Thin Air’s money isn’t created out of thin air

A recurring conversation I have with clients concerns the ability of banks to create credit, and of governments to monetize debt, and whether this ability is the solution to or the cause of financial instability and economic crisis. Monetarists and structuralists (to use Michael Hudson’s names for the two sides, whose centuries-long debate pretty, exemplified by Thomas Malthus and David Ricardo during the Bullionist Controversy, dominates the history of economic thinking) have very different answers to that question, but I will suggest that each side disagrees because it implicitly assumes an idealized version of an economy.

We are normally taught that banks allocate credit by lending the money that savers have deposited in the banking system, but in fact banks create deposits in the banking system by creating credit, so it seems to many as if they can create demand out of nothing. Similarly, if governments are able to create money, and if they can borrow in their own currency, they can easily monetize debt, seemingly at no cost, by “printing” the money they need to repay the debt (actually by crediting bank accounts, which amounts to the same thing). This means that when they borrow, rather than repay by raising taxes in the future, all they have to do is monetize the debt by printing the money needed to repay the debt. It seems that governments too can create demand out of nothing, simply by deficit spending.

There is a rising consensus – correct, I think – that the misuse of these two processes – which together are, I think, what we mean by “endogenous money” – were at the heart of the debt surge that was mischaracterized as “the great Moderation”. For example in a book published earlier this month, Between Debt and the Devil, in which he provides a description of the rise of debt financing in the four decades before the 2008-09 crisis, along with the economic risks that this has created, Adair Turner specifies these two as fundamental to the rising role of finance in the global economy. He writes:

…in modern economics we have essentially two ways to produce permanent increases in nominal demand: either government fiat money creation or private credit money creation.

I am less than half-way through this very interesting book, so I am not sure how he addresses the main characteristics of debt, nor whether he is able to explain how much debt is excessive, or identify the main ways in which the liability side of the macroeconomic balance sheet intermediates behavior on the asset side to determine the growth and volatility of an economy. He invokes the work of Hyman Minsky often enough, however, to suggest that unlike traditional economists he fully recognizes the importance of debt.

And it is because of this importance that the tremendous confusion about what it means to create demand out of nothing is dangerous. When banks or governments create demand “out of this air”, either by creating bank loans, or by deficit spending, they are always doing one or some combination of two things, as I will show. In some easily specified cases they are simply transferring demand from one sector of the economy to themselves. In other equally easily specified cases they are creating demand for goods and services by simultaneously creating the production of those goods and services. They never simply create demand “out of thin air”, as many analysts seem to think, and doing so would violate the basic accounting identity that equates total savings in a closed system with total investment.

I had originally intended this blog entry to be a response to questions in some of the comments following my last blog post, but because my response turned out to be too long to submit as a comment, and because the questions lead to a far more complex answer than I had originally planned, it has become a blog entry in its own right. The questions arise in the context of a discussion of some of Steve Keen’s work among several regular commenters on my blog. Keen is an Australian post-Keynesian who heads the School of Economics, History and Politics at Kingston University in London.

I’ve known of Keen’s work for many years, and last year he spoke at my PKU seminar on central banking (as has Adair Turner, by the way). He is one of the most hard-core proponents of Hyman Minsky, and regular readers know that I think of Minsky as one of the greatest economists since Keynes. In the third chapter of my 2001 book, The Volatility Machine, I explain the ways in which developing countries designed balance sheets that systematically exacerbated volatility – and which eventually led to debt-based contractions or financial crises – in terms of a framework that emerges from the work of Minsky and Charles Kindleberger. This framework – something that many Latin American economists have no trouble understanding but which has been ignored by nearly all Chinese and foreign economists covering China – explains why three decades of economic expansion in China, underpinned by rapid growth in credit and investment, would lead almost inevitably to destabilizing debt structures.

Hyman Minsky’s balance sheets

Minsky is important not so much for the “Minsky Moment”, a phrase he never used, but rather because of his profoundly intuitive balance-sheet oriented understanding of the economy, something that set him completely apart from most contemporary academic economists who, for the most part, have barely begun to incorporate balance sheet dynamics into their analyses. Minsky’s insights include his now-well-known description of accelerating financial fragility, along with his explanation of why instability is inherent to the financial sector in a capitalist economy.

Most insightful of all, Minsky characterized the economy as a system of interlocking balance sheets, and because he taught us to think of every economic entity as effectively a kind of bank, with one entity’s assets being another’s liabilities, it follows that economic performance is partly a function of the direction and the extent in which the two sides of each balance sheet are mismatched. Because these mismatches vary as a consequence of past conditions and future expectations, when institutional distortions are deep, balance sheet mismatches in the aggregate can be systemic, in which case they determine how an economic system behaves and responds to exogenous and endogenous shocks.

Minsky’s framework made it especially easy to predict the difficulties that China would face once it began to rebalance its economy. China can be described as an extremely muscular illustration of Minsky’s famous dictum that “stability is destabilizing”. Its financial system was designed to meet China’s early need for rapid credit expansion, and it evolved around what seemed like permanently high growth rates and uninterrupted access to financing. Two decades of “miracle” levels of investment-driven growth, the role of the financial sector in that growth, and the unrealistic expectations that Chinese businesses, banks, and government entities had consequently developed, reinforced by sell-side cheerleaders, made it obvious that the interlocking balance sheets that make up the Chinese economy had added what was effectively a highly “speculative” structure onto the way economic entities financed their operations.

