Keen drops Bank of England on Krugman


The recent Bank of England paper embracing post-Keynesian endogenous money creation has Steven Keen punching Paul Krugman on the nose today at locked-Business Spectator:

Stage one in the textbook money creation model is that the Fed (or the Bank of England) gives the banks additional reserves — say $100 billion worth. Then in stage two, the banks lend this to their customers, who then deposit it right back into banks, who hang on to 10 per cent of it ($10 billion) and lend the remaining $90 billion out again. This process iterates until an additional $1 trillion of deposits are created, so that the reserve ratio is restored ($1.1 trillion in reserves, $11 trillion in deposits).

This is the traditional “fractional reserve banking” model of money creation. The BOE is now arguing that:

• Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits. (p. 1)

• In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits… (p. 1)

Keen the turns to Krugman:

I will in particular be curious to see whether Paul Krugman notes this paper, and how he reacts to it. Krugman has been the most visible and aggressive defender of the proposition that banks don’t matter, with this including throwing a haymaker at me for making the case that the Bank of England is now making.

…he wrote: “Banks are just another kind of financial intermediary, and the size of the banking sector — and hence the quantity of outside money — is determined by the same kinds of considerations that determine the size of, say, the mutual fund industry.”

Keen is right and Krugman is wrong. Fractional reserve banking went out with arc, except in a few places like China. Reserves don’t limit lending only capital does.

How? When a bank creates a loan it also creates a deposit so, in theory, there is no limit how many loans/deposits that can be created. But there are still constraints. To prevent banks from lending infinitely against an ever declining capital base, Basel III requires them to hold a ratio of capital versus the amount of loans. Capital takes the form of long-term sub-ordinated debt, equity, reserves etc. 

This is modern monetary theory (MMT) and to this point it makes perfect sense. It starts to lose its way when MMT practitioners  claim that because loans create deposits and we issue our own currency, there is no limit, ever, on lending. At its most extreme this argument concludes we could have an employment guarantee because debt just doesn’t matter, ever.

The problem with this is that the economy is not closed. We exchange goods and services with other economies and they lend to our banks the capital (and equity) to expand our lending. They don’t want to be paid back in devalued currency and so they won’t lend any more if they see excessive monetary creation. Of course you could close the border and let the central bank keep lending to the banks but that’s hardly realistic.

Western banking systems are post-Keynesian but markets are monetarist.

Houses and Holes
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  1. At its most extreme this argument concludes we could have an employment guarantee because debt just doesn’t matter, ever

    And a wage guarantee as well. Irrespective of employment status, you need to be able to repay the debt.

      • Funny you say that. I met a friend of a family member the other day. Old lady, in her seventies or eighties. On pension, housing commission house etc but lives the life. Has 10K on CC and her moto is, you guessed it…”never pay it back”.

        No debt collectors in the afterlife….

      • casewithscience

        Except the living end up having to pay it back through increases in the personal credit interest rate when adjusted to meet to costs of bad debtors.

        BBs crapping on the young yet again.

  2. In case b_b visits this thread after his disappearance mid discussion last week:

    So answer me this, do you agree with Mike Norman’s claim that the United States cannot go broke? Can the US print whatever they want, to cover whatever costs arise, with no limit, without running the risk of “going broke”? And by going broke, I mean “printing” to the point where their currency is decimated by lack of confidence in USD denominated debt/money (this could materialise through hyperinflation or force the US to change their currency in some way to restore faith, whether that be putting their Gold reserves up as collateral, replacing the currency or restructuring the debt, for continued international acceptance of their debt &/or currency).

    Still hoping for an answer.

    • that is just one giant straw man BB.

      IMHO Norman goes well overboard with his explanations,which is what turned me off him, but if you accept that he exaggerates the issue and point to get people to take notice of him,it’s easier to reconcile his views.

      personally I avoid his videos.

      • It’s not a straw man. But you are grasping at straws by trying to justify his comments, putting it down to exaggeration to draw viewers. Maybe I’ll use that excuse next time you point out one of the Gold crackpots.

        Rest of above comment from last week:

        Mike doesn’t highlight any limits when he is mouthing off.
        He does not add any provisos.
        He does not otherwise suggest his claims are hyperbolic.

