The event included both MMTers and Sovereign Money proponents. It was a great event, and I think everyone got a lot out of it, even the Sovereign Money people.
Here is a photo of us, with Warren (somewhat ironically) holding up a Positive Money shirt. Notice smiling non-Brits on one side, unsmiling Brits on the other (hee hee hee):
One of the pleasures of the evening (for me at least) was hearing Warren making a careful, line-by-line criticism of the book Where Does Money Come From?, published by the New Economics foundation. I’ve heard little but praise for that book, which I believe to contain a number of misleading statements. So it was reassuring to hear Warren taking issue with it.
Ralph asked Warren if he could write his criticisms up into a review of the book. Warren replied by asking why people were always trying to give him more work, which is fair enough! But I take Ralph’s point; it would be nice to have a written version of the criticisms to refer to. Thus I’m going to try to present, in my own words, the gist of a few of the comments I remember Warren making on the first two chapters of the book.
Please be aware that I’m going on nothing but memory here – I became too engrossed to take notes. I’ve listed the sections of the book Warren was criticising and quoted the relevant passages. The criticisms are, of course, in my own words.
I’m going to put this up and then invite others who were present at the event (including Warren) to correct me where they think my memory has failed, so please check back to see what has come up.
1.2.1 The money supply and how it is created
Defining money is surprisingly difficult.
So why bother defining it? You only end up getting into Scholastic disputes about whether credit cards, payslips, McDonalds vouchers count as money. Why not just say “cash” when you mean cash, “bank deposits” when you mean bank deposits, “Treasury bonds” when you mean Treasury bonds, etc.?
New money is principally created by commercial banks when they extend or create credit, either through making loans, including overdrafts, or buying existing assets.
This only follows from defining money in a particular way. So it doesn’t have the sort of operational significance the book gives it.
Physical cash accounts for less than 3 per cent of the total stock of circulating money in the economy. Commercial bank money – credit and coexistent deposits – makes up the remaining 97 per cent.
This completely leaves out Treasury bonds, which are also highly liquid and circulate widely. The reason is that Treasury bonds have not been included in the definition of “money”. But that, as above, is quite arbitrary. Including Treasury bonds in the money supply would in fact make a lot of the textbook quantity effects show up more clearly. [UPDATE – Warren adds: MOST IMPORTANT IS THAT TSY SECURITIES ARE NOTHING MORE THAN TIME DEPOSITS AT THE FEDERAL RESERVE BANK. THAT IS, FROM THE STANDPOINT OF THE DEPOSITOR, THEY ARE JUST BANK DEPOSITS- DOLLARS DEPOSITED IN A BANK. SO FOR ME THE BURDEN OF PROOF IS WHY THEY AREN’T ‘INCLUDED’ THE WAY OTHER BANK DEPOSITS ARE? AND WHEN YOU DO THAT, YOU SEE THAT QE, FOR EXAMPLE, DOES NOTHING TO ‘THE MONEY SUPPLY’ THAT INCLUDES THOSE TIME DEPOSITS AT THE FEDERAL RESERVE BANK.]
1.2.2 Popular misconceptions of banking
In fact the ability of banks to create new money…
Why not say “create deposits”? It would be much more precise.
…is only very weakly linked to the amount of reserves they hold at the central bank.
It isn’t limited by the reserves they hold at all.
…it is the commercial banks that determine the quantity of central bank reserves that the Bank of England must lend to them to be sure of keeping the system functioning.
It’s not a matter of “keeping the system functioning”. In the first instance a reserve requirement per se is an overdraft, so it’s not wrong to say loans create both deposits and reserves, as a matter of accounting, or something like that. In other words, “adding reserves” is never subsequent to lending, as a point of logic. [The words from the second sentence of this paragraph onwards were supplied to me by Warren and replace what I had there earlier.]
