December 29, 2017

The creation and value of money and near-monies

Comment on Clint Ballinger on ‘Of Bitcoins and balance sheets: the real lesson from Bitcoin’

Blog-Reference

Clint Ballinger argues: “The national government creates the numeraire for the system (the “Dollar” in the US, the “Pound” in the UK, etc.) and in addition to spending directly in to the economy in that numeraire, the government allows a public/private system (publicly regulated private banking system) to operate with the same numeraire. This creates a single system for the public but in fact, arises from two separate but linked balance sheet expansions.

But why do the tokens from either of these balance sheet expansions have and maintain value?

The government maintains the value of its balance sheet tokens by demanding that some of its tokens, once a year, must be paid back to the government. This guarantees that everyone in that nation will accept and value the tokens from the national balance-sheet expansion.

The tokens that arise from the public/private bank balance-sheet expansion maintain their value analogously ― by the obligation to repay bank loans.

Together, the obligation to pay taxes and the obligation to repay bank loans maintain the value of a currency. Note that both of these rest on the government/legal system of a nation.”

The claim that the value of money depends ultimately on the taxing power of the state is, of course, plain MMT nonsense.

Time to finally settle the theory of money. Because economics is a failed science it has to be reconstructed from scratch. Walrasian microfoundations and Keynesian macrofoundations have to be scrapped.

As the new analytical starting point, the elementary production-consumption economy is defined with this set of macroeconomic axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

Under the conditions of market-clearing X=O and budget-balancing C=Yw in each period, the price is given by P=W/R (1), i.e. the market-clearing price is equal to unit wage costs. This is the most elementary form of the macroeconomic Law of Supply and Demand. For the graphical representation see Figure 1.#1


The price is determined by the wage rate, which takes the role of the nominal numéraire, and the productivity. The quantity of money is NOT among the price determinants. This puts the commonplace Quantity Theory to rest.

The real value of money is ultimately given by the productivity. From (1) follows W/P=R, i.e. real wage = productivity. The value of money has NOTHING AT ALL to do with the taxing power of the state. In the production-consumption economy with budget-balancing and market clearing, the wage income receivers always get the whole output O=RL.

Monetary profit for the economy as a whole is defined as Qm≡C−Ywand monetary saving as Sm≡Yw−C. It always holds Qm≡−Sm, in other words, the business sector’s surplus = profit (deficit = loss) equals the household sector’s deficit = dissaving (surplus = saving). This is the most elementary form of the macroeconomic Profit Law. Under the condition of budget-balancing total monetary profit is zero.

What is needed for a start is two things (i) a central bank which creates money on its balance sheet in the form of deposits, and (ii), a legal system which declares the central bank’s deposits as legal tender.

Deposit money is needed by the business sector to pay the workers who receive the wage income Yw per period. The need is only temporary because the business sector gets the money back if the workers fully spend their income, i.e. if C=Yw.

Overdrafts are needed by the household sector for consumption expenditures if the households want to spend before they get their income. This time sequence is no problem for the central bank because the temporary overdrafts vanish with wage payments.

For the case of a balanced budget C=Yw, the idealized transaction sequence of deposits/overdrafts of the household sector at the central bank over the course of one period is shown in Figure 2.#2


The household sector’s deposits/overdrafts are ZERO at the beginning and end of the period. The business sector’s transaction pattern is the exact mirror image. Money, that is, deposits at the central bank, is continually created and destroyed during the period under consideration. There is NO such thing as a fixed quantity of money. The central bank plays an ACCOMMODATIVE role and simply supports the AUTONOMOUS market transactions between the household and the business sector.

From this follows the average stock of transaction money as M=κYw, with κ determined by the transaction pattern. In other words, the average stock of money M is determined by the AUTONOMOUS transactions of the household and business sector and created out of nothing by the central bank. The economy NEVER runs out of money if the central bank makes a good job.

The transaction equation reads M=κYw=κPX=κPRL in the case of budget balancing and market clearing and this yields the commonplace correlation between the average stock of money M and price P for a given employment level L, except for the fact that M is the DEPENDENT variable.

