Monday, March 21, 2011


From Billy's of 16 March, 2011:

The national government of Japan can always afford to purchase concrete, wood, steel, glass, health care, road contractors etc as long as those resources are available for sale in Yen.

There is no question about that. It issues the currency as a monopoly provider (that is, as a consolidated treasury/central bank unit). It doesn’t make any sense to say that the issuer of the currency can be constrained in terms of using that currency.

Intrinsically that cannot be the case. Politically, it is a different matter and the politicians might attempt to put themselves in a straitjacket and pretend that they have to spend on a quantity rule...

Billy's argument, as always, is that the government "can" print money enough to buy whatever it decides it needs. "There is no question about that," he adds, but "Politically, it is a different matter."

Politicians "pretend that they have to spend on a quantity rule." Billy always says stuff like that, suggesting politicians should use their judgment about spending, rather than a quantity rule. I would bet he loses a lot of readers because of it. Politicians obviously need some kind of spending constraint, some kind of rule.

But I'm not sure Billy objects to politicians using a rule, really. I suspect he objects to them using a rule that is wrong. At least, that is my objection.

The accepted rule -- the wrong rule -- says that if there is inflation, somebody's been printing too much money. This is a major rule. We even have an institution created specifically for the purpose of making sure we have just the right amount of money in the economy, not too much money.

Some people today want to "end" that institution. Why? To restore financial stability to America's economy. Largely, because the Fed has failed to prevent inflation.

But ending the Fed is like shooting the messenger. The problem is the message. The problem is the rule that is used to prevent inflation, the quantity rule. You know: Printing money causes inflation. That rule.

Sure, the Fed is more than just a messenger. The Fed acts on the rule. But if the rule is wrong, it is the rule that must change. If we just end the Fed, best-case, we set up some other system, apply the same rule, and again get a result we don't want.

The correct solution is not to end the Fed, but to change the rule. So the question is: What is wrong with the existing rule?

The problem with the existing rule is that there could be something else, other than printing money, that is causing inflation. Something like the use of credit.

The Old Rule

The rule we use now says that if there is inflation, then we must reduce the quantity of money. As I have noted before, the rule is open-ended: It provides no lower limit to the quantity of money.

So then if something other than printing money is causing inflation -- if the use of credit is causing inflation -- then our rule will cause us to drive the quantity of money down to too low a level. Below optimum. Below reasonable. Below the minimum we need to keep our economy working, even. With this rule, as long as there is inflation, there is no limit to how low we may drive the quantity of money.

Furthermore, since the rule does not address the actual cause of inflation, the policy can never be successful. All it can do is undermine economic performance.

The history of the U.S. economy since World War II shows that we have in fact driven the quantity of money to an extremely low level (see Graph #1.) History also shows we have allowed debt to climb to an extremely high level (Graph #2).

Graph#1: Not Enough MoneyGraph#2: Too Much Credit Use

Debt is the measure of credit in use. If we have a lot of debt, it means we have a lot of credit in use. And credit-use can cause inflation. In the Arthurian view, it is credit-use, not printing money, that caused the inflation of the past 40 years.

We stuck by our rule and drove money to an impossibly low level. And then to keep our economy working we used more and more credit in place of that money. This is the reason we have so much debt today, and so much trouble to pay it off.

The New Rule

The time has come to abandon the old, open-ended rule. It hasn't worked anyway for a long time. We never did end the inflation. We need a different rule to tell us how much money we need in our economy. We need a new rule.

The new rule is a lot like the Laffer Curve. Remember the Laffer Curve? It said there is a particular tax rate that will generate the most revenue. It said that other tax rates -- higher or lower -- generate less revenue.

The new rule is like that. The new rule says there is a particular ratio of debt relative to M1 money that will generate the best economic performance. It says other ratios -- higher or lower -- give us less satisfactory economic performance.
Let's say instead: a narrow range, not a particular ratio of debt to M1 money.
The new rule takes into account both money and credit-use. The old rule said if there is inflation there is too much money. But the old rule never did stop inflation. And obviously, the old rule did nothing to prevent the excessive use of credit and the excessive accumulation of debt.

The new rule says we must consider both money and credit-use, we must keep the ratio between the two at a level that gives us maximum economic performance, and that we should increase or decrease the quantity of "money and credit-use" together, as needed to fight inflation.