Keynesians and Austrians argue about whether the central bank should or shouldn’t supply required reserves to the banking system. This is all a red herring, since in fact the central bank can’t not lend the reserves.
1.2.3 Implications of commercial bank money creation
…capital adequacy requirements … are mainly ineffective in preventing credit booms and their associated asset price bubbles.
Boom and bust cycles are just a fact of life under capitalism; you’ll have them regardless of what you do with the banking system. People will always find ways to go in when times are good and get out when times are bad. The point is to have the state mitigate the effects of the cycles, not to try to build a system that makes them impossible. [Warren adds: I’M IN FAVOR OF REMOVING THE INCENTIVES AND OTHER CAUSES OF MUCH OF WHAT’S HAPPENED, AS PER MY PROPOSALS FOR THE FED, THE FDIC, THE TSY, AND THE BANKING SYSTEM. AND IT’S ALL A WORK IN PROGRESS, OF COURSE. BUT NOT TO LOSE SIGHT OF THE RESPONSIBILITY OF THE STATE TO SUSTAIN AGGREGATE DEMAND WITH FISCAL ADJUSTMENTS. THE CURRENCY IS A PUBLIC MONOPOLY, THE STATE IS IN CONTROL OF THAT MONOPOLY, AND MONOPOLY IS WHAT IT IS- IT’S UP TO THE MONOPOLIST, NOT ‘MARKETS’. THE MONOPOLIST IS SOLELY RESPONSIBLE FOR FISCAL MANAGEMENT.]
Banks decide where to allocate credit in the economy.
No they don’t. All their loans can be investigated by the state, which has the power to tell them what loans they can and can’t make. As an analogy, an individual soldier can choose where to point his rifle, but this doesn’t mean that the military isn’t controlled by the state. Soldiers have their orders, and so do the banks. The regulators can make the orders as precise or as imprecise as they like.
Basically, banks are public-private partnerships, working in the public interest as determined by the state. If they don’t provide net social benefit, that’s the fault of the state for not setting their purposes properly. (Warren’s main idea for reforming bank regulation is to have the state tell banks what they are allowed to do, rather than, as currently, trying to tell them all the things they aren’t allowed to do – a hopeless task, which always leaves out something important.)
Fiscal policy does not in itself result in an expansion of the money supply.
Only because Treasury bonds have not been included in the definition of money! So this is a fact that follows from a mere definition and can’t have any operational significance. [At this point Warren looked at me to give a helpful philosophical explanation, which I was unable to do. I now propose Collingwood’s phrase: “trying to pull a concrete rabbit out of an abstract hat”.]
Also, if the Treasury didn’t sell bonds to drain reserves after it spent then fiscal policy would result in an expansion of the money supply as defined by the authors. In fact bonds are a relic of the gold standard (when an importance difference between them and reserves was that reserves were gold certificates and bonds were not). Today bonds are sold for the purpose of maintaining a higher-than-zero interest rate, but this could just as well be achieved by paying interest on reserves.
2.2. Popular perceptions of banking 1: the safe-deposit box
A poll conducted by ICM Research on behalf of the Cobden Centre found that 33 per cent of people were under the impression that a bank does not make use of the money in customers’ current accounts. When told the reality – that banks don’t just keep the money safe in the bank’s vault, but use it for other purposes – this group answered “This is wrong – I have not given them my permission to do so.”
Your deposit never leaves the bank’s balance sheet. The bank doesn’t debit or credit your account without your instruction, and so your money isn’t “used for other purposes” by the bank.
2.4 Three forms of money
While many assume that only the Bank of England has the right to create computer money, in actual fact this accounts for only a tiny fraction of the money supply. The majority of the money supply is electronic money created by commercial banks.
Commercial banks can create deposits, which are liabilities for the banks and assets for the depositors. This must all net to zero overall. Only the state can create net financial assets for the private sector.