Money comes into existence on the balance sheet of the central bank as soon as the central bank enters an overdraft for the business sector on the asset side and a deposit of equal amount on the liability side (step 1). This deposit is then transferred to the household sector as wage payment (step 2) and returns in the form of consumption expenditures (step 3).#3

Now the commercial banks are introduced. They can create and destroy ‘money’ technically exactly in the same way as the central bank except for the fact that it is bank money and not central bank money. The crucial condition for the functioning of the two-monies system is that the business sector and household sector accept bank money as practically identical to central bank money.

To be sure, in the strict sense bank deposits is NOT money, only central bank deposits are money. This becomes clear as soon as the households/firms try to exchange huge amounts of bank money for central bank money. This is known as a bank run. In this case, the central bank has to step in and help the banks out with the one and only genuine money. The best way to prevent bank runs from ever happening is the unconditional guarantee of the central bank to exchange bank money anytime and in any amount into central bank money.

So, the private sector = banks can create near-money that works under the appropriate institutional conditions just as central bank money. The real value of near-money is the same as central bank money. Acceptance and the real value of money and near-money do NOT depend on the state’s taxing power.

Problems arise if money is not in the right way brought into circulation. Roughly speaking, as long as the central bank or the private banks or whoever else finances the wage bill Yw, and the wage rate W moves exactly with the productivity, the price P remains according to (1) absolutely constant. The real value of money/near money rises and falls ultimately with productivity.

However, if the money is brought into circulation at the demand side such that the household sector takes up credit and spends it on consumption goods things are radically different. The market-clearing price rises and this reduces the real value of wage income. The output is now redistributed between income spenders and credit spenders, i.e. P1=(C+Ccr)/O > P=C/O with C=Yw and O=X.#4

Secondly, the business sector now makes a profit, i.e. Qm=Ccr. It holds: the household sector’s deficit (dissaving) is equal to the business sector’s surplus (profit). If the money is brought into circulation by the government’s deficit spending it holds Public Deficit = Private Profit. Hence, MMTers as champions of state money creation and deficit-spending are ultimately ― knowingly or unknowingly does not matter ― agenda pushers for the one-percenters.#5

With regard to Bitcoin follows that it is not even remote-money, like a traveler’s check for example, because the issuer does not guarantee to exchange it back at any time one-to-one into bank money or central bank money. The value of Bitcoin depends alone on the expectation that another private person will eventually exchange it for money or near-money or a financial or real asset.#6

Egmont Kakarot-Handtke


#1 Wikimedia AXEC31 Elementary production-consumption economy
#2 Wikimedia AXEC98 Idealized transaction pattern, household sector, balanced budget
#3 Basics of monetary theory: the two monies
#4 MMT, money creation, stealth taxation, and redistribution
#5 MMT is ALWAYS a bad deal for the 99-percenters
#6 Primary and Secondary Markets

Related 'The ultimate ― analytical ― origin of money'.

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REPLY to Matt Franko, Tom Hickey Dec 30

In the political realm, there is rhetoric, storytelling, and obfuscation. In the scientific realm, there is axiomatization, consistency/proof, and clarity.

In the political realm, Humpty Dumpty rules: “‘When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’ ‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’ ‘The question is,’ said Humpty Dumpty, ‘which is to be master — that’s all’.”#1

In the scientific realm, Aristotle rules: “When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.”

Economists never got above the level of proto-scientific storytelling and political agenda pushing.#2

Money is clearly defined and measurable with the precision of two decimal places. Money (liability side of the central bank’s balance sheet) is different from bank-money, near-money, remote-money, pseudo-money, quasi-money, fake-money, crypto-money, clay-tablets, bullion, IOU, etcetera.

Needless to emphasize that the representative economist in general, and the MMTer in particular, have until this very day NO clear idea of the basic concepts of his subject matter, e.g. profit, income, money, and so on. But he has a lot to blather about democracy, the mob, and liberalism.


#1 Humpty Dumpty is back again
#2 Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist