Guest Author: Derryl Hermanutz
The commenter quoted below is laboring under a very common (actually it’s pretty much universal) misconception about how our economies work. This is why the “authorities”, who are laboring under this same misconception, do not know how to “fix” the current monetary problems. The misconception prevents people from seeing what is actually happening in our economies, because it creates a false “worldview” that sees things that aren’t there and is blind to things that are there.
Picture is of Nicolaus Copernicus.
Criticizing the conclusion of Gavin Kakol’s article, “Public Employment: This Time Is Different”, that the federal government should fund local governments so they can restore public sector employment, the commenter wrote,
“If you do not care about the National Debt that all makes total sense. But if you do think the National Debt matters, then government expenditures have to contract. This is clearly a drag on GDP and employment. So there is a choice to be made. Pain now or Credit crisis later. Neither is a happy outcome. Fairly obvious but not to many who post here. Living beyond one’s means has consequences.”
Yes, from the microeconomic perspective of a household, living beyond one’s means today by borrowing money to spend more than their income requires that they live below their means tomorrow because they must devote their income to debt pay down rather than spending. A household’s ONLY long term source of spending money is its income, if we assume that the household will in fact eventually repay all the money it borrowed rather than default and go bankrupt, suffering a household scale “depression”. Repaying its debts causes the household to suffer a “recession”, where total spending decreases and causes the standard of living that is purchased with that spending to decline. But if the household eventually pays its way out of debt it can resume spending its income to purchase its standard of living.
Recessions vs. Depressions
“Recession” implies a dip and a recovery. There is no “orthodox” way out of a “depression”. Escape from depression requires a paradigm shift out of the flawed orthodox paradigm that caused the depression and into a new paradigm that “works”.
A Nation is Not a Household
Spending borrowed money may be harmful to a household’s long term economy, but from the macroeconomic perspective of a national economy, one person’s spending is another person’s income. A reduction in household spending to pay down debt directly causes a reduction in national income, unless the nation can sell its economic output to foreigners ("export") and capture the spending money from a foreign economy to add to their own national income.
Permanent Positive Balance of Trade is Unsustainable
Of course this is unsustainable as the foreign incomes whose spending you are capturing will soon collapse because the foreigners are not earning incomes by producing their own consumption goods but are drawing down their savings and increasing their debt in order to purchase the outputs from your nation. Once their savings are exhausted and their credit limit is reached you can no longer rescue your national balance sheet by "exporting".
This is what happened to Greece (importer) and Germany (exporter). Eventually the net importer runs out of borrowed money to spend buying your exports. This "mercantilist" approach, trying to export your way out of an arithmetic problem, necessarily ends like this, under our current zero sum global monetary system.
Seeing What You Believe
The universal monetary misconception of classical, neoclassical and Austrian economic theory blinds adherents to the simple arithmetic realities of our zero sum money system. People who have learned and believe in these economic models are seeing a “barter economics” world that isn’t there, which blocks their view of the “money economy” world that IS there. This includes pretty much everybody, except for a smattering of “heterodox” economists who understand money and are gleefully guilty of heresies against orthodox economic beliefs.
So pretty much “everybody” is wrong. Orthodox understandings of economics, all the “received wisdom” of the past two and a half centuries of economic thinking, pretty much everything that is taught in university macroeconomics courses, pretty much all of the economic and monetary policy making authorities, are simply and fundamentally wrong about how macro economies work. We need to abandon these false worldviews and start over with a true understanding of how our economies work, or we will reap the financial-cum-economic whirlwind of our monetary ignorance.
Economics is Numerical, Not Theological
Macroeconomics is written in arithmetic equations with positive and negative numbers so ALL of the solutions are necessarily numerical. Not political. Not economic. Arithmetic. Money is numbers. Our solutions will be monetary, not economic.
A nation’s macro economy is described as: GDP = C + I + G + X.
X = net exports = exports minus imports + net flows into your economy of foreign investment capital buying your national bonds or companies or real estate or other assets + tourism, where foreigners come and spend their money enjoying your economy and leave their money behind when they go home.
Your central bank converts the foreign currency that is invested or spent in your country into your national currency which becomes a net addition to your national money supply, and a net loss to THEIR national money supply.
GDP is a Record of Spending
Each of the letters in the equation above represents a sector that is SPENDING money into your national economy, your national monetary arithmetic equation: consumers, investors, governments and foreigners.
GDP is simply an account of the total net spending into an economy in a year, money spent in minus money spent out of your economy. Saving your money is not unconditionally virtuous and spending is not some evil act of profligacy as some miserly schools of moral economy suggest.
Without spending there is no GDP and no “economy”. If oil is the economy’s lifeblood, money is its nervous system. Money that is being spent or invested into the economy signals and “commands” the economy to act according to the will of the spender. Without the spending of money no commands are being sent and the economy sits there doing nothing.
So where do these C, I G and X sectors GET the money they spend? C and I get their money by "earning" it as incomes or from sales or by "borrowing" it as debt. G gets its money by "taxing" or borrowing, but taxing merely redistributes private sector incomes and does not add any new spending power to your national economy, so G can only ADD to GDP by borrowing and spending. And borrowing adds no full cycle net spending power either, as the borrower is essentially agreeing to tax his own future income in order to repay the borrowed spending: the borrower is redistributing spending power FROM his own future TO his present, without any net ADDITION to his total full cycle spending.
Horizontal and Vertical Redistribution of Money
Where taxing is a “horizontal” redistribution of spending power across a population, debt-funded spending is a “vertical” redistribution of spending power over time. “Redistribution” is not “addition”. No net new spending power can be added by redistribution. Only addition can add net new spending power. Under the current operation of our monetary and economic system, no addition is being done. This failure is the source of our current crisis.
Ultimately, “earned income” is the economy’s source of spending power. Earned income can be redistributed by taxation, and earned income can repay in the future debt-spending that was done in the present. Income is “earned” by working for or selling goods and services to “Investors”; and Investors earn their income from selling their outputs to Consumers and Governments and to other Investors. Investors are the businesses who hire the economy to produce the national economic output, and in the process pay out the national earned income. Without the earning and spending of income money there can be no C, consumption spending. Consumers have to earn income BEFORE they have any power to consume the economic output (or reduce future consumption by borrowing for consumption now).
Government is also a large scale employer of the economy, but under the current system government can only fund itself by redistributing earned incomes both horizontally (present taxation) and vertically (future taxation to repay today’s debt-funded spending). Here is where we might find part of our solution. Monetarily sovereign national governments who have the constitutional authority to issue their national money can partially fund themselves by creating their own debt-free money and spending it into the economy where it becomes “incomes” to the people who receive the money. This is one way of net “adding” to the national income.
At present the government’ main source of income (aside from fees for services) is taxation. Deficit spending, where governments spend more than they tax, is funded by bank debt, by borrowing money via “bond sales” from their banking systems or from domestic and foreign financial markets. So the current mechanisms of government deficit spending merely redistribute their national earned incomes vertically over time without adding any net new spending-cum-incomes into their economies. Funding this deficit spending with money they create themselves debt free, rather than with money they borrow as new debt, is one way of adding net income into their national economies.
Balance of Trade
X might be either a government or a private sector buyer from a foreign country but it doesn’t matter to your own national GDP equation because all that counts is that they are adding positive money numbers into your national spending equation. Or they are adding negative numbers if you have a trade deficit or capital account deficit rather than a surplus: if you are spending and investing more of your own national income and borrowed money into foreign economies than they are spending and investing into yours.
Money Creates Demand
You will note that there is no “real economy” in these equations. We are seeing flows of money numbers but no flows of real economy goods and services. Indeed, macroeconomics is about nothing other than the economy’s money system, which is a numbers system. Money is the “demand” side of every economic transaction. If there is no money flowing from buyer to seller, there is no “sale”, and no “economic” exchange occurs.
A Fallacy of Composition
Microeconomics deals with the “supply” side of transactions, producing the stuff that is available to buy: issues in the real world economy such as supply and demand of resources and flows of real goods and services, resource scarcity, “value”, etc. All of the fallacious schools of macroeconomic theory: classical, neoclassical, Austrian, etc., try to build a macro theory by scaling up their micro economics: “A national economy is simply a household or firm writ large.” they believe.
This can’t work, because the macro economy is about the money system, the demand side of transactions, and all of these schools of microeconomics leave banking and money entirely out of their economic models: as they should, for they are dealing with the real economy, the supply side; not the money system, the demand side of economic transactions.
Effective Demand – A Macro Concept
Macroeconomics is a purely arithmetic description of the flows and stocks of money, credit, debt, and the distributions of these across a population and across time. Macroeconomics is about banking and the money system where “effective” demand gets created and distributed by the creation and lending of “money”. “Real” demand, people “wanting” stuff, is naturally occurring and virtually unlimited. “Effective” demand is real demand that is backed up with having “money” to pay for the stuff you want.