This would sharply enhance growth rates during the expansion phase, much like margin borrowing enhances returns when market prices are rising faster than the debt servicing costs, but at the expense of sub-par performance once conditions reverse. The process is actually quite easy to describe, and the fact that it caught nearly the entire community of analysts by surprise should indicate just how unfamiliar economists are with the approach championed by Minsky.

Ignoring the balance sheet framework does not always result in bad economics. When debt levels are low, and the economy close to a kind of Adam Smith type of economy, in which there are no institutional constraints and no entities large or important enough to affect the system as a whole, it makes sense to ignore liabilities and to analyze an economy only from the asset side in order to understand and forecast growth. Evaluating only the asset side would still be conceptually wrong, because both sides of the balance sheet always matter, but the difference between analyses that ignore the liability side and analyses that incorporate the liability side are small enough to ignore.

When conditions change in certain ways, however, the differences can become too large to ignore. The more deeply unbalanced an economy, the higher its debt levels, or the more highly systematically distorted its balance sheets, the more the two forecasts will diverge and the more urgent it is that economists incorporate the balance sheet in their analyses.

In a way it is like an engineer who builds a bridge using Newton’s equations rather than Einstein’s. In a motionless world, or in the close approximation in which most of us live, Newtonian errors are insignificant, and the bridge the engineer builds will carry traffic almost exactly as expected. As objects accelerate, however, these small errors eventually become vast, and the Newtonian bridge risks becoming useless.

In the early 1990s the models that most economists used to analyze and explain Chinese economic growth were good enough, like the Newtonian bridge in the slow moving world in which humans operate. By the late 1990s, however, the sheer extent of bad debt within the banking system should have provided a warning that mismatches and imbalances might have become large enough to invalidate the old models. They clearly did invalidate the old models over the next few years as credit misallocation accelerated, along with the depth and direction of now-unprecedented imbalances and highly self-reinforcing price changes in commodities, real estate, stock markets, and other variables – what George Soros might have cited as extreme cases of reflexivity.

Violating identities

To get back to the discussion in the comments section, a very brisk and active debate broke out among a number of readers over Keen’s claim that next period growth is a function of both this period’s economic conditions as well as this period’s change in debt. I won’t summarize the discussion, which is long and wide ranging, but part of the disagreements have to do with whether Keen’s dynamic model, which incorporates changes in debt, implies that the accounting identities I use are somehow invalid.

One reader, Vinezi, wrote “Michael has been repeatedly saying that he is using the same identities as the basis of his research for the last 10 years. All his insights presented on this blog, which, in my opinion, are spectacularly correct, are derived from the application of these very identities”. Vinezi then goes on to ask for my response to Keen’s rejection of these identities, most importantly the identity between savings and investment.

I don’t know if Keen actually rejects the identity, but I doubt that he does because he is too good a mathematician not to know that identities cannot be “accepted” or “rejected” like hypotheses or models. More generally I would never say that I am using this (or any other) identity as the basis for my research, as Vinezi states, because the point of research is, or should be, to test hypotheses (or, in a common but sloppy practice, to discover hypotheses). You cannot “test” accounting identities, however, because they are not hypothetical. They are true either by definition or as a logical necessity (which may well be the same thing), and there is no chance that they can be wrong.

I do refer often to basic accounting identities, but mainly because too many economists and analysts allow themselves to become so confused by balance of payments arithmetic, money creation, and so on, that they try to explain the relationships among different variables by proposing hypotheses that violate accounting identities. In that case their hypotheses are simply wrong, and rejecting them does not require any empirical support. Rather than use empirical data to “test” the identities, it is more accurate to use the accounting identities to “test’ the data. If the data seems to violate the identities, then it must be the case that the data is incorrectly collected or incorrectly interpreted.

The important point about accounting identities – and this is so obvious to logical thinkers that they usually do not realize how little most people, even extremely intelligent and knowledgeable people, understand why it matters – is that they do not prove anything, nor do they create any knowledge or insight. Instead they frame reality by limiting the number of logically possible hypotheses. Statements that violate the identities are self-contradictory and can be safely rejected.

Accounting identities are useful, in other words, in the same way that logic or arithmetic is useful. The relevant identities make it easier to recognize and identify assumptions that are explicitly or implicitly part of any model, and this is a far more useful quality than it might at first seem. Aside from false precision, my biggest criticism of the way economists use complex math models is that they too-often fail to identify the assumptions implicit in the models they are using, probably because they are confused by the math, and they would often be forced to do so if they weren’t so quick dismiss accounting identities on the grounds that these identities don’t tell you anything about the economy.

It’s true, they don’t. But arithmetic doesn’t tell you anything about how to build a bridge either. Unlike economists, however, engineers have no choice but to stick rigidly to the identities. While economists tolerate models that are not constrained by accounting identities because, for some reason, economists do not seem constrained by the need for their models of the economy to conform to reality, any engineer whose model for a bridge requires that two plus three equal seven would find it hard to build bridges, harder to find clients, and even harder to get a teaching job at any university. Remembering always to maintain accounting identities does not lead to true statements or to brilliant insights, but it does make it easy to reject a very large class of false or muddled statements. Just as logic doesn’t create science, but it prevents us from making bad science, identities do not create models, but they protect us from useless models.

Keynes, who besides being one of the most intelligent people of the 20th century was also so ferociously logical (and these two qualities do not necessarily overlap) that he was almost certainly incapable of making a logical mistake or of forgetting accounting identities. Not everyone appreciated his logic. For example his also-brilliant contemporary (but perhaps less than absolutely logical), Ralph Hawtrey, was “sharply critical of Keynes’s tendency to argue from definitions rather than from causal relationships”, according to FTC economist David Glasner, whose gem of a blog, Uneasy Money, is dedicated to reviving interest in the work of Ralph Hawtrey. In a recent entry Glasner quotes Hawtrey:

[A]n essential step in [Keynes’s] train of reasoning is the proposition that investment an saving are necessarily equal. That proposition Mr. Keynes never really establishes; he evades the necessity doing so by defining investment and saving as different names for the same thing. He so defines income to be the same thing as output, and therefore, if investment is the excess of output over consumption, and saving is the excess of income over consumption, the two are identical. Identity so established cannot prove anything. The idea that a tendency for investment and saving to become different has to be counteracted by an expansion or contraction of the total of incomes is an absurdity; such a tendency cannot strain the economic system, it can only strain Mr. Keynes’s vocabulary.

This is a very typical criticism of certain kinds of logical thinking in economics, and of course it misses the point because Keynes is not arguing from definition. It is certainly true that “identity so established cannot prove anything”, if by that we mean creating or supporting a hypothesis, but Keynes does not use identities to prove any creation. He uses them for at least two reasons. First, because accounting identities cannot be violated, any model or hypothesis whose logical corollaries or conclusions implicitly violate an accounting identity is automatically wrong, and the model can be safely ignored. Second, and much more usefully, even when accounting identities have not been explicitly violated, by identifying the relevant identities we can make explicit the sometimes very fuzzy assumptions that are implicit to the model an analyst is using, and focus the discussion, appropriately, on these assumptions.

No surpluses on both the capital and current accounts

A case in point is The Economic Consequences of the Peace, the heart of whose argument rests on one of those accounting identities that are both obvious and easily ignored. When Keynes wrote the book, several members of the Entente – dominated by England, France, and the United States – were determined to force Germany to make reparations payments that were extraordinarily high relative to the economy’s productive capacity. They also demanded, especially France, conditions that would protect them from Germany’s export prowess (including the expropriation of coal mines, trains, rails, and capital equipment) while they rebuilt their shattered manufacturing capacity and infrastructure.

The argument Keynes made in objecting to these policies demands was based on a very simple accounting identity, namely that the balance of payments for any country must balance, i.e. it must always add to zero. The various demands made by France, Belgium, England and the other countries that had been ravaged by war were mutually contradictory when expressed in balance of payments terms, and if this wasn’t obvious to the former belligerents, it should be once they were reminded of the identity that required outflows to be perfectly matched by inflows.

If Germany had to make substantial reparation payments, Keynes explained, Germany’s capital account would tend towards a massive deficit. The accounting identity made clear that there were only three possible ways that together could resolve the capital account imbalance. First, Germany could draw down against its gold supply, liquidate its foreign assets, and sell domestic assets to foreigners, including art, real estate, and factories. The problem here was that Germany simply did not have anywhere near enough gold or transferable assets left after it had paid for the war, and it was hard to imagine any sustainable way of liquidating real estate. This option was always a non-starter.

Second, Germany could run massive current account surpluses to match the reparations payments. The obvious problem here, of course, was that this was unacceptable to the belligerents, especially France, because it meant that German manufacturing would displace their own, both at home and among their export clients. Finally, Germany could borrow every year an amount equal to its annual capital and current account deficits. For a few years during the heyday of the 1920s bubble, Germany was able to do just this, borrowing more than half of its reparation payments from the US markets, but much of this borrowing occurred because the great hyperinflation of the early 1920s had wiped out the country’s debt burden. But as German debt grew once again after the hyperinflation, so did the reluctance to continue to fund reparations payments. It should have been obvious anyway that American banks would never accept funding the full amount of the reparations bill.

What the Entente wanted, in other words, required an unrealistic resolution of the need to balance inflows and outflows. Keynes resorted to accounting identities not to generate a model of reparations, but rather to show that the existing model implicit in the negotiations was contradictory. The identity should have made it clear that because of assumptions about what Germany could and couldn’t do, the global economy in the 1920s was being built around a set of imbalances whose smooth resolution required a set of circumstances that were either logically inconsistent or unsustainable. For that reason they would necessarily be resolved in a very disruptive way, one that required out of arithmetical necessity a substantial number of sovereign defaults. Of course this is what happened.

The same kind of exercise eight-five years later, shortly after the euro crisis, made it clear that Europe was limited by similar accounting identities to three options. First, Germany could reflate domestic demand by enough to exceed the consequent increase in its domestic production of goods and services by at least 4-5% of GDP, and probably more (i.e. it had to run a current account deficit). Second, peripheral Europe could tolerate excruciatingly high unemployment for at least a decade, and probably more.

Third, peripheral Europe could leave the euro and restructure its debt with substantial debt forgiveness – or, which is nearly the same, force Germany to leave the euro, which would require much less debt forgiveness – causing losses in the German banking system at the same time that it caused Germany’s manufacturing sector to drop precipitously. (A fourth option, that Europe could run huge surpluses with the rest of the world, perhaps two times or more than its current surplus, was too implausible to consider, and although Europe is certainly running irresponsibly high surpluses, they are not high enough to allow Europe to grow.) So far Europe has chosen the second option, with a high probability, in my opinion, that before the end of the decade it will be forced into the third.

This is why we must keep accounting identities firmly in mind. They don’t tell us what to do, but keeping them in mind prevents us from proposing, or believing arguments, that are clearly inconsistent, or often simply idiotic. To take another immediate example, one of the few recent bits of cheer in our otherwise very glum world has been the almost teenagerish excitement with which David Cameron has been BFFing. It’s not all just unconditional friendship, however, and apparently he hopes to get big deals and significant inward investment announced in the next week. It sounds good, but, a firm grasp on the accounting identities would identify which kinds of “big deals” are likely to boost GDP and which merely to shift the locus of GDP creation.

More importantly, it would show that for a rich, developed country like England, inward investment almost always affects growth adversely (unless it brings technological and managerial advances with it) and never more obviously so than when interest rates are struggling against the zero bound and every country is urgently trying to export excess savings. As one of my exasperated PKU students asked me after class last Saturday when we discussed the president’s trip: “So everyone agrees that it is good for England to get much more foreign investment, and everyone also agrees that it is bad for England to have a much bigger trade deficit. Don’t they know it’s the same thing?”

Not everyone does, but to return to the reference I made to discussion in the comments section that started this essay, regardless of whether or not Vinezi is correctly interpreting Steve Keen on the savings and investment identity, does his claim – that an increase in debt causes a corresponding increase in GDP growth (and the conditions under which this is likely to be true correspond closely, I think, with current conditions) – imply that investment can exceed savings? Or as Vinezi puts it:

Steve Keen, ErikWim, Suvy & Willy2 claim that the mistake Michael makes is that he is using a “loanable funds model” in which savings and investment are “merely being matched with each other”. Steve Keen, ErikWim, Suvy & Willy2 are pointing to the new “endogenous money model” of the modern-banking sector in which investments can be made even without having the savings a priori. Yes? Would the “Steve Keenites” here please confirm that this is how all of you would like to correct Michael’s “flawed” identity? Michael, if you read this, would you please respond to their attack on your most fundamental research assumption?

Before responding I have two parenthetical responses. First, the savings and investment identity is not my “most fundamental research assumption” because it is not an assumption at all, and it cannot be meaningfully used in research. Second, the loanable funds model does indeed permit credit to be created “out of thin air” (it is perhaps what we would call the neoclassical tradition that doesn’t, although I have to admit I don’t always keep the lines between different traditions terribly sharp), and while there is much that I find deeply insightful in both Knut Wicksell – and I assume that his “cumulative process” is part of the intellectual tradition on which “loanable funds” is based – and his rival Irving Fisher, I don’t think of the work of either of them as supporting or opposing my use of the saving and investment identity to understand global imbalances.

It might seem that Wicksell denies the savings and investment identity because he says that the two are equal only when the money interest rate is set equal to the natural interest rate. We see that in a 1986 paper by Richmond Fed economist Thomas Humphrey (whose books are unfortunately out of print):

The cumulative process analysis itself attributes monetary and price level changes to discrepancies between two interest rates. One, the market or money rate, is the rate that banks charge on loans. The other is the natural or equilibrium rate that equates real saving with investment at full employment and that also corresponds to the marginal productivity of capital. When the loan rate falls below the natural rate, investors demand more funds from the banking system than are deposited there by savers. Assuming banks accommodate these extra loan demands by issuing more notes and creating more demand deposits, a monetary expansion occurs. This expansion, by underwriting the excess demand for goods generated by the gap between investment and saving, leads to a persistent and cumulative rise in prices for as long as the interest differential lasts.

This might seem indeed to violate my claim that any model that requires or even permits global investment to exceed savings is logically impossible, but this is only because the difference lies in what economists call the ex ante quantities. This means that at any given money interest rate (other than the natural interest rate), desired savings may differ from desired investment, but one or the other (or both) must adjust so that in the end they do equate, the result being a sub-optimal amount of investment. Excessively low interest rates in China (until 2012) meant, for example, that desired investment was far too high, and much higher than desired savings, but in a financially repressed system, as I have shown many times, low interest rates can actually force up savings by constraining the household income share of GDP, which is what happened not just in China before 2012 but also in Japan in the 1980s.

I think what Keen might actually be saying is that if investment in the next period is greater than savings in the current period – if it is boosted, so the argument goes, by the ability of the banking system to fund investment by creating debt “out of thin air” – this does not violate the identity, and it is not only possible, but even likely. (If by any chance Steve keen should read this, perhaps he might respond.)

Creating demand “out of thin air”

But it is possible not because banks can fund investment by creating debt “out of thin air”. This statement is either highly confused or it too-easily leads others into confusion. There is a related form of this question that often seems to come out of the MMT framework, although I have no idea if this is a misreading of MMT or if it is fundamental to the theory, but while banks can create debt, they do not automatically create additional demand. According to MMT, as I understand it, there is no limit to fiscal deficits because governments who control the creation of money can repay all obligations regardless of their taxing capacity simply by monetizing the debt (which of course means nothing more than exchanging debt which we call “debt” for debt which we call “money”).