        Here is one of his rants as an example:

        “The Unites States can’t go broke because it issues it’s own currency. If it needs dollars to satisfy a debt or spend fixing infrastrucutre or pay for international defense or any entitlement like social security, it’s just a matter of changing numbers in a bank account. That’s it, the numbers just get marked up. That’s how the government spends & that’s why the US cannot go broke.”

      • The point that Norman is trying to make is that the USA cannot run out of US dollars, they are the monopoly supplier for those currency units.

        They may default for political reasons (debt ceiling) but they can’t run out of what they supply – USD.

        I think it may have been Guy de Belle who said last year something like “We (the RBA) have more Australian Dollars than anyone else in the world, I know because we print them” or words to that effect.

        As long as a country has all of it’s debts denominated in it’s own currency technically they will only default if they choose to.

        That is why Japan has a debt of about 250% of GDP and yet borrows at very low rates.

      • As long as a country has all of it’s debts denominated in it’s own currency technically they will only default if they choose to.

        And that Sir, is the catch….. This was raised in Rumples article over the weekend as well.

        You can’t run out of AUD or USD etc. But if you need to borrow (internally but mainly externally) the cost of your borrowing goes through the roof and your currency also suffers.

        Like any borrower, the confidence in your ability to pay matters and the exchangeability of your tokens for real goods and services matter.

        Big problem if you want to continue to run a deficit. It would be interesting to see if the US can continue to support the current debt levels if the USD loses reserve status.

      • I am not disputing that the USA cannot run out of dollars, I am saying that this very ability could potentially lead to them going broke for the reasons that I already pointed out in last weeks thread using the baron peso example and ratified by HnH above i.e “The problem with this is that the economy is not closed. We exchange goods and services with other economies…”

        What do you think would happen if the US decided to mint up 17 of their trillion dollar coins to repay their public debt and then tried to sell more of their treasuries or exchange dollars for oil? They would be rejected Peter, because as far as the rest of the world is concerned they would be broke.

        A countries ability to print it’s own currency is not a factor that can stop them going broke if they rely on external trade.

      • @Peter Fraser: the reason Japan can have debt of 250% of GDP but still pay low interest rates is that very little of the debt is owed to foreigners.

      • BB says: ‘What do you think would happen if the US decided to mint up 17 of their trillion dollar coins to repay their public debt …’

        No net change to US financial liabilities outstanding – just the form has been changed, to something rather less convenient for all concerned.

      • This conversation needs to reference the basics of what we know – Lehman and Freddie May and Freddie Mac – the study of this event given the monetary creation environment that is being dicussed on this thread.

        We can also look through time and see what happens when money creation contracts and expands – see the great depression that followed a significant contraction in money supply. In Australian terms as far as I am aware the Reserve Bank has only been publishing this data for around a decade? As Steve Keen has dicussed previously we need to look at M1, M2 and M3 money supply and how this impacts the major Banks.

        So as an evidence base we have:

        1. Money Supply – M1, M2 and M3 expansion and contraction
        2. The FX Trade and Capital Flight scenarios – movement of capital (value) into and out of the country
        3. Alleged sharholder limits on balance sheet growth?
        4. historical artefacts on monetary events

        CAPITAL FLIGHT in action as we speak – see:

      • @Tea Merchant,

        Thank you for that post. I applaud getting down to “reference the basics”.

        In that same vein, I’d like to again reference the fact evidenced by an examination of the difference between money supply and debts owed, that debt has always exceeded the money supply—and the degree of diver­gence has grown over time” (Steve Keen, “The Roving Cavaliers Of Credit”)

        The reason for this difference, is Usury.

      • Op8

        Not necessarily – the supply of money is reduced when the government runs a budget surplus, and it is increased when they run a deficit – IE they spend more into the economy than they take out through taxes.

      • Tea Merchant – that link is about Russian companies with overseas debts, presumably in foreign currency.

        It’s not about the Russian government debt in Russian roubles.

        If a country or a large organisation borrows in a foreign currency and doesn’t hedge, they expose themselves to that situation.

      • @PF,

        “Not necessarily”

        Sorry, you’ve lost me. How is that relevant to the point about debt always being greater than money supply?

        Perhaps you can explain (and more importantly, evidence) how it is that your observation re government budget surpluses represents a significant, and/or relevant exception, to the broad fact evidenced and observed by Keen, that “debt has always exceeded the money supply—and the degree of diver­gence has grown over time”.

      • Op8

        That was a statement that Keen made back in 2009 to prove that our banking system is no longer on a Fractional Reserve System.

