Thursday, April 8, 2021

It's the Debt, Stupid. I Mean the GOOD Debt.

Sichuan man with 13,500 copper cash, same as the Qin dynasty more than 2,000 years earlier, 1917, photo by Sydney D. Gamble via Wikipedia.

My mind is still stuck on money here, and all the wonderful things I've learned about it in the last couple of weeks, of which a lot is scattered around the comments and not necessarily quite coherent, starting with the point about where money comes from. Willie Sutton was right! It comes from the bank! 

Seriously—this was not always the case, and it was never the case as much as it is now, but banks make money, by which I don't mean physical currency, the bills and coins in your wallet that represent your money, which are of course manufactured by the Mint and the Bureau of Engraving and given to the bank to distribute to the public as a convenient way for us to move our money around, as in buying things, turning them over to the shopkeeper as a token of our exchange that she can send back to the bank to inform them that the money is now hers and have them adjust her account accordingly. 

That money, actual money, is not a thing at all, but a relationship, or potential relationship, between a person who has something and a person who wants something, the relationship of indebtedness: when I give the person my dollar bill, she is obligated to give me a cup of coffee, she owes it to me—or if I don't, and take the coffee anyway, I am obligated to her, and must bring her the dollar bill later on (these tiny credit operations hardly happen anywhere any more, I think, but they used to be a normal part of life, where they'd keep you a tab at the grocer and the barber and the bar and so forth).

The way banks create money is by creating a debt: a loan, which they used to mark by giving you a lot of bills and coins, but not any more: the banker just adjusts your account to say it now has $10,000 more dollars in it than it did this morning, and adjusts the bank's Excess Reserve account to say it has $10,000 less—excess reserves are the money the bank keeps in the books to pay out in depositor demands or loans, around 80% of total reserves, and they are supposed to get rid of more or less all of it, so that's where the money is. 

And then it adjusts the account to reflect the bank's new asset, the loan, $8,000 in the Excess Reserve, which will be available to turn into new loans, and $2,000 in the Required Reserve. You, with your $10,000, have a new asset, and a new liability, having to pay it back, but that liability is the bank's asset, which is what leaves the bank basically in the same financial position, exactly as able to satisfy depositors' cash needs, it was in before. While your money, as you spend it, or preferably invest it in some profitable opportunity so that you get an even better return from it than the bank, will continue to travel the world, as part of the M1 money supply—it exists! 

And the bank conjured it up out of practically nothing! And money with this kind of origin accounts for some 97% of the money supply (according to one UK source). 

This fractional-reserve banking system got started in a time and place where your money was mostly represented by gold and silver, in Amsterdam in the 16th century in goldsmiths' shops, where customers used to leave their coins for safekeeping. But it's not the only way to create money out of nothing, as the classic paper by James Tobin explains, just the neatest and clearest; and in fact the principle of creating money by creating a debt is far older, going as far back as Babylonia in the 3rd millennium BCE,  where palaces and temples in each local city state served as repositories for people to keep their treasure, for a fee, used their accumulated wealth to provide farmers with loans of seed-grain which they had to pay back in harvested grain at the end of the growing season, as recorded on clay tablets: deposited wealth as a basis for creating credit. Private banking, managed by a Sumero-Babylonian family called the House of Egibi, is recorded in an archive of tablets from the 7th through 5th century BCE. In Asia Minor, the temple of Artemis at Ephesus was a famous repository for many centuries, down to when Mark Antony robbed it during the Roman civil wars; further east, regular letters of credit emerged in India by the 4th century B.C.E. and China (along with standardized coins, already the round copper cash with the square hole in the middle for keeping it on a string) in the 3rd. 

Banking developed slowly in medieval Europe under Christian (and in Spain, Muslim) restrictions on usury, which left borrowers (in particular, royalty) dependent on Jews (whose reading of the Tanakh allowed them to collect interest from Gentiles, just not each other) or on bankers figuring out workarounds of the kind that still exist in "Islamic banking". An assertion that the Bible allowed interest payments on loans used to purchase non-consumable items (as opposed to food or fuel) was what allowed a burgeoning of credit institutions, including the great banking families like the Medici and Fuggers, to arise in Italy and Germany starting in the 14th century. All these entities were effectively creating debt-money in the form of letters of credit, demand notes, and a form of scrip you could buy for coin at one of the huge trade fairs in cities like Hamburg and use subsequently at a different fair, the thing that evolved into bills of exchange. Still, it was the goldsmiths of Amsterdam and, shortly afterwards, London, who figured out the double-entry bookkeeping that proved the created money was real and devised the formal structure of the fractional reserve, and truly modern banking began to exist.

Not without severe bumps in the road, because the fractional reserve could fail in the case of a panic-driven run on the bank, not because the bank didn't have the money, by definition, but because it didn't have enough of it to give out in a liquid form, like gold guineas or paper pound notes, and such panics were frequent, driving operations into bankruptcy. This is where governments began to step in.

Government has always been interested in the production of currency, originally coins, eventually notes, for what seems to me the obvious reason that it's a guaranteed medium in which to collect the taxes it needs to carry out its projects, like Henry II of England, who reformed the currency (silver pennies) over the period from 1158 to 1160, getting rid of debased coins reducing the number of people licensed to mint coins and having his name put on them, and raised taxes, increasing his income from around £18,000 per year to £22,000, as well as bringing out a big increase in the amount of money circulating in England and corresponding increase in trade, alongside salutary inflation, and (sadly) financing the definitive conquest of Ireland. Modern Monetary Theory turns this upside down to say that, au contraire, government owns all the money already and only collects taxes in order to force people to use the currency:

A consequence of this view, and of MMTers’ understanding of how the mechanics of government taxing and spending work, is that taxes and bonds do not and indeed cannot directly pay for spending. Instead, the government creates money whenever it spends.

So why, then, does the government tax, under the MMT view? [One of two big reasons is that] taxation gets people in the country to use the government-issued currency. Because they have to pay income taxes in dollars, Americans have a reason to earn dollars, spend dollars, and otherwise use dollars as opposed to, say, bitcoins or euros.

But this, in addition to not making a lot of sense, and never as far as I know having been claimed by a member of a government, is clearly untrue of all the actual sovereigns who instituted sovereign currency before the ultramodern era, who always needed the money, usually desperately. Ask Louis XVI—oh wait, you can't, they cut off his head.

Anyway, it was the London goldsmiths that realized that when they issued a loan based on their own gold holdings, the promissory note they got in return for the cash was in fact a new form of money, not tied to precious metal, directly negotiable, that the goldsmith could give anybody in lieu of cash, and this was the origin of the idea of the banknote—like the pound note, a small piece of debt, worth just 20 shillings or one pound Sterling, which the bank was supposed to repay anybody who carried it, on demand. 

In 1694, the government of William III, in terrible shape after a series of military defeats by the French and unable to raise the money he wanted to rebuild the navy because his credit in London was so bad, incorporated this idea into the design of a new bank somewhat in the form of another state bank, the Amsterdamsche Wisselbank (founded 1609), in which he would entice a group of lenders to offer him a £1.2-million loan (at a usurious 8%!) by making it the capital for a company in which they would all be shareholders, the Bank of England, which would among other things issue banknotes like the goldsmith's to depositors withdrawing funds and borrowers taking out loans, instead of gold or silver, just pure debt, which the bank would promise to convert to coin on demand, but would rarely have to do so, since the notes (originally handwritten, but eventually the engraved bills with which we're familiar) were so much more convenient:

William III's government wanted to build a naval fleet that would rival that of France; however, the ability to construct this fleet was hampered both by a lack of available public funds and the low credit of the English government in London. This lack of credit made it impossible for the English government to borrow the £1,200,000 (at 8% per annum) that it wanted for the construction of the fleet.

To induce subscription to the loan, the subscribers were to be incorporated by the name of the Governor and Company of the Bank of England. The Bank was given exclusive possession of the government's balances, and was the only limited-liability corporation allowed to issue bank notes. The lenders would give the government cash (bullion) and issue notes against the government bonds, which can be lent again. The £1.2 million was raised in 12 days; half of this was used to rebuild the navy.

As a side effect, the huge industrial effort needed, including establishing ironworks to make more nails and advances in agriculture feeding the quadrupled strength of the navy, started to transform the economy. This helped the new Kingdom of Great Britain – England and Scotland were formally united in 1707 – to become powerful.

And that, kids, is not only the first national bank, but also the first modern bank, the place that holds your money not necessarily as precious metal but much or almost all in the annotations of a ledger, and gives it to you in the form of a promissory note, printed by the government. The computer hasn't really made that part any different, just added an alternative and even more convenient, if less elegant, format. The abandonment of the metal standard in the 1970s didn't really make it all that different, either, since the metal had already become a much less significant part of it over the decades, as the proportion of pure debt increased.

Please note—and refer back up to the second and third paragraphs above if necessary—that those banknotes are not money when they come off the engraving plate or when Steven Mnuchin and Louise Linton pose for pictures with it. They become money—debt—only when they are delivered to the bank and the bank turns them over to you, as a depositor or borrower, after deducting the amount from your ledger account. When the government prints bills it is not creating money; it is creating objects that the (private commercial) banker can turn into money by making a record that she gave it to you, registering the debit in the books; and the important thing about the government's involvement is their guarantee that "this note is legal tender for all debts public and private". The government did not endow that dollar bill with real value—it just promised that the value would be reliable when the bank gave it to you, unlike the dollar bills from all those crappy private banks that existed before there was a Federal Reserve to regulate them. 

This is really important in the critique of MMT, whose theorists often seem not to understand the point, when they say government "spends currency", or that it can "spend without borrowing", or the like. You may be able to call it "currency" when it comes off the plate, but it's not money until it made into a debt of some kind. Leaving aside the very pathological Weimar and Zimbabwe cases, if the government just gives it to you and tells you it's valuable, as in the Soviet Union, it's nothing but a ration card for which the government takes no real responsibility, permitting you to pick out stuff off the shelves if there's any stuff there, and there usually isn't, which is why the Soviet Union ended up using so many alternatives, from a welter of different kinds of ration cards to forbidden foreign currency. It's the magic of debt that makes it work (and this was after all true of the precious metals that served as currency through most of human history—people were convinced it was valuable because it really was magic, and the specialness of gold and silver was just the magician's misdirection).

Which would explain why the US has to borrow the money it fails to raise from tax receipts, as it does (except for some special small areas where it acts as a banker, in issuing loans for students or for veteran housing). That's where the value comes from; that's what makes it money. And that's not a bad thing! Sovereign debt, properly deployed, is magic!

The last bit of quotation on the Bank of England illustrates, even better than the story of Henry II, what the magic can do, as it did in England, when the government's leveraged debt—the explosion of the British economy at the beginning of the 18th century, welcoming a certain amount of inflation as part of the cost of progress created by investment. As I was trying to explain earlier. You can bet Alexander Hamilton was perfectly familiar with this story and thinking about it as he made his plans, starting with the federal assumption of all the state debts and moving on to the creation of the First Bank of the United States, imagining the glory that would accrue to the young country through his financial acumen. 

I think a lot of this stuff is so obvious to economists that they don't realize they know it or bother to talk about it, whence the errors of something like MMT, and hope the magic of narratology can bring it to life.  (Should probably add that I think the late anthropologist  David Graeber may deserve credit for much of what I'm getting from third hand.)

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