A lot of people seem to think that this means the state can create demand out of thin air, and so demand created by the state can be added to existing demand with no other change, including no increase in savings. If savings and investment had previously balanced, according to this argument, and the state creates new demand, either this new demand is in the form of investment, in which case investment becomes greater than savings, or the new demand is in the form of consumption, in which case savings is reduced (savings is the obverse of consumption), and so once again investment exceeds savings.

This seems like a perfectly logical argument, except that it is perfectly impossible. For reasons that I will explain in the appendix to this essay, to say that investment is greater than savings is to say that the total amount of goods and services we produce is greater than the total amount of goods and services we produce, and that cannot be true.

So where is the flaw in the argument? It turns out that thanks to these same identities it is pretty easy logically to work out the flaw, and in fact to extend this process of working it out to show – and maybe this is contrary to what MMT implies, or at least to what many people think MMT implies – that there most certainly are limits to fiscal deficits, and that the state’s ability to monetize its debt does not mean that it can borrow indefinitely without, eventually, destroying the economy and undermining the credibility that allows it to borrow in the first place.

At the beginning of this essay I said: “When banks or governments create demand, either by creating bank loans, or by deficit spending, they are always doing one or some combination of two things, as I will show. In some easily specified cases they are simply transferring demand from one sector of the economy to themselves. In other, equally easily specified, cases they are creating demand for goods and services by simultaneously creating the production of those goods and services. They never simply create demand out of thin air, as many analysts seem to think, because doing so would violate the basic accounting identity that equates total savings in a closed system with total investment.”

To work through the two different ways demand seems to be created, for convenience I will refer to the entity for whom demand is created “out of thin air” as Thin Air. Thin Air, in other words, is either the entity to whom the bank made a loan, or it is the government agency responsible for the deficit spending:

  1. In the first case, assume that we are in an economy in which there is absolutely no slack. Workers are fully employed, inventories are just high enough to allow businesses to operate normally, factories are working at capacity, and infrastructure is fully utilized.

If in this case Thin Air’s expenditures cannot be satisfied without diverting goods and services that are being used elsewhere. Whether the new credit or the deficit spending goes to support investment or to fund consumption, all the goods and services that an economy is capable of creating are already being used by other economic entities.

This means that if Thin Air wants to spend money to buy goods and services, it must displace some other entity that is already using the goods and services that are being created by the economy, and it can only do so by bidding up the price of wages or resources. As a result prices will rise, and these higher prices will reduce the real value of money.

As a result, and because higher prices reduce the total amount of goods and services that can be acquired with a fixed amount of money, every economic entity that is long monetary assets – assets such as money, deposits in the bank, bonds, or most expected payments, like wages, pension receipts, etc. – loses some amount of wealth equal to the reduction in the real value of these monetary assets. Everyone who is short monetary assets – anyone who has fixed obligations, for example a borrower, or an employer who owes wages, etc. – gains some amount of wealth. The losses of the former exceed the gains of the latter, with the balance representing a net transfer of wealth to the government or to the bank that created the loan for Thin Air.

The transfer need not occur only through inflation. In a financial system that is highly repressed, Thin Air’s actions might even be disinflationary. China’s case shows how. Until 2012 whenever credit was created by the system, it was done so at extraordinarily low interest rates – nominal lending rates were often negative in real terms, and were always a fraction of nominal GDP growth rates, and deposit rates were always seriously negative in real terms – and these low rates represented a transfer of purchasing power from net savers, who were households for the most part. In that case the consequent growth in production exceeded the consequent growth in consumption (because it repressed household income growth) and so was disinflationary, but once again Thin Air’s spending represented a transfer because it simultaneously suppressed consumption.

Demand can only be created “out of thin air”, in either case, by suppressing consumption or investment elsewhere (in the latter case it is often called “crowding out”). At the moment the new demand is created, there is no change in the real value of GDP, although of course nominal GDP can rise or fall, depending on whether the transfer is inflationary or disinflationary.

Either way, if the suppressed demand consisted of investment, investment in the rest of the economy declined, whereas if it consisted of consumption, savings in the rest of the economy rose. This reduction in investment, or increase in savings, is the exact obverse of the increase in investment or consumption set off by the new demand created “out of thin air”, so that at no point is the identity between savings and investment ever violated.

  1. In the second case, assume the other extreme, in which the economy has a tremendous amount of slack – there are plenty of unemployed workers who have all the skills we might need and can get to work at no cost, factories are operating at well below capacity and they can be mobilized at a flick of the switch, and there is enough unutilized infrastructure to satisfy any increase in economic activity.

In this case when loan creation or deficit spending creates demand “out of thin air”, in other words, it also creates its own supply. When Thin Air spends money to buy certain goods or services, those goods and services are automatically created by switching on the factory equipment and putting unemployed workers to work.

There is also a multiplier at work here. Assume that Thin Air’s spending is for investment, and that it plans to acquire $100 of goods and services for investment purposes. Because it has no need to build capacity or acquire inventory, the full expenditures will go towards paying wages. Let us further assume that the newly hired workers save one-quarter of their income.

As Thin Air pays wages, the workers will spend 75% of those wages on their own consumption, and they will save 25%. Their own consumption will require the production of additional goods and services, which will require hiring more workers. In order that Thin Air acquire $100 of goods and services, it can easily be shown that the total expenditures of Thin Air and of consuming workers will be the original $100 divided by the 25% savings rate, so that in the end GDP will rise by $400, consisting of $300 additional consumption and $100 additional investment. Because the increase in GDP exceeds the increase in consumption by $100, total savings will have risen by $100.

In an economy with enough slack to absorb Thin Air’s investment fully, in other words, the investment creates enough of a boost in the total production of goods and services that it becomes self-financing – it increases savings by the same amount as it increases investment. Notice then, once again, that at no point is the identity between savings and investment ever violated.

  1. In reality no economy will ever have zero slack, as in the first case, or full slack, as in the second, but instead will exist in some combination of the two. In that case Thin Air’s demand created “out of thin air” will partly be met by suppressing demand or investment elsewhere within the economy, and partly by creating the larger amount of goods and services needed to satisfy the increased demand.

An important point that is often obscured by the intensely political discussion about savings is that in the second case, in which the demand created by Thin Air creates its own supply, it turns out that the lower the savings rate, the more GDP is created by any additional spending unleashed by Thin Air. Savings automatically rises to fund investment by causing the total amount of additional goods and services produced to rise by more than the total amount of additional goods and services consumed, with the difference between the two, savings, rising by exactly enough to fund Thin Air’s investment (and the same can easily be proven to be true if Thin Air’s expenditures were actually in the form of consumption).

What this exercise shows, among other things, is that in an economy working at full capacity, a higher savings rate is likely to increase GDP by more than a lower savings rate, whereas in an economy operating with a considerable amount of slack, i.e. with high unemployment and low capacity utilization, a lower savings rate is likely to increase GDP by more than a higher savings rate. What this also shows is that in an economy that has recently experienced a crisis, with falling output to below capacity, there is a tendency for households to raise their savings rate, and because of the multiplier, as they increase their savings rate the reinforce the downward trend in the economy.

As an aside this exercise also helps to reconcile the monetarist tradition with the structural tradition (within which I think MMT belongs). The debate between the two is a debate that has been raging for hundreds of years, most famously during the debate over the causes of inflation during the Napoleonic War, with the monetarists, or extreme bullionists led most famously by David Ricardo, and the structuralists, or moderate bullionists, led most famously by Malthus. Neither side is right or wrong except under specified conditions. The monetarists operate in a supply-sider’s world of full capacity utilization and zero unemployment, whereas the structuralists operate in a Keynesian world of weak demand, high unemployment and low capacity utilization.

  1. In the first case, the monetarist’s world, if Thin Air’s demand is invested in a project that increases productivity by more than the reduction in productivity caused by the transfer of wealth, it is sustainable. Otherwise it is not. If Thin Air suppresses consumption to fund productive investment, it will always lead to higher growth. If Thin Air suppresses productive investment to fund consumption, it will always lead to lower growth

If Thin Air suppresses private sector investment to fund investment, it becomes a little more complicated, and depends on which of the two “investments” is more productive. Because monetarists usually do not believe that government can ever choose investment projects that are more productive than the market can, they would argue that if Thin Air were a government agency engaged in deficit spending, GDP growth would be reduced, because more productive investment by the private sector was suppressed in favor of less productive investment by Thin Air.

There are however many cases of highly productive investment that the government directed in the past which the private sector was unlikely to have initiated. Today, with the private sector unwilling to fund much productive investment because of weak demand, much private sector investment consists of buying assets, which is not productive. In countries that have weak infrastructure, if Thin Air, whether a government entity or a government-encouraged entity, were to build infrastructure, it would almost certainly lead to higher growth.

  1. In the second case, the structuralist’s world, as long as there is enough slack in the economy that the new demand causes an increase in output that is equal to the sum of new demand and the marginal cost of new output, it is sustainable. Otherwise we eventually revert to the first case.
  1. Monetarists always insist that if the government is to spend money, it should not be in the form of deficit spending. The expenditure should be fully funded by tax increases. Notice however that in the first case, the monetarists’ world, expenditures are fully funded by tax increases, but this tax consists of the inflation tax. The monetarists argue that deficit spending, aside from reducing overall productivity, is inherently inflationary and increases economic uncertainty by undermining the stability of money. This is likely to be true the closer we are to an economy that resembles the first case.
  1. Finally one of the stranger and more incoherent arguments used by China bulls to propose that China’s large and soaring debt burden doesn’t matter is that China “owes the money to itself”. In that case why not simply monetize or socialize the debt, as MMT seems to suggest? One of the reasons is that in a world without an infinite amount of slack, monetizing the debt is no different than paying taxes, except that the tax is borne by those who are long monetary assets, i.e. Chinese household.

If China were to monetize the debt, which is effectively what it did in the past decade to resolve the enormous amounts of bad debt it had accumulated in the 1990s, this would simply reduce the household share of GDP, just as it did then, and with it the household consumption share. Put differently, it would force up the savings rate, which is the opposite of what China needs to do it if it to limit the growth of its debt burden. And notice that as the savings rate rises, growth drops through the declining multiplier as the GDP impact of Thin Air’s activities increases the savings rate.

What this exercise shows is that fiscal deficits or credit creation are good for the economy when there is enough slack in the economy that Thin Air’s expenditures do not suppress investment or consumption elsewhere in the economy, and they are good for the economy if and when Thin Air’s spending is more productive than private sector spending. Otherwise they are bad for the economy and are not sustainable.

But we already knew that. Supply-siders have explained why it is the case in a well-functioning economy, and Keynesians have explained why it is the case when the economy is operating far below capacity.

 

Appendix – savings is equal to investment

While defining investment and saving as different names for the same thing might at first glance seem a useless exercise, in fact, as I argued most recently in my long review of The Leaderless Economy (Peter Temin and David Vines), it is a rich way of understanding the links among national economies within the global economy as a single system. “Savings” can be defined in a number of ways, but the most useful way, and the convention in economics, is to define the supply of all the goods and services an economic entity produces in any period as consisting of two things. The first is everything currently consumed, including things that are lost, thrown away, or that rot away to nothing.

What is left and stored for future use is savings. The intuition is fairly obvious: everything that the economy produces is either currently consumed (or used up in some way), or it is set aside for future consumption, and we define savings broadly as whatever we set aside for future consumption out of current income. The important point is that these are accounting identities and are true because of the way we defined them.

Supply is equal to demand (another accounting identity), so that we can restate the accounting identity by saying that the demand for everything produced is either the demand for stuff we currently want to consume, or it is the demand for stuff that we want to use for future consumption. We call the latter “investment”. We might find it useful to further distinguish between two kinds of investment. One, which we might call an increase in “inventory”, consists of taking some of the goods we consume and storing them for later consumption. The other consists of goods and services that we cannot directly consume, but we produce them anyway because they might help us produce even more goods and services for us to consume in the future. If we produce a hammer, for example, or a tractor, we will probably never want to “consume” either, but these can help us produce even more goods and services in the future.

Buying an existing asset is often called “investing”, but we can safely ignore its impact, either because we define investment as setting aside additional goods and services, or, if we decide to define the buying of existing assets also as investment, because in that case the existing asset is simultaneously an increase in investment and an equivalent increase in savings. Either way it does not change the result of our accounting identity at the time it occurs, although of course when enough money is invested in existing assets so that its price rises, we may feel wealthier and so reduce our savings, or, which is the same thing, increase our consumption.

Because the supply of all the goods and services that an economy produces is equal to the demand for all the goods and services that an economy produces, then as long as we are consistent in our definition of consumption, it is true by definition that investment is equal to savings. This is only the case, of course, in a closed system, like the global economy. In an open system, like a country, investment and savings are rarely equal, but the sum of the excess of savings over investment in some countries and of the excess of investment over savings in others must always equal zero – another accounting identity.

This is just a way of saying that all the current account or trade surpluses in the world must add up to the same number as all of the current account or trade deficits. I explain why in my review of The Leaderless Economy. This is also a way of saying why this statement by the St. Louis Federal Reserve Bank, provided to educate the public in their “Ask an Economist” program (how ironic), is wrong to the point almost of inanity:

Perhaps the most serious issue with foreign investment is that it effectively disguises a lack of domestic savings. But domestic savings are the result of Americans’ individual and governmental decisions and are only modestly influenced by foreign demand for U.S. assets. We have our economic destiny in our own hands.

Because savings and investment must always balance, the idea that the savings rate in any country is determined at home is nonsense. In countries that intervene heavily in trade and capital flows, this is almost true, but in countries that don’t, like the US, the truth is almost completely the opposite. The US does not determine its own savings rate, and almost cannot as long as it allows unlimited access by foreigners to its asset markets. Knowing the accounting identities would have made this very clear.

 

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  1. https://twitter.com/ProfSteveKeen/status/656017519287914496

    > Forthcoming paper in ROKE answers Michael @Lprochon. “Period” thinking by economists also a source of errors.

    (I’m not L.P. Rochon, I don’t know why Keen brought his name up.)

    • ^MB Drapier WROTE: “I’m not L.P. Rochon, I don’t know why Keen brought his name up.”
      ————————————————

      This Rochon fellow seems to be the editor of some journal (“ROKE”?) in which Steve Keen publishes his papers. I don’t know why he thought it necessary to involve Rochon in this matter either.

      ~~~~~~~

      To change the subject completely, here is something for everyone to consider:
      https://en.wikipedia.org/wiki/Trofim_Lysenko

      1) Trofim Lysenko claimed to be leading a people’s scientific revolution that aimed to overthrow bourgeoisie conventional science.
      2) Whenever somebody raised a question about Lysenko’s theories, Lysenko would respond to them with a terse letter. For example, Lysenko might write, “my forthcoming paper in the Journal of Revolutionary Science answers this reactionary question. Bourgeoisie thinking by scientists also a source of errors”.
      3) He would then copy that letter (‘cc’) to the attention of Stalin, who held the final decision-making authority on the direction of all scientific research.
      4) Regardless of whether Stalin actually read the letter or not, the people raising questions about Lysenko’s theories would be so intimidated by seeing Stalin’s name on the cc-list that they would immediately stop asking questions.
      5) This name-dropping intimidation technique helped Lysenko to silence the debate about his theories and allowed him to continue with his bizarre ideas completely unchecked– with disastrous results for the USSR.