Production – A Micro Concept
Microeconomics is about the real economy that produces the supply of all the stuff that is available to buy with the money. The real economy produces real goods and services, real wealth, but it produces exactly zero “money”. Only “banks” (and governments, should they choose to do so) are allowed to produce money.
Money “activates” the real economy but money is neither an input into the production of real wealth like bread and houses nor is money an output of real economic production. Bakers and carpenters produce bread and houses, not “money”. How people get “money” by working with flour and lumber is an enduring mystery to the fallacious schools of macroeconomics.
Two Separate Worlds
The real economy transforms real resources into goods and services that are useful and desirable to people. The banking system creates all the money. The real economy and the banking system inhabit completely separate universes that work with mutually exclusive kinds of “stuff”. The real economy works with real physical stuff like wood and grain combined with mental stuff called “ideas”. The banking system works with immaterial numbers that have a $ sign on them. Banks produce no real wealth and the real economy produces no money. They are separate systems.
This is why microeconomics models moneyless “barter” economies where real goods and services are produced and “traded”, value for value, rather than “bought and sold”, value for MONEY. In the micro universe the money system doesn’t exist. “Value” exists and “wealth” exists, but no “money” and no bankers creating that money as loans then uncreating it as loan repayments.
The Marketplace – Where Accounting and Values Meet
“The marketplace” is where the micro and macro universes intersect, where supply meets effective demand, where money changes hands and real economy goods and services are purchased and thus distributed for final consumption.
But we need to remain vigilantly clear that macroeconomics is about the demand side of the economic equation, the money side that is described exclusively by arithmetic equations. Trying to add the real economy and subjective concepts like “value” into these equations merely confuses the arithmetic, which in itself is very simple and easy to understand.
Macroeconomics is totally amoral and apolitical, totally numerical and “objective”. Arithmetic equations do not care about and cannot describe our “values”. But arithmetic equations are the ONLY way we can follow the flows and stocks of MONEY, which is a system of positive and negative numbers: “money” and “debt”.
Locked in a Zero Sum Prison
So we see a zero sum macroeconomic equation where over a full cycle spending can only be equal to earned income, because borrowed spending merely redistributes the borrower’s spending of his lifetime income vertically over time, and taxing only redistributes present incomes horizontally to people other than the income earners.
To understand the problems that are caused by this zero sum monetary arithmetic you have to abandon the universal fallacy that all the money already exists in some big gigantic pile that God distributed around the Earth for people to find and that people somehow get this money and deposit it in banks as their “savings”, and banks then lend out their depositors’ savings, in which case it would be true that ALL borrowing merely redistributes spending of the fixed supply of money rather than adds to it, as neoclassical and Austrian economics has mistakenly believed for decades and as classical economics has mistakenly believed for centuries. In fact bank loans are the creation of NEW ADDITIONAL money (as Adam Smith crowed in praise of “the Scotch banks”, which added credit money into their local economies allowing those economies to grow and mature at a delightful pace). So spending borrowed money adds to GDP. And repaying borrowed money contracts GDP.
Micro Does Not Extrapolate to Macro
Whether the spending creates “value” is an issue for microeconomics, the realm of political economy, and whereas I have called the traditional schools of economics “fallacious” because they have no understanding at all of the macro money economy, these schools nevertheless offer very finely honed understandings of the micro real economy. The micro real economy is the “political economy” where issues of values, etc. are argued and incorporated into the understandings. But masquerading as macro theories they are indeed fallacious, blind and pig headed in their arrogant inability to see outside their conceptual box.
The Source of Money
In fact “borrowed” money is our ONLY original source of money. If nobody borrowed any money from banks and spent that money into the economy, there would be no “money” in the economy. Bank loans CREATE bank “deposits”. That is where virtually all of the money comes from. It doesn’t come from God. It comes from banks, as loans, as “debt” to the people who took out the loans and spent the borrowed money; and who have to pay it back to the banks that created the money on their balance sheets as a positive number bank deposit (the “money”) and as an equal negative number loan account (the “debt”).
A “balance sheet”, by definition, balances to “zero”. Money = Debt. All of the positive numbers of money on one side of the balance sheet are offset by the negative numbers of debt on the other side. When positive repayment money is brought together on a bank balance sheet with the negative loan balance, the positive and negative numbers cancel each other out and sum to zero. Both the money and the debt cease to exist when the bank loan is repaid. A bank loan “creates” money as a bank deposit; and repayment of that bank loan “uncreates” that money when the repayment money and the debt account extinguish each other.
The Business of Banking
This is the business of “banking”, creating and distributing the national money, and micromanaging the flows of financial credit out from and back into the banking system. A prudently operated banking system is critically necessary to the functioning of any modern economy. This is why it is crucial that banking legislation and regulation get the “incentives” right, so that bankers are incentivized to operate prudently on the macro scale. Here we have utterly failed.
At the time that the new US Federal Reserve banknotes became the exclusive official US dollar under the 1913 Federal Reserve Act, people already had “money”, and all this money was originally added as credits into the new money system. So the 1913 system didn’t start with zero money. There was already some money there. But by today’s standards that original money is a pittance. In those days a “millionaire” was a rich person. Today a “billionaire” is a rich person. That’s a 1000 times inflation of “rich”.
Growth of Economy Has Required Growth of Money
Consider that the Federal Reserve dollar has lost over 95% of its purchasing power since its 1913 inception while the economy has grown enormously in real terms requiring enormously more of the inflated dollars so that today there is at least 100 times more US dollar money in the economy than there was in 1913 (I have no numbers: I’m guessing; the multiple might be MUCH higher than 100 times). If the multiple is 100 times, that means for every dollar that exists today that was not created as a bank loan, there are 100 dollars that were created as bank loans and that exist today as “debt” to the people and firms and governments who borrowed and spent the money into the economy, and who have not yet earned or taxed that money back out of the economy in order to repay their bank debts. Because the economy and the government remain in debt, the money that they borrowed and spent into the economy remains “outstanding”.
Those same “outstanding” bank loan balances are also held as “money” by other people. That money, still owed as outstanding debt by its borrowers, has become the “savings” and “operating capital” and “financial liquidity” when held by the people who earned or otherwise received the money that was borrowed and spent into the economy. Today the people who have the money are not the same people as the ones who owe the money as debt to their banks. The only way the private sector debtors can get their borrowed money back out of the economy is if the current holders of the money spend or invest it back into the economy where the debtors can earn it back by, essentially, working for the spenders; or if the indebted governments tax it back from the people who now have it, or sell services to the people who have the money.
Savers and Spenders
The problem is that some people are by nature savers and others are by nature spenders, so over time the savers accumulate all the money—and they won’t spend it—while the spenders have all the debt, and the savers won’t spend so the debtors can’t earn the money back to repay their debts. Under these conditions the debts become simply unpayable, unless prudent ants suddenly decide to become profligate grasshoppers and grasshoppers suddenly decide to become ants, which is not going to happen. Savers save and spenders spend until we reach a crisis of money and debt distributions, where we are at now. Ancient cultures solved these distributional impasses with “clean slates” and “Debt Jubilees”. If we are going to get out of our current straits without first suffering the historical pattern of collapse, depression and world war, we will have to do something similar.
This is Not a Question of Morality (or Justice or Fairness)
Remember, macroeconomics is the wrong venue for “morality”. Our macro solutions involve accepting the arithmetic realities of our situation, then taking appropriate numerical measures to solve the arithmetic problems. If you don’t “like” the answers, that doesn’t mean the answers are arithmetically “wrong”, even if you think they are morally wrong.
National Treasuries mint coins and “sell” them to their banking system in exchange for credits of bank deposits in the government’s bank accounts, so coins are actually a net non-zero sum addition to the money supply. But coins are only about one ten thousandth of the total money supply. All the other money is originally distributed into the economy as the spending of money that was created and loaned out by the nations’ commercial banking systems.
Even US dollar paper money is loaned into the economy, because government printers sell the banknotes to the Federal Reserve banks for the cost of printing, and the central banks then lend or sell the banknotes at face value to the commercial banks in their region, and bank customers “out in the economy” can only get their hands on banknotes by converting a deposit balance in their bank account into currency by “making a withdrawal” (or by borrowing against a credit card or line of credit, etc., but that just takes us back to the vertical zero sum equation of future repayment, without adding any additional money into the equation over the full cycle).
Repeat after Me: Today Virtually All Money is Lent into Existence …
And as we saw, bank “loans” CREATE all the bank “deposits”, so even though many people have a positive bank account balance that they can convert to banknotes, other people owe that same money as debt to their bank, so on the macro view even the banknotes get into the economy by “lending”, not by “spending”. Some schools of economics believe that governments or central banks “spend” paper banknotes into their economies and thus add net money into the economy, but this is another fallacy.
Banknotes in modern central bank banking systems are lent into our economies, not spent into our economies. So like other forms of borrowed money, banknotes are not a source of full cycle ADDITIONAL money. They are merely a convenient way to convert your bank account balances into “walking around money”. Your bank account balance goes down by the same amount that your pocket money supply goes up. There is no “addition” in this equation, only “conversion” of your money from one form into another.
… By the Banking System
“The banking system” is the entire supply side of money. “The economy and the government” are on the demand side of money. They want and need money, but they don’t “produce” any money. Banks produce all the money as zero sum balance sheet equations. This is a problem.
Aside from the money that already existed in 1913, and coins, and money that central banks created to buy whatever gold they purchased from the economy at the start of the modern money system, ALL of the economy’s money exists as loans of bank deposits that were created by our commercial banking systems. Some schools of economics believe that government bond sales add permanent net money into our economies, but this is another fallacy.
In the US system there are 21 national and international “primary dealer” banks who are authorized to bid on auctions of new Treasury debt. These banks pay for the new Treasury bonds, bills and notes in the same way all banks fund all their loans, by CREATING DEPOSITS in the government’s bank accounts. The PD banks might then turn around and sell those bonds to non-PD banks who likewise create money to buy them. Or the PDs might sell the bonds to parties in the economy who actually have savings to invest such as individuals or pension funds, etc. In this latter case the bond sale generated no additional new money. It merely redistributed spending power from savers who bought the bonds to the government who spends the money. But when banks buy and hold bonds they pay by creating new money, and this adds to the money supply when the government spends its new bank account balances into the economy.
So like a private home buyer who takes out a 30 year mortgage, spending $300k of freshly created bank deposit money into the economy “today” and removing that same $300k (+ interest) “out” of the economy over 30 years (a vertical zero sum equation), government sales of Treasury debt cause the primary dealer banks to create new bank deposit money to buy the debt, but when the bonds/bills/notes “mature” the government has to “redeem” them, by paying “money” to the holder of the debt instruments, and governments can only get their debt redemption money either by taxing money out of the economy or by additional new borrowing via new bond sales.
The Government Does Not Create Debt Money
So government debt is exactly the same kind of vertical zero sum equation as private sector debt. All the money that was borrowed by governments and private sector debtors added to “today’s” spending-cum-national income, but it all has to be paid “back”, out of future incomes/taxes. Banks create money by making loans and by “purchasing securities”. US Treasury debt is composed of “securities”. Primary dealer banks CREATE the money they use to buy the Treasury debt. In support of this assertion, which would be heatedly disputed by devotees of the MMT school who believe that the government spends money into existence by “marking up accounts” somewhere within the banking system, I offer the following:
Graham Towers was the first governor of Canada’s central bank, the Bank of Canada, which began operating in 1935. Canada’s monetary system is substantially the same as the US system, as well as all other modern central bank money systems (except perhaps China, as the Chinese government owns China’s commercial banking system which gives the government monetary and fiscal policy powers that other governments have relinquished to their private banking systems). During the Depression, which was a failure of the monetary system just like the post-2008 failure we are in now, there was heightened awareness of money and the money system, again just as there is now. Towers gave testimony to a 1939 Royal Commission on Banking and Commerce about the nature and structure of the monetary system. The following questions (from Canadian Members of Parliament) and testimony (from Graham Towers) are quoted from this link: http://www.sustecweb.co.uk/past/sustec16-4/a_monetary_education_for_mps.htm
Page 223 Question from Landeryou (SC from Lethbridge): "Ninety-five percent of all our volume of business is being done with what we call exchange of bank deposits – that is, simply book-keeping entries in banks against which people write cheques?"
Towers: "I think that is a fair statement."
Page 285 Question from McGeer: "When you allow the merchant banking system to issue bank deposits – with the practice of using cheques – you virtually allow the banks to issue an effective substitute for money, do you not?"
Towers: "The bank deposits are actually money in that sense."
Page 287 Question from McGeer: "But there is no question about it, that banks create that medium of exchange?" [i.e., bank deposits]
Towers: "That is right. That is what they are for. Each and every time a bank makes a loan or purchases a security, new bank credit is created — new deposits — brand new money. Broadly speaking, all new money comes out of a Bank in the form of loans. As loans are debts, then under the present system all money is debt."
McGeer: "And they issue that medium of exchange when they purchase securities or make loans?"
Towers: "That is the banking business, just in the way that a steel plant makes steel."
Fishing for Concessions
One of the infrequently heard members observes on p. 400 that "McGeer and the social credit people are circling around ‘debt-free money.’" McGeer affirmed that his purpose was to persuade the Committee that there is a costless (or at least lower cost) way of mustering the money (finance) to get men and materials into operation for important productive activities. (Towers freely acknowledged that although an "easy monetary policy" had been in place for several years, there was still plenty of under-employed labor and materials. He defined "easy money" as no need to impose bank rate restrictions or cash reserve requirements on banks – they had plenty.) McGeer kept returning nonetheless to this question: Why should a government with the power to create money give that power away to a private monopoly? And especially, why should it then borrow from the banks and pay interest? Towers’ response: "If Parliament wishes to change the way the banking system operates it is certainly within Parliament’s power to do so."
Austerity Now Equals Pain Later …
The critic of Kakol’s article believes it’s either "Pain now or Credit crisis later". But what he advocates, "austerity", a reduction of deficit spending by G, causes BOTH pain now AND a credit crisis, because the money government borrows and spends adds to the incomes that people earn (or receive as unearned entitlements) in your national economy, and if their income is reduced or eliminated (in the case of layoffs) they will have no source of money to spend (which becomes other people’s incomes, part of which becomes the taxes governments use to repay their debts) or to repay their bank debts, which causes systemic loan losses to the banking system that created all the nation’s money by "lending" it into existence. And you get the 2008 financial crisis and bank bailout because when borrowers are no longer making their payments the banking system loses its source of revenue and income and suffers a "liquidity" crisis because not enough repayment and interest money is flowing back "in" to the banking system.
Then, because debt/money growth has gone negative, all the bubbled asset prices that were inflated by people buying them with newly created bank loans start to deflate. For a bank, its actual “assets” are the promissory notes borrowers sign when they get loans, promising to pay interest and repay the principal according to the terms of the loan. Government bonds are a form of “promissory note”, just like our private sector bank debts. Banks create deposits by “purchasing assets”, but the assets are really nothing more than our signed promises to pay interest and repay loan principal.
… As Debt Peonage …
But most bank loans are created against the “security” of “collateral” assets: real assets like houses and commercial buildings and cars, assets that the bank can “repossess” and sell in case the borrower fails to make his payments. Bonds are secured by the issuing government’s power to tax its economy. YOUR TAXABLE INCOME, present and future, is the “collateral” securing your government’s debts. You have been sold into debt peonage, and for the rest of your life you will pay every last nickel of interest by your sweat, unless the monetary paradigm is updated to accommodate the modern world.
… Combined with Endemic Defaults that Destroy Banks
The banks are holding those collateral assets on their balance sheets, but if the value of the assets declines by 30% (as in the case of US real estate post-2007) then the liability side of the banking system balance sheet will exceed the market value of the asset side, and no bank holds 30% of its own money and its shareholders’ money as its capital that it can use to pay its loan losses in the event of the kind of systemic loan default that began after 2007, so deflation of the market value of the post-bubble collateral assets renders the banking system insolvent .
Then, unless central banks create new money to add “liquidity” into their banking systems to fend off the liquidity crisis (where banks have no money to pay the debts they owe to other banks and the global payments system seizes up and the economies stop working because nobody is getting paid), and unless government banking regulators exercise regulatory forbearance rather than force their insolvent banking systems to foreclose and liquidate all their collateral assets in a vain attempt to restore solvency (the Andrew Mellon version of monetary innumeracy), you get financial system collapse and economic collapse.
Churches of Divine Money
The various schools of orthodox macroeconomics, more properly seen as Churches of the Divine Money for their complete ignorance about money and their absolute faith in the correctness of their fatally mistaken worldviews, believe in a variety of futile approaches to resolving a financial collapse. Most believe that economic “growth” will solve the problems.
But we have a macro problem, not a micro problem; a problem of money numbers, not a problem of a lack of economic goods and services available; an effective demand problem, not an economic supply problem. Indeed, we are swimming in oceans of excess “economic output”, and there is an entire large scale industry devoted to hauling our overflowing household goods to garbage dumps. In the 1930s farmers were encouraged to destroy their crops to reduce supply to raise prices to profitable levels, while people went hungry. In 2009 Americans were encouraged to have their perfectly good older cars destroyed and buy new ones as a Cash for Clunkers “stimulus” measure to get people spending money and to rescue the auto industry from its demand doldrums.
If destroying perfectly good stuff that people actually want sounds stupid, it’s because it is stupid. It is a policy based on the economics of monetary ignorance oppressed upon us by the numerically blind but vigorously self-righteous Churches of the Divine Money. Economic “growth” adds new money into your national monetary equation when investors and consumers borrow new bank money and spend it into the economy. In other words, economic growth restores the upward trend of debt growth. But financial collapse happens at the terminal stage of a debt supercycle where both public and private sector borrowers are financially exhausted and cannot afford to pay interest and make principal repayments on any additional debt.