        Read his Roving Cavaliers of Credit blog in full. He was one of the early economists to understand the banking system correctly.

      • @PF The statement “that debt always exceeds money supply”is either correct or incorrect. So which is it?

      • Brokers moonlight as economists?

        These opinions we can dismiss

        Fraser the credit crusader

        Obfuscating slave trader

        Dealing in debt’s death kiss

      • The U.S. Treasury cannot spend unless it has a Congressional appropriation. It technically CAN meet any obligation denominated in dollars, however, the act of creating infinite money is not synonymous with spending same.

    • Yes the US federal government can always repay its USD treasury bills and bonds.

      Yes it could cause massive inflation and falls in the value of its currency if it “printed” way too much. But the USD is merely a claim on USD products, services of assets, or a means of buying a different currency. It can also buy goods services of assets of anyone else who will accept it, but they then have the same future claim on USD goods services or assets.

      Those claims exist until the USD are extinguished by:
      1 repayment of debt owed
      2 payment of US taxation

      Governments in a democracy are always satisficing multiple parameters, never, except in case of outright war on a large scale, maximising one parameter.

      Taking extreme examples is rarely helpful to any serious analysis, but they are a potential black swan event.

      The US has just proven that it can put money into bank reserves by issuing bonds to fund its deficit spending and those bonds are bought by the Fed who can them hold them to maturity without capital loss in nominal terms.

      The Bank of England paper shows that the bank reserves are irrelevant to the lending decisions of commercial banks.

  3. migtronixMEMBER

    LOL 1.2% “teir 1” debt is “capital”?!?!? What a joke, so if you have government debt on your books your are stable enough to loan to the moon! What stops governments issuing infinite amount of debt? Not bloody much.

    Its all a crock, make usury illegal and let anyone keep a spreadsheet if they want to.

    @flawse: You want to earn a decent interest? Just type in whatever amount you like into an excel cell, come back every months and watch it grow! Thats all the bank does – its not like they can actually honour the obligation.

  4. MMT practitioners claim that because loans create deposits and we issue our own currency, there is no limit, ever, on lending.

    I’ve never seen any claim that. They recognise that there are regulatory restrictions, political barriers, and shareholder capital reserve restraints.

    They outline the operational requirements, and then the regulatory requirements of each country have to be superimposed on those operational guidelines to appreciate what can and will happen in each country.

    That said, it’s pleasing to see that you are prepared to discuss this matter. Well done.

      • I don’t know, I don’t even know who he is, but his views are always interesting.

        Can I ask a small favour? Can you leave the post by NMT below and don’t delete it. that way everyone can see what a complete goose he is.


    • and who audits them to ensure they follow regulatory requirements and reserve constraints..?

      Oh thats right, no-one because they audit themselves.
      You are a clown, go back to your Whoredom brokerage firm Peter !

    • PF,

      Reader b_b and other MMT advocates have often made it clear, variously by implication and/or direct assertion, that (to paraphrase) “because loans create deposits, it all nets out, and so, there is no limit on how much ‘money’ / debt a currency-issuing sovereign can create”.

      Certainly in context of recent MB reader discussions, HnH’s statement is perfectly accurate.

      • I’m confused by your terminology – by “Sovereign” do you mean the Central Bank or do you mean commercial banks.

        I presume the first – they print but only notes/coin for circulation as required.

        If you mean commercial banks, then b_b said quite clearly recently the constraints were creditworthy borrowers and the required shareholder reserves.

        So there is a limit.

      • migtronixMEMBER

        What does “credit worthy” mean? Unless there a definite term there are no limits. And there are no limits. GFC could not ever have happened if there were. It did happen so QED…

      • PF,

        Yes, I meant the first. And yes, I think (from memory) you are correct re what b_b may have said about the second.

        To clarify the original point, it seems clear to me that, in arguing for systemic change (ie, for government to be the currency issuer/originator, rather than private banks), MMT advocates typically point to the argument I paraphrased above as their primary rationalisation for why there is (would be) no limit to how much currency/debt a sovereign could issue. And as HnH and many others have pointed out, this is where MMT fails to be cognisant of other realities (eg, the external account).

      • @ mig – if what you are saying is true, why did the USA so publicly recapitalise their major banks – why didn’t they just write themsleves another loan?

        Look no one is saying that this is the ideal system, but it is what it is, and understanding it is an advantage to you. Surely you appreciate that.

      • @ PF

        Look no one is saying that this is the ideal system, but it is what it is, and understanding it is an advantage to you. Surely you appreciate that.

        You’re not convincing anyone by repeating the same stuff as if it is gospel.

        waves hand….”these are not the droids you are looking for”…

        No one has even began to take the demographics equation into account yet….

      • @ Op8
        You probably should address that to b_b, but remember the rule is that governments should only borrow in their own currency.

      • PF,

        In my view, government should not “borrow” at all. Ever. That is the root of the private-banks-leeching-off-the-public system, going back hundreds of years now; have the sovereign issue a bond owing usury to the bondholder, rather than just create currency, having zero obligation.

      • migtronixMEMBER

        @PF they did write themselves another loan, why do you think Obama added 5 trillion to the debt ?

        EDIT: understanding is an advantage absolutely! I’ve about accumulating as much debt as I can. Probably buy an IP soon but I want a boat first. So far it’s all equity

      • @Op Interesting concept. All government expenditure is paid for my newly created money plus maybe some taxation. Taxation is essentially inflation from the newly created money…. I like it.

  5. The most important contribution of MMT is that it makes it perfectly clear why fractional reserve or zero reserve banking should be eliminated – gradually of course.

    Not that MMT actually seeks that as far as I know.

    The only organisation who should have effective control over the money supply is the elected government.

    Certainly we need to improve our system of government to reduce our exposure to the careerists our current system attracts like bogon moths to a street light, but something like the money supply is far too important to leave to bonus chasing shiny suits.

    EDIT – Actually there is a more important contribution. Governments are the organising body of the body politic and they should do everything possible to reduce involuntary unemployment. I personally think that means more reform and facilitating private economic activity than job guarantees but the essential point is correct.

      • migtronixMEMBER

        @peter ever say across from a banker that wants what he/she wants? As dull and self important as pollies. Let’s cut the spread they eat to 0 and see how important they are!

        We don’t need politicians or bankers and computer program can easily manage it.

    • @ Pfh007
      The only organisation who should have effective control over the money supply is the elected government.

      The problem with that is we trust governments even less than private enterprise.

      Having worked in the CBA before privatisation I can tell you every damn politician and union rep poked their noses into the affairs of the bank. I was looking after two state government MP’s and one Federal minister at the time. great guys, I liked them all, but very strong and forceful people who are used to getting their own way.

      But they didn’t.

      • At least government is — in theory — accountable for their actions. In theory, their (mis)management of the money supply would/could be rendered somewhat transparent; public opinion and voting choices swayed by direct reference to government performance in that specific regard.

        Sure, I do not trust government. But in spite of all my beefs with our bogus “democracy” (give me a Swiss DD system), I would still much prefer being giving the opportunity to judge government performance on this at the ballot box, rather than sit here in total impotence watching unelected private bankster sociopaths — incl. the “independent” RBA — gradually decimate the real economy and assume control of everything, via their control over money supply.

      • I suggest that you have never sat at a desk across from a politician who wants what he wants.

        You are in for one hell of a ride when you do get that opportunity. Trust me, under the skin they are all identical regardless of their policy platform.

        Interesting people though.

      • PF,

        I don’t doubt you are right about that. However, it still does not alter my view that the lesser of two evils is for the elected government to be directly responsible for money supply.

      • PF,

        I am not in favor of banning private banks nor suggesting that government should run banks or provide banking services, merely that the Banks should be no more than intermediaries between savers and borrowers and the providers of payment networks etc.

        Deposits for term that can be lent for term

        Deposits at call cannot be lent at all (the depositors are depositing for security and access to the payments network)

        Mortgages can be provided by way of RMBS etc.

        That range of services should keep banks nice and busy and out of mischief.

        Plenty of work for banks and probably even more work for those who advise people on sources of finance etc.

        I have no doubt that the old days of the CBA were no bed of roses and certainly would not encourage a return to that state of affairs.

        Note: I don’t have a problem, for the time being, with banks charging interest for their intermediary services as, with the government managing the money supply and the generally lower level of debt through the economy, I doubt the resulting level of ‘usury’ will present a problem. But I am keeping an open mind on that as Op8’s concerns and the historical record do have some force.

      • Pfh007
        It’s not our decision to make, this is the global standard (Basel I II and now III) and it will remain that way until they change the global standard.