Central bank reserves are used by banks for the settlement of interbank payments…
In the US most clearing is done by private clearing houses, because they are cheaper than the Fed for member banks. Only end of day net clearing is done at the Fed. [These words are from Warren, who adds: ideally the Fed would just allow member banks to have unlimited overdrafts and not charge a penalty rate, but just the policy rate, which would end the need for the interbank market.]
When banks do what is commonly, and somewhat incorrectly, called ‘lend money’ or ‘extend loans’, they simply credit the borrower’s deposit account, thus creating the illusion that the borrowers have made deposits.
Where is the illusion? The loan just creates a deposit for the borrower.
Bank deposits are not legal tender in the strict definition of the term…
Legal tender laws are only relevant when payments are demanded in the courtroom. They are of little significance anywhere else since people circulate all sorts of assets that aren’t legal tender (many countries have no legal tender laws and get by just fine).
The term ‘money supply’, usually refers to cash and bank deposits taken together…
Which is a purely stipulative definition and leaves out a lot that is operationally significant.
2.5 How banks create money by extending credit
…let us just consider whether it is really meaningful to describe the balance in your bank account as anything other than money. You can use it to pay for things, including your tax bill, and the Government even guarantees that you will not lose it if the bank gets into trouble.
So why not include Treasury bonds in the definition of “money”? Also, on this definition only deposits under the insured amount count as money.
The main constraint on UK commercial banks and building societies is the need to hold enough liquidity reserves and cash to meet their everyday demand for payments.
This is not a constraint at all, as explained above.
2.8 How money is actually created
…the authorities are not free of responsibility for results produced by the largely unchecked behaviour of the banking sector.
This is a massive understatement, since banks are public-private partnerships, as explained above.
Equally, while banks can create deposits for their customers, they cannot create central bank reserves.
But, again, required reserves are always automatically loaned to banks, though possibly at a punitive rate.
Therefore, they can still suffer a liquidity crisis if they run out of central bank reserves and other banks are unwilling to lend to them.
When a central bank chooses to adopt a laissez-faire policy concerning bank credit, as now in the UK, boom-bust credit cycles are likely to result, with all their implications for economic analysis and policy. This is obvious when we think about the link between credit creation and economic activity.
What matters in terms of business cycles is the solvency of debtors, not the quantity of credit. And, again, boom-bust cycles are a fact of life. You can’t stabilise the economy by fixing banking alone.
More generally, you can’t read public purpose off the monetary system. You need to decide on public purpose and then make whatever monetary system you have work for that purpose.
Footnote on MMT (in section 6.2)
The book contains a footnote on MMT, which Warren found to be inaccurate. The main passage reads:
If the Government cannot borrow money from the central bank or create its own money, how then does it ‘spend’? Governments must, like me and you, obtain money from somewhere before they can spend.
The footnote reads:
Modern Monetary Theory (MMT) is an approach in macro-economics which argues against this.
Warren pointed out that this is false. MMT agrees that if the government can’t issue its own currency / borrow from its own central bank (i.e., on a fixed exchange rate system), then it has to obtain currency before it can spend. But on a floating exchange rate system, the government spends by crediting reserve accounts and has no financial constraint. Bizarrely, the footnote goes on to say that:
MMT says that in nation states with fiat money, sovereign currencies and central banks … [t]here is no restriction on governments’ ability to spend by creating new money.
But a nation state with ‘fiat money’ is not in the condition specified above (“the Government cannot borrow money from the central bank or create its own money”).
So Warren concludes, as I do, that the authors seem not to understand MMT and to be confused about what it is actually proposing.
Indeed, there seems to be a general confusion surrounding concepts like money, debt, creation (of money), etc. Frank van Lerven of Positive Money agreed that most of the differences between MMT and Positive Money come down to conceptual or semantic distinctions. I think I remember that Laurie MacFarlane of the New Economics Foundation also agreed on this point.
What we need, therefore, is a philosophical investigation of the relevant concepts aimed at clarification and improving consistency.