It’s like ‘rescuing’ a drowning man by getting him back in the water swimming again. He’s been staying afloat by treading water for 3 days in the heaving seas and if you put this poor exhausted soul back in the drink he will die, not “recover”.
Other economic faith traditions, notably the Andrew Mellon/Ludwig von Mises schools, believe that collapse is just the medicine the economy needs to restore it to “sound footings”. A hurricane blows your house into the sea, killing half of your family, leaving you with “sound footings”. Then you get the economy going again by rebuilding your house and family upon your “sound footings” that were not blown away. But why rely on the vagaries of nature when we have the military capacity to blow the world to hell at our leisure?
The Shiny Objects Sect of the Church of Divine Money
These magnificently perverse policies are the direct consequence of monetary ignorance combined with the misplaced desire to preserve the purchasing power of money. Unlike all other economic wealth that deteriorates over time until it is rotted and rusted and worthless, money’s value must be held sacred, according to the economic worldview of this Church. If we have to destroy the real world in order to save the value of money, then that is a sacrifice that our god demands and we must do it. This god loves gold because unlike other economic goods gold never deteriorates or loses its luster. Let’s call this the “shiny objects” sect of the Church of the Divine Money.
Still other branches of the faith believe that governments must resume and massively increase deficit spending, to add new money into the private sector economy. But under the current operations of our money systems all this government borrowing has to be paid back, and even if the government simply gets its repayment money by selling even more new debt rather than getting the money by taxing the economy, this doesn’t save the taxpayer from the burden of paying interest on trillions of dollars of national debt. Right now the US taxpayer is paying nearly half a trillion dollars per year in interest on the national debt.
This is because the 1913 banking system legislation granted exclusive authority for creating US dollar money to the private banking system. So now commercial banks create the money and the government borrows that money from the banks, just like you and me when we want to spend more than our income. This system puts the taxpayer in a state of permanent debt bondage, supporting half a trillion dollars (and rising) of bond merchant unearned annual interest income. Good deal for the bond merchants who create the money. Not so good for beleaguered taxpayers who pay the interest.
The government still “could”, but doesn’t, issue its own non-debt money. Until the government actually begins issuing its own debt-free money, there can be no solution to our macro problems of monetary arithmetic. The issuance of debt-free government money is the sine qua non for ANY viable solution to our current macro ailments. Any proposed ‘solution’ that does not include something along these lines, any solution that merely adds to or reshuffles the distribution of existing debt, simply will not work. We have reached end-of–paradigm. More of what got us here will not save us from what is coming next.
The Federal Reserve banks are owned by and work for the private banking system, not for the US government or the people (increasingly it looks like the politicians are financed by and working for the banking system). When the Fed (and euro equivalent) practices quantitative easing, all of the newly created central bank money is injected into the “banking system”, not into “the economy”. The only way the economy gets its hands on any of that money is in the usual way of “borrowing it” from the commercial banks. Fed money injected into the banks will not solve our problems of excessive unpayable debt, because Fed money can only enter the economy as even more debt.
And with the “Keynesian” solution of increasing fiscal deficits, total national debt for both public and private sectors can only ever go “up”, because when debt/money growth flatlines or declines we get the kind of financial crisis we are in now. If evermore debt is the only ‘solution’, then we are headed ultimately toward infinite debt and infinite interest payments. Not an attractive prospect, even if it was arithmetically possible.
What we actually need to solve the problems we are currently immersed in is additional non-debt income money injected directly into the economy by governments who create, not borrow, that money. More debt cannot resolve a debt crisis. Only additional income money can empower the indebted economy to repay its debts and resume its spending. The government will have to spend or simply “give” this money into the economy.
None of this is designed to generate a monetary “profit” or a monetary “return” of any kind to the governments who issue the money. This is a “new paradigm” solution to the old paradigm failure. And the new paradigm violates the religious beliefs of the old failed paradigm, such as the belief that all spending must generate economic wealth and/or monetary profits in order to preserve the purchasing power of money.
Quantitative Easing for the Economy
The purpose of the exercise, Steve Keen calls it “quantitative easing for the economy”, is to add positive quantities of new money into the economy and leave it there permanently (though the money that is used for debt pay down is simply extinguished as the loan is extinguished; those positive and negative money numbers simply cancel each other out and cease to exist when repayment money and debt come together on a bank balance sheet). This money, paid out equally to everybody so that you don’t reward the ‘profligate’ debtors to the detriment of the ‘prudent’ savers, comes attached to the condition that any recipient of the “solvency checks” money will automatically have his money paid out against any outstanding loans he has.
Debtors will get liquid and then solvent as their debts are paid down. Savers will get more money added to their savings. Debtors whose loan payments are restored to “performing” status bail out and deleverage the insolvent banking system the old fashioned way, by resuming making their loan payments on time, which solves the banking system’s illiquidity-cum-insolvency problems. This large scale debt pay down program deleverages both the economy and the banking system, pulling us back from the brink of the collapse cliff. And people who aren’t in debt get “free” money to save, spend or invest. Good deal for everybody.
We Don’t Need More Debt, We Need More Income
The government adds income money into the economy without simultaneously taking on more bond debt owed to the banking system and financial markets. More debt cannot resolve a debt crisis. Only money created and distributed freely and received by the economy as “income” can permanently extinguish debt, because neither the party who paid out the money (the money-issuing government) nor the recipient of the income money owes the money “back” to anybody. The new money can pay out the old debt, WITHOUT having to take the money away from the savers who have accumulated all the borrowed money that was spent into the economy.
This is a positive sum “addition” to the economy’s money and income, making the money system positive sum to match the arithmetic structure of our for-profit economic system where participants need to get more money “out” of the equation than they invest “in” to the equation. Investors collectively pay out the national income as their “costs”, but they have to sell their outputs at cost + profit. But Costs = Income. There is no additional “income” money in this equation to allow for sales of the outputs at profitable prices. Nor is there any money created by the banking system to pay the “interest” that banks charge on the bank deposit money they create. We have been adding the additional needed money to pay profits and interest as ever rising “debt”, but we have reached the end of that myopic Ponzi road and a vast expanse of nothing opens up below us, beckoning us over the edge to our doom.
A Zero Sum System Means No Profits Systemically
A zero sum money system cannot accommodate the economy’s need for profit and the banking system’s need for interest income. So the money system must be made positive sum to match the economic and banking system. Or else we can choose the Mellon/Mises solution and proceed over the edge of the Wile E Coyote cliff until we reach our “sound footings” on the rocks far below. Wile E always lived thru the fall. Maybe we can too. Or maybe that’s just a cartoon fantasy after all.
The ONLY ultimate source (aside from net exports) of a nation’s EARNED income is I, Investment spending. The nation’s businesses hire labor and buy materials and services and capital goods in the process of producing the national output of goods and services. That investment spending becomes the national earned income. Governments tax and horizontally redistribute some of that earned income money, but taxing does not ADD to total national income. Consumers borrow and spend enormous amounts of money beyond their current incomes as mortgage debt to buy real estate and as car loans, student loans, etc. But this debt-funded spending is vertically zero sum over the long term, removing as much spending-cum-income money “tomorrow” as they add “today”.
The full deficit spending – debt repayment cycle is a vertical zero sum equation over time. The additional positive GDP boost (and the additional money for Investors and bankers earn as profits and interest) from deficit spending-cum-income you get today is offset by an equal and opposite negative GDP contraction when the borrowed money is earned or taxed back out of the economy and used to repay the debts. So we are back to, "The ONLY source (aside from net exports, which is unsustainable on a global scale, or regional scale as the eurozone is discovering) of a nation’s EARNED income is I, Investment spending."
We Cannot Continue with Debts that Cannot be Paid
And we have arrived at “tomorrow”, the time to repay debt rather than add to it. The time has come where both the private sector and the public sector have reached their credit limits and cannot afford to finance a new round of debt-funded economic “growth”. But due to the implacable arithmetic of our zero sum money system, any flat-lining or decline of debt-money growth causes a financial-cum-economic collapse.
Under current operation of our money system the private sector’s and government’s debts simply CANNOT be paid, because the savers have all the money and won’t spend it and nobody is solvent enough to borrow and spend more new money into the equation, so the debtors have no way to earn or tax the money back to repay their bank debts. As “rogue economist” Michael Hudson puts it from his usual refreshingly clear-eyed perspective, “debts that can’t be repaid, won’t be”.
Time to Remove the Micro Blinders
We have reached end-of-paradigm – the final failure of microeconomics masquerading as macro. The solution, the new macro paradigm, requires monetary literacy and numeracy. And this can only be achieved by removing the conceptual blinders by which micro models encircle the minds and cover the intellectual eyes of all the economics professionals and policy makers who mistakenly believe they are seeing in macro. What they are really seeing is a reflection of their conceptual universe, and this universe is very much unlike the real world in which we are trying to live.
Note: There is an interesting discussion in the comment stream for this article at Global Economic Intersection