        Plenty of people don’t like it.

      • PF

        “Pfh007 – It’s not our decision to make,”

        We have the power to make any decision we choose. One of the joys of being a sovereign country – apart from issuing fiat currency.

        But I do get your meaning.

        Our policy makers are so enamored with being besties with the international policy making jet set that an independent course is hardly likely.

      • Pfh007,

        Indeed. And it’s not just a case of their being enamoured with being besties with the jet set. The historical record bears witness to the fact that any policy maker who has dared to take (or indeed, threaten to take) an “independent course” on money supply generally meets with an untimely personal fate.

  6. Thanks HnH. Excellent summation. Now, all we need is to narrow the focus even further, to examine the critical factor of each individual loan creating only the principal, and not the means of repaying the included usury obligation.

    Steve is almost there, in recognising that this “interest” obligation is the key problem. When he does so, hopefully MB will follow suit.

  7. HnH says: ‘MMT practitioners claim that because loans create deposits and we issue our own currency, there is no limit, ever, on lending…. we could have an employment guarantee because debt just doesn’t matter, ever’

    I think use of ‘we’ here (and in recent discussions) is confusing.

    For Australian banks, there are constraints on lending and borrowing, as Peter indicates – as well as the practical constraints posed by the difficulty/impossibility of raising capital or borrowing for reserves when a bank’s got too many bad loans.

    As regards the Australian government, it could fund an employment guarantee (or for that matter, a housing guarantee), and do so through issuing Australian currency – not through borrowing and spending the borrowed funds. The constraints here are the resources and capacity of the economy.

      • But the deposit is a liability (with a corresponding asset – the loan contract with the borrower – but query the value of that asset). Doesn’t really get the bank out of a jam.

      • migtronixMEMBER

        @chrism sure it does now the volume of non performing loans is smaller – just by creating a new loan. Genius!

        I can’t figure out why the banks would even want shareholders? Why would you want to spread the loot and thin it for yourself? Loans create deposits which creates loans which creates deposits which creates loans which creates deposits. What could ever go wrong?

      • Got a bad loan? No problem write another one. More deposits hey presto!

        Yes but a loss of capital because the loan loss must be absorbed by the capital buffers. Keep it up the bank goes broke. Check out Spain as a recent example.

      • migtronixMEMBER

        @DE what capital? Why does it need capital? Throw away cap requirements and what changes? Nothing!

        Governments gift banks by issuing bonds, so they have something they can call “safe”. Why should the government issue bonds? Why should the government care what credit rating moodys give it? They can just print more what’s moodys gonna do about it.

        The cap requirements are fictional so your injuction is perfunctory.

      • DE,

        Fair point. But haven’t there been numerous revelations to the effect that the banks have all manner of tricks for “hiding” (redefining) bad loans, so as to avoid that capital buffer restriction?

      • @ mig – DE is spot on, the bank has to cover losses out of its own shareholder funds, and if it can’t it will close it’s doors.

        End of story. Your “write another loan” is baloney, they can’t write loans for themselves and the audit process will quickly pick up that they are short of funds.

      • migtronixMEMBER

        Oh really peter? And how many banks closed in 08/09? How did they get themselves liquid again? Wasn’t it by writing a new loan?

      • @migtronix – in the USA, where there were a *lot* of bad loans, hundreds of banks did shut their doors due to insolvency. In Australia, many small banks were in big trouble – due to liquidity issues though due to their securitisation based funding model, rather than due to bad debts – they were quicky bought/absorbed by the big boys for a bargain price.

        The big Oz banks themselves never had to close – they never experienced a spiralling increase in bad debts the way the US banks did. Ie the locals were able to cover the losses they did incur out of their capital base with no problem – their profits dropped a little, but they still made a profit through the whole GFC.

        And as to the question of how the AU banks improved their liquidity/capital position due to the above? It wasn’t by writing new loans (this was just business as usual), it was via capital raising through the equity markets.

      • migtronixMEMBER

        @gonder great bit of revisionism there. Let’s start with “they were profitable through out the GFC” : so funding was drying up, loans getting paid down and deposits increasing. How did they do that? Are “the big 4” really such exceptional stand out stewards of their ship ? Why didn’t every bank in world come pinch our bank CEOs? Something doesn’t compute.
        Secondly, the banks in the states that did fail? Why were they little local banks? That’s not where the subprime debt was, it was with countrywide! Oh yeah they had derivative exposure to the big banks but they didn’t get a bail out! Why not? Why is there always concentration instead of competition in banking? I mean loans create deposits which creates loans which creates deposits – anyone can do it, why is the banking sector getting smaller? So many questions.

      • Op – they did cope well with the GFC. Some people may have different political views, but if you want an unbiased view look at the share price graph for the big four during that period, up until now.

      • PF,

        You are not seriously arguing that a bank’s (or indeed, any listed company’s) share price represents an “unbiased” view of its innate, stand-alone stability, surely.

        In the absence of Australian government, RBA, and Federal Reserve support — to the tune of hundreds of billions — the Big Four would no longer exist.

      • dumb_non_economistMEMBER


        I doubt there are many shareholders who would have a clue as to the real position of the banks as being discussed here, pure ignorance (shareholders).

  8. H&H; excellent reasoning. But please consider the following.

    I am agnostic on whether “stable money” – like a gold standard – is “the” essential alternative. It seems to me that increases in the money supply COULD be neutral as regards the essential thing – the creation of REAL WEALTH – that is, actual stuff in which there is as much consumer surplus as possible. It almost does not matter what are the units in which this real wealth is denominated and traded, as long as there is a level playing field with regard to everyone’s remuneration for goods and services provided.

    BUT the way the whole system is geared under the status quo, the MEANS by which there is increase in the money supply essentially creates “economic rent”, which I firmly believe REDUCES the creation of real wealth. Even MMT “might” work – everything finding its own level (inflation, exchange rates, etc) – PROVIDED it was set up to NOT create economic rent for someone in the process. But pigs might fly. Give politicians the money-printing press and who can expect rent-seekers to remain in their cages? Much government spending already IS a cause of destruction of creation of real wealth, simply because it involves so many people getting something in return for NO provision of consumer surplus (or even no value at all). No matter how “fair and just” it is that someone gets something for nothing, it WILL erode the creation of real wealth.

    Real wealth creation – that is, the utilisation of resources to create goods and services in which there is as much consumer surplus as possible – is a completely separate matter to the monetary units in which people trade stuff. The supply of monetary units is irrelevant to how “REALLY” wealthy people in an economy are.The mechanism by which monetary inflation destroys wealth, is simply that it reduces the creation of real wealth by a variety of mechanisms. It is virtually impossible to utilise resources to create goods and services in which there is consumer surplus, when there is hyperinflation. It becomes increasingly difficult to utilise resources to create goods and services in which there is consumer surplus, when a bigger and bigger share of the total “monetary units” in circulation are being captured by sectors that get their share for nothing.

    I suppose it might be impossible to define and administer a QE or MMT system that would actually put the newly created money into the economy via the wealth creators rather than the rentiers, and thus create the right incentives for growth. But this impossibility is the real reason to oppose MMT and indeed the entire monetary status quo.

    • migtronixMEMBER

      Brilliant PB ! Though with anything but 0 interest you are letting someone make a claim on creating a ledger entry. A robot can more than adequately do that for crying out loud, what do you need the banker for?

      • That is just ONE aspect of the rent that money creation causes. My main point relates to economic actors actually getting the “free money” first. Expansion in the money supply causes inflation, but this inflation does not hurt the people who first spend the money they got free.

        And much worse, some of the free money is paid out indirectly in straight-out economic rent, because it is the government spending the money, for which bonds are being “bought” by the central bank. The more that this spending is economic rent, the worse the impact on the real economy, of the inflation that results.

        And then, because increased money supply causes inflation in the price of certain asset classes, there we have another wealth-destroying rent mechanism. Capital gains made in the course of asset bubbles are pure rent.

        I hold that what matters is the proportion of rent to wealth creation, in the economy. The higher this proportion, the LESS actual goods and services produced by utilising resources, and in which there is consumer surplus, will be getting created and shared out among all. It hardly matters whether the average wage is 100 dollars a day or a million; what matters is how much of that you HAVE to pay for necessities, and whether you have much left over afterwards to buy more stuff that entrepreneurs have created for you. It is the level of this discretionary spending where Say’s Law or Aggregate Demand is particularly relevant.

        People who say that it doesn’t matter because everyone who gets the money for whatever reason, spends it or banks it and it keeps right on circulating, miss the point that “rent” versus discretionary spending, are the two parts of a closed feedback loop. Firstly it really matters for what share of the products of scarce resources are captured by whom; and secondly it has to reduce “the production of actual goods and services via utilisation of resources”. Resources will be under-utilised or badly utilised BECAUSE of the economic rent in the system.

    • +1 PB. Note that some government spending goes beyond paying people to create no value at all – it involves people being paid to create negative value. Good reason to support the Coalition’s repeal days and similar concepts.

    • Great points PhilBest.
      If government ever adopts MMT getting them out of the trough will be hard.

      But without that understanding the Politicians have another tool to get their goodies and keep their rich backers happy.
      There Is No Alternative, any crisis or problem and budget deficit means government gets to cry crocodile tears while cutting funding to welfare, lowering taxes on the rich, grinding the unemployed further into the dirt, etc.

      MMT takes those lies away. Sadly politicians who understand actual economics might be more dangerous than those who don’t. It’s difficult but I think it has to start by improving understanding, even if the increased power brings other problems.

  9. MB is amazing – this is literally peer-to-peer discussion of some of the deepest questions of economics. On a blog….! The mainstream forums are next to useless. What happens to all the boat-rockers out there? They get nowhere, I suspect, and nobody ever hears of them.

    • It is a madly impressive phenomenon, PB. A heterodox economic discussion conducted in full view, followed by an army of spruikbots ready to seize any opportunity to vilify, government agencies picking up ideas and members of the public learning about economics in real time. I think we are witnessing a new and unremarked benefit of the digital revolution.

  10. Loans are not, in the end, limited by Capital.
    As banks can lend money to people to buy their shares. So lend 90 to Bill to buy property and 10 to Susie to buy bank shares. I am sure you have noticed that all the banks offer margin loans to people to buy their own shares. I have pointed this out to APRA but it was all too much to handle at the time. Infinity here we come…. (Sorry if others have already made this point)

    • migtronixMEMBER

      Of course! That’s the whole bloody point otherwise why bother even issuing shares? It’s a cheque kitting operation: the forward date of the loan means that the cheque is good today, just as if I gave you a post dated cheque for $1M, you bank it and now have a virtual million dollars you can loan to me today. It’s ok if banks do it for each other but not you or I.

      • When you pause to think about it mig, it is no wonder banksters consider themselves the “Masters of the Universe” (ie, “doing god’s work” — Lloyd Blankfein).

        They control the world, via their exclusive power to monetise Time itself.

    • That only works if you issue new shares to Susie. If she just buys existing shares on market, the bank doesn’t have any new capital.

      • No they don’t. Shareholders benefit when the market value of their shares rises, but the bank doesn’t, except insofar as the rise is attributable to additional retained earnings. Bank capital bears no relation to market value.

      • I used a somewhat simplistic example. More realistically this “method” i described is played out by the banks issuing the hybrid debt instruments that count as equity. A lot of these instruments are bought by SPVs setup by other banks. Man the pumps!

        I have not done any research on this but i have run it past a bank treasurer who agrees, in principle at least that it ‘could’ work this way.

      • migtronixMEMBER

        @Alex spoiler: bank directors are shareholders too. And where does collateral get parked?

      • Thanks for the clarification, Rosscoe. As you say, it would be a good way to market hybrids. I’m sure the banks are doing just that.

      • Rosscoe – Hybrids are limited to a percentage amount of fundamental Tier one capital.

        Which means you need to issue more shares and/or retain more earnings.

        Which risks diluting existing shareholders and/or decreasing payout ratios

        Which usually means a CEO gets on the nose very quickly

      • migtronix, yes, it is definitely still in the interest of bank management. Particularly management with share bonuses lined up that depend on meeting market price targets …

      • Alex, Swifty, Rosscoe (and FF and Migtronix),

        Thank you to all of you for this point and counterpoint discussion. Most enlightening.

        I for one am sensing this as yet another area of likely corruption / manipulation by bankers. I cannot help but note that, if true, then the motive is the same as always.

        Finding “legal” ways to further increase leverage on the bankers’ fundamental profit mechanism — the Net Usury Margin.

        Ban Usury (again). Problem Solved.

      • @AH

        I am probably wrong in my line of reasoning so please correct me.

        The capital adequacy ratio is defined as the sum of T1 and T2 cap over RW assets.

        Now equity is part of T1 capital ratio. All else being equal, an increase in market cap will result in an increase in T1 and therefore and increase in CAR.

        This would mean you can increase you RW assets to to keep the same CAR. Hence more loans … ??

      • @flyingfox: Equity is not the same as market value. In fact the two are fundamentally unrelated. As I said earlier, market value can rise long term because the bank increases its retained earnings. However, it can equally rise because the market reassesses the company’s future earnings potential or because of other factors such as changes to interest rates.

        Equity, on the other hand, is essentially the face value of the shares on issue plus all the accumulated retained earnings.

        As an example, consider CBA. Its shareholders equity at June 2013 was approximately $45b, up $4b on a year earlier. Its market value at the time was $111b, up $27b on a year earlier.

        Market value is a measure of what people are prepared to pay. Equity is an accounting concept.

      • migtronixMEMBER

        @Op8 Nah that’s marginal stuff, they’ll you give margin to short the bank too. What they want is spread volume for retained earnings – everything else is small potatoes, profitable to be sure but in the scheme of things…

      • Pretend you are in a market dominated by 4 large profitable banks. Perhaps each bank could lend money to people to buy shares in the other three banks, and all the banks hold shares in each other.

      • wycx – if a bank holds shares in another ADI that amount is deducted from their capital base (ie no double counting of capital)

        See APS 111 Attachment D para 8 of the prudential standards for ADIs at APRA’s website.

  11. I have a slightly different take on this.

    – Running a CA deficit means the e.g. Australia or the US experiences a net outflow of money. VERY Deflationary.
    – Running a CA deficit can go on for a long long time, as long as those foreigners are willing to re-invest that money into the country of origin.
    – A good example where that went wrong is Spain. Foreigners were no longer willing to re-invest the money back into Spain.

  12. It’s sad that Keen gets a better audience everywhere but Australia. Nice to see someone reading him.

    His insights into debt and banks creating money are very important to understanding our current problems.

  13. “MMT practitioners claim that because loans create deposits and we issue our own currency, there is no limit, ever, on lending. At its most extreme this argument concludes we could have an employment guarantee because debt just doesn’t matter, ever.”

    Certainly not how I understand MMT. Maybe I’m doing it wrong.

    Bank loans are limited by whatever laws you have, or by their supply of actual currency (controlled by gov) to meet their obligations. And willingness of people to borrow.

    With MMT Government should never borrow its own currency, there is no point. Spending is constrained by resources not funding. i.e. you can’t buy things that aren’t for sale in your currency and if you bid too much for things supply may not keep up and the price will rise (inflation). Even then the inflation only becomes contagious or risks hyperinflation with inelastic demand goods priced in foreign currency (eg. food or War reparations). Also waste is always a drag on the economy so always need to be careful spending money.

    Which is why the Job Guarantee is possible. If there is surplus labour then Government can buy it with little or no distortion in price. Flow on effects could inflate the things the newly employed buy but if they are also creating something then the net result should be positive and not inflationary overall.

    Government foreign borrowing (in reality print $AU buy foreign currency so it’s really spending) is limited by exchange rate. Sell too many $Au and the price goes down. Exchange rate is just as much an issue for MMT as anyone else.

    Also Private debt matters a LOT, MMT agrees with Keen on this point.

      • Government employment therefore China is a bit of a non-sequiter there migtronix. Care to fill us in on your meaning?

      • migtronixMEMBER

        The Party can and does either directly, or via easy lending standards, effect labour demand by, say, the construction of ghost cities. But it can not get people to voluntarily go there and utilise the amenities.

      • Thanks for elaborating Migtronix. Great example of the broken window fallacy in action, and other fallacies. Wasteful spending is still wasteful even if employing people. Better off just paying them a dole instead.
        Centralised planning and corruption make for sad results. Don’t want to end up as either China or the USA.

        Edit: To be clear the mistakes I refer to are China’s not yours. pointing out their stupid is only a mistake if you live there.

        Any job guarantee would need to employ people to do things that actually need doing.
        Personally I think we should have continued reducing our work week as productivity went up. If we run out of work that needs doing why not work less? But that’s another issue.

  14. Edit: to be clear the mistakes I refer to are China’s not yours. pointing out their stupid is only a mistake if you live there.

  15. Krugman is spot on. Banks are just another kind of financial intermediary who need to attract savings. Being able to momentarily create a non interest paying deposit when a loan is made doesn’t change that. The loans/ deposits sequence debate is a distraction, because the sequence doesn’t matter.