The Arthurian said...

When you read anybody else's stuff, always ask one question: Do they consider the relation between money and credit-use?

None of'em do.

Greg said...

Credit IS money. It can be used to make a monetary transaction so it is money.

I agree with your analysis but everyone knows credit is money so I think you are making a confusing distinction.

Credit when it reaches a certain level becomes DEFLATIONARY because credit must be serviced out of an income stream thus removing spending on something else. Then defaults occur because the decrease in spending leads to layoffs and inability to service private debt. Then, wrongly in my view, we prop up the ailing banks balance sheets to keep them lending (to no avail) and keep assets from falling in value. Now you have decreased incomes, asset prices steady or rising which LOOKS LIKE inflation because the cost of living is going up but all measures of inflation are low. The policy goals are to keep wages from rising which is feared to be inflationary.

My $.02 worth

The Arthurian said...

I can only say it the way I see it:

Money that cost interest to use is credit. Money that does not cost interest to use is money.

If I borrow from the bank I am putting credit to use. If I use that money to pay you, you receive money. You receive money because you do not have to pay interest on it.

But I do, so my credit is still in use until I pay off the loan.

The thing that people call "debt" is only a measure of how much credit is in use.

To me, this makes much more sense than the three words "credit is money."

I like your 3rd paragraph there.

The Arthurian said...

The way I put it sometimes is: We use credit for money.

The Arthurian said...

The increasing reliance on credit is the problem (and the policies & misunderstandings that give rise to it). But just because we use credit for everything doesn't mean it is okay to use credit for everything. That's the main problem, after all.

Calgacus said...

Replying to several threads here:
Arthur:Anyway, everyone KNOWS what money is.Das Bekannte ├╝berhaupt ist darum, weil es bekannt ist, nicht erkannt. - What everyone KNOWS (is familiar with) is often what is least understood, truly known, most in need of explanation.

"somebody [like me :-) ] says money and debt are the same thing. Maybe that's true on some definition, but wow is it irrelevant. And wrong.."

"Public debt is actually private sector money."

The last is much of MMT/chartalism/functional finance/creditary economics in a nutshell. If you understand government money, dollar bills as government debt, just like government bonds you've made a key leap. So you see all forms of money (government debt, private bank accounts etc) everywhere and everywhen are a credit/debt relationship. Money is not, never was a thing, a commodity. Money is always a relationship.

Greg:Credit IS money. It can be used to make a monetary transaction so it is money. I agree with your analysis but everyone knows credit is money so I think you are making a confusing distinction.

That's not exactly right. Money is necessarily, always, credit, but credit is not necessarily money. Money is a special kind of credit/debt. It is assignable, transferrable credit/debt. If your debt can circulate, it is by that token money in the circles where it circulates. For example, bank credit money = bank deposits = bank notes=bank IOUs are money for almost all purposes in modern economies. But bank credit money is not money for banks for final settlements with the government; only government money, dollar bills or reserves will do. Modern states back bank credit, so that bank money circulates at par with government money. Personal IOUs are credit, but not usually money nowadays. (Bills of exchange were personal IOUs, of major merchants, that formed most of England's money around 1800.) The purpose of going to a bank for a loan is to exchange your credit, your personal IOU for a bank IOU, a deposit, which is usable as money for almost all purposes.

Greg:Using terms like currency, credit, asset etc is MORE descriptive and makes people consider what they are actually referring to.

I am not disputing Modern Monetary Theory as a theory. I am disputing common theories of how to write about it, which are a barrier to comprehension, as shown by how much Arthur (and anyone else sensible) likes your short explanation of public debt as private sector money, which is not highlighted sufficiently in most explanations. But cf at Mike Norman's.
The current crop of theorists has advanced beyond the past. But they do not know how to write as well as some of their predecessors, e.g. Abba Lerner, and avoiding the word "money" or ambiguous terms is a prime example. Not making clear the definition of money as a general concept, a case of an even more general one- "credit", then the state's money, like reserves, as the universal money, and then other kinds of money like bank credit as nothing but specializations, disambiguations of the general concept sows confusion and makes for longwinded exposition.

The Arthurian said...

Cal, how do you distinguish between money that costs interest and money that does not cost interest?