution in accounting, whereby money becomes a pure asset, with no corresponding liability, rather than a liability of the government. This is all wordplay and empty rhetoric. The results they want can be achieved within the current system with a permanent zero rate policy and the phasing out of bond issuance by the government.

Well, not quite. PM also want the elected government rather than the banks to decide where investment goes in the economy. That, also, is easy under the current system. It requires an active fiscal policy by a government not afraid to run deficits, combined with firm regulation of what banks are allowed to lend for (at least those banks with access to deposit insurance and lender of last resort).

The PM proposal to bring about this result is unnecessary and probably insufficient. Effectively they want to impose a 100% capital requirement on banks. That changes the way banks finance their lending; there’s no reason it should change what they lend for. If it does, this will be as an uncertain and indirect result. Why be indirect, when you can be direct? If you want banks to stop making massive profits out of asset bubbles, for example, forbid them to lend into asset bubbles. No more mortgages on the secondary market, etc., etc.

There are features of the monetary system that desperately need fixing. For that, we need to start recruiting the energetic thinkers and activists that Positive Money and other organizations currently have tilting at windmills. I should know; I used to be one of them.

 

* – that is, ∀ time(t): ∃ sector(x) & x is in deficit at t, not ∃ sector(x) & ∀ time(t) x is in deficit at t. Never mind the Inflation Monster; beware the Scope Ambiguity Monster.

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10 thoughts on “Presenting at PFA – Principal and Interest – Why I Fell Out with Positive Money

  1. Barney

    Im not sure if you have conceptualized this incorrectly, or if you are purposefully play with words here- but you are misrepresenting what Positive Money is saying:

    Steve Keen knows and understands money creation and you have also misrepresented what he and the likes of Adair Turner, Martin Wolf as well as PM have said:

    PM Says: “More Money = More Debt”

    “It is only when somebody is taking money out of the economy, by saving it and not spending it, that somebody else needs to go further into debt.”

    What you are saying is perhaps true from a Keynesian perspective but that doesn’t make what PM is saying false. PM is not talking about growth per se, they are talking growth of the money stock- and for growth of the money stock you need more debt. As Steve Keen and all Post-Keynesian’s say, banks create money by issuing loans. So when they issue new loans they create new money.

    If for whatever reason therefore, new money needs to enter the economy (whether its because people are saving, not spending, paying down debts, flows of transactions have slowed) then you need more people to take on more debt. If you want more money on aggregate (the stock of money to increase) you need more debt. Or are you saying this isn’t the case???

    Next:
    “There is one other Positive Money myth in serious need of debunking. This is the myth that governments (with floating fx) currently have to borrow from private banks in order to spend.”

    Where does PM say that currently have to from private banks in order to spend?

    Next:
    “…so that the government can create money ‘debt free’ instead of going into debt with the private banks”

    Steve Keen and 18 other prominent economists have endorsed this Sovereign Money…Need I say more? See FT letter “Better ways to boost eurozone economy and employment”.

    Next:
    “PM also want the elected government rather than the banks to decide where investment goes in the economy. That, also, is easy under the current system.”

    Lets be clear, PM wants all new money creation to first be decided by the BOE, and then passed on to the Government for allocation. Banks will still be offering credit and deciding where investment goes (or do you think banks shouldn’t perform this function???). This specifically designed to be “easy”, as no fundamental changes really have to happen- thanks for pointing out the obvious.

    Next:
    “That, also, is easy under the current system. It requires an active fiscal policy by a government not afraid to run deficits…”

    This is illusory…have a government not afraid to run deficits, would most likely mean the end of politics. Under a PM system there would still be deficits and plenty of room for politicking about deficits…

    Next:
    “Effectively they want to impose a 100% capital requirement on banks. That changes the way banks finance their lending; there’s no reason it should change what they lend for. If it does, this will be as an uncertain and indirect result. ”

    It would most certainly change what banks lend for! Banks would actually have to compete for savings. Peoples savings would be at risk, and would induce them to see exactly where they are putting their savings. Banks would start being competitively more transparent about their lending practices.

    Next:
    “Why be indirect, when you can be direct?”
    Great you mention, why be indirect with manipulation of interest rates, OMO, and QE (which according to the BOE take 3 years to influence inflation), when you can be much more direct with Sovereign Money??

    Next:
    “There are features of the monetary system that desperately need fixing. For that, we need to start recruiting the energetic thinkers and activists that Positive Money and other organizations currently have tilting at windmills.”
    Positive Money has undoubtedly had the greatest affect on educating the public on how money is created. Everything you have mentioned here has painted them in a dark light. I dont know what happened to you, how you got your ego or feelings hurt, but the fact that you are a so called academic/activist and you cannot give an objective/realist analysis of PM completely discredits you. They have done a lot of great work, more than you on the subject, and for that matter they deserve applause! You should know; you used to be one of them…

    Reply
    1. axdouglas Post author

      You’re right; there’s a clear sense in which ‘more money = more debt’ is true. I’ve removed my criticism on this point – thanks for drawing that to my attention.

      Several times I’ve acknowledged the good work PM have done in raising awareness, etc. I just think the ultimate goal of the campaign – to overhaul the monetary system – is the wrong goal.

      If ‘Sovereign Money’ is just your term for active fiscal policy, of the kind advocated in that FT letter, then I’m in favour of Sovereign Money. But most people use the term to mean something else: a proposed comprehensive reform to the monetary system. It is, as Neil Wilson has argued, based on an illusion (I really recommend that you read the linked post). You seem to vacillate, using it in both senses at different times in your comment.

      The rest of your comment seems a bit breathless and aggressive; maybe we can discuss this more when you calm down a bit.

      Reply
  2. NeilW

    “Lets be clear, PM wants all new money creation to first be decided by the BOE, and then passed on to the Government for allocation”

    Why? The Queen is sovereign in the UK. Why not let the privy council decide? Why is the BoE to be elevated to position of sovereign?

    The BoE has no more idea about what is happening than the privy council, the House of Lords or the Sovereign Herself. As they have demonstrated over the last six years or so.

    Why are you in favour of unelected entities ruling the country rather than the elected parliament?

    Are you so desirous of a return to feudal rule or would you just like a rerun of the 1910 constitutional crisis?

    There’s rather too many people around in economic circles who want to end democracy, or pen it in so they can implement their view of the world Once and For All Time.

    If you want an autocracy ruled by the elite you should say so. The British system is peculiarly setup for that mode of operation since the elite is still in place. Just need to repeal the Parliament Act.

    Reply
  3. Barney

    Apologies, Alex, it easy however to get lost in translation. I definitely tried to write it as quickly as possible (breathless) but did not mean to sound aggressive- as it seems you did not either. For this Im sorry and really hope you accept my apologies.

    Neal, you know that what PM advocates is that the BOE only decide how much to create, and the decision to allocate the newly created would rest with elected members of parliament, so why say: “Why are you in favour of unelected entities ruling the country rather than the elected parliament?” Please explain? Im so tired of MMTers misrepresenting PM, it is exhaustive…

    Reply
    1. NeilW

      If the House of Lords or the Privy council decide on the amount of money the elected members would still decide how to spend it.

      So why not use the existing institutions. They are already employed. After all it was only in 1910 that the House of Lords lost the veto over the elected house on Finance Bills – because Lloyd George wanted to push through the People’s Budget and spend *more* than the House of Lords felt was appropriate.

      Are you saying the House of Lords was right in 1910?

      So again why are you in favour of unelected elites deciding how the elected parliament achieves what is has been elected to do. What you are proposing is *precisely* the same situation we have in Greece where neo-liberal elites stuck to a particular paradigm continue to rule *even though* they have been defeated in a General Election – because they hold the purse strings.

      The Lords at the BoE have no more clue about what is going on that the Lords on the Privy Council, or the greater number of Lords who have seats already in parliament because somebody appointed them there decades ago. We can’t get rid of any of them either – no matter how bad they are at their job.

      You are proposing an autocracy of the elite controlling parliament as though it is a town council.

      That is anti-democratic and you should be ashamed of yourself.

      Reply
    2. axdouglas Post author

      No worries.

      But I agree with Neil.

      Re 100% capital requirements: if banks need to guarantee a 10% odd return to their equity investors, how is this meant to result in them doing less volatile and dangerous lending? That’s precisely the sort of lending that gets you the highest (short term) return.

      You might think there’s less systemic risk if banks only lend their equity, but this is an illusion founded on the illusion that a sovereign money system prevents banks from creating money. It doesn’t. Even if you just had Bradbury pounds, banks could ‘create money’ by relending the same pounds as many times as recipients of spending financed by loans used those pounds to purchase equity in the bank. Maybe this is an elementary point, but Positive Money literature obscures it with all this talk of banks not creating money.

      Reply
      1. axdouglas Post author

        Also, MMT people aren’t misrepresenting PM. The point is, as Neil says, holding the purse strings gives you a huge amount of power, regardless of your control over how money is spent.

        Imagine that the government desperately needs to run a deficit to sustain production and reduce unemployment, but the BoE, in the grip of austerity ideology, refuses to create the required money. The BoE now has total control over the level of unemployment in the economy.

        Mass unemployment is the greatest evil an economy can face; under the PM system the pointy heads at the BoE have free rein to create or fail to prevent it at any time. And if we don’t like it, we can’t vote them out (cf. Greece and the Troika).

        This doesn’t require them to be corrupt or malicious. It just requires them to be mistaken, as central banks have been known sometimes to be.

        The fact that the government can choose how to spend the money, *if* it gets any, is irrelevant.

        You say: ‘Under a PM system there would still be deficits and plenty of room for politicking about deficits’. But deficits would mean something completely different under the PM system. If the BoE won’t issue new money, the government can only borrow by competing with private investors on the bond market. It would be just like how orthodox economists think it already is.

        The upshot is this: if what is needed to stave off unemployment is *more* investment, there is *nothing* the elected government can do to bring this about, under the PM system, unless the BoE agrees to do its part and create new money.

        What’s the point of this dramatic surrender of democracy? If you want the government to create money for sensible investments, to maintain full employment and a high level of production, why not just campaign for a better fiscal policy, carried out by the politicians we elect? Why campaign to give power over to the unelected, in the hope that they’ll govern in our interests?

        ‘I dont know what happened to you, how you got your ego or feelings hurt…’ It’s really not about me. It’s about sensible, democratic reforms versus throwing in the towel and giving up on democracy altogether. It’s also about understanding what would and what wouldn’t change the behaviour of banks.

  4. NeilW

    Everybody I know in banking chuckles quietly to themselves when they see people getting excited about the currency view. I half suspect that the lobbying structures in the banks encourage the process since it guarantees a lot of people are tied up making a change that will have no material effect on banking.

    And while they are ‘seen to be doing something’ in that direction the actual controls required on banks – limits on what they can lend money for, what other businesses they can be in and the excessive size and political power of the banks – stay unaddressed.

    Reply
  5. Pingback: The Government Debt is NOT a Burden on Future Taxpayers (slightly wonkish) | Origin of Specious

  6. Pingback: The Government Debt is NOT a Burden on Future Taxpayers (slightly wonkish) | Origin of Specious

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