      Luckily, this sort of thing is not possible in the West today; however, we must all work to ensure that it remains impossible in the future as well. Therefore, whenever we see potential Lysenkos in the making, it is our DUTY to call them out.

  2. Great post Professor Pettis! Looking forward to seeing the discussion continue in the comments section!

  3. Excellent post, Mr Pettis!

    I’ll start with pointing out a typo, so you know I’ve read the article: “Because the increase in GDP exceeds the increase in investment by $100, total savings will have risen by $100.” Instead of “investment” you meant to write “consumption”, right?

    I very much agree with your thinking around debt, and I do mostly agree with Adair Turner, too. I don’t subscribe to any particular school of economic thought, because I haven’t found any of the frameworks these offer compelling enough when it comes to explaining debt or “money”. Post-Keynesians/Circuitists (Keen)/MMT get many of the technicalities around “money” right, but to me, the really big picture is still missing in those explanations.

    So, I was forced to build an understanding of my own around these matters. It was quite a struggle, as anyone who is into monetary economics can surely understand. What I have ended up with is — to borrow your words — a “balance-sheet oriented understanding of the economy”. I believe this view is more or less consistent with Minsky’s view but makes it much more concrete.

    I call it the “bookkeeping view”. Simply put, I view our current economy as a “pure credit economy” — something Wicksell, Hawtrey and Schumpeter, even Jevons and Hicks, imagined and perhaps thought possible, but nevertheless considered non-existent as long as “fiat money” existed. The bookkeeping view defines even this “fiat money” in bookkeeping terms, and thus gets rid of it. All “money” that exists (i.e. is non-abstract) is just a credit balance in a ledger. For instance, physical cash refers directly to, or acts as, a credit balance in the CB ledger. This view describes the whole monetary system simply in terms of credit and debit balances, and changes in these balances. These changes arise from credit and debit entries (always respecting the accounting identity “credit=debit”) that are made in course of buying and selling. (I believe I’m very close to the Stuart-Mcleod-Innes “credit theory” line of thinking, and the way I interpret these writers is such that they are in agreement with me.)

    According to this view, banks (CB included) and other financial institutions can be considered “bookkeepers”. They don’t record their own debts and claims (for instance Schumpeter suggested that deposit holders should not be viewed as creditors of the bank), but the debts and claims — credit/debit relationships — of the entities found on both sides of the bank balance sheet.

    We are all used to think that what these credit balances refer to, i.e. what it is that is owed, is “money” (ultimately “cash”). But the “bookkeeping view” challenges this. According to this view, these credit balances are just denominated in an abstract unit of account (numéraire; e.g, USD). In other words, they refer to a price. *

    A price of what? A price of whatever is bought and sold. It might go like this: A creditor (owner of a credit balance) goes on the market, looking for goods or services, and chances upon a debtor (owner of a debit balance). The debtor is selling and the creditor is buying. (Of course, it is likely that they don’t know each other’s balance, nor should they know.) Assuming the creditor is interested in buying what the debtor is selling, they agree on a price. A transaction is made. And it is this transaction that is recorded in our monetary bookkeeping system. By selling, the debtor has redeemed (part of) his debt (to the amount of the agreed price), and that will be reflected in his reduced debit balance in the bank ledger (let us assume we are dealing through a bank; and you might want to think of this in terms of overdrafts, if you’re comfortable with it, instead of “traditional loans”, because it gives a more accurate picture of this reality. What is essential is the net balance, which overdraft gives us automatically.). Similarly, the creditor’s credit balance is reduced. Now — only ex post — we know what was it that was owed. It was the object of the transaction, often a good or a service. And only ex post can we establish a direct link between a single creditor and a single debtor, brought together most likely by the “invisible hand” (or, market forces).

    Think of this as an alternative way to view the world. One cannot prove this view wrong by just positing that money-as-a-means-of-payment must exist because, well, we are used to agree that it exists. Naturally, adopting this view makes great demands on the flexibility of our minds (it’s been a tough journey for me), but the rewards in the form of new insights on the most pressing problems in economics, and the economy, are, I believe, well worth the effort. As I hinted earlier, this view seems to prove the point Minsky was trying to make.

    * For an overview of the “abstract unit of account” concept, see, for instance, http://willembuiter.com/numerairology.pdf . Note: What Buiter says doesn’t correspond with the “bookkeeping view”. He thinks that currencies like USD and GBP are “money” which serves as a “means of payment”, in addition to their function as numéraire (abstract unit of account). The “bookkeeping view” position is that USD and GBP are only abstract units of account that are used to express the nominal value of a credit balance. These credit balances refer to prices denominated in USD or GBP.

    • ^P.G. WROTE: “…The bookkeeping view defines even this “fiat money” in bookkeeping terms, and thus gets rid of it. All “money” that exists (i.e. is non-abstract) is just a credit balance in a ledger….”
      ————————————————

      In principle, your idea is quite sound. However, there are some issues to keep in mind–

      1) We know that the US government can create money out of thin air by arbitrarily expanding its balance-sheet. This is why it is said, and correctly so, that the US government can never fail (i.e. default on its debts).

      2) If banks can ALSO create money out of thin air by arbitrarily expanding their balance-sheets, then why do people worry about banks failing (i.e. defaulting on their debts)? Why did WaMu, for example, fail? Why didn’t WaMu just create money out of thin air and save itself?

      Would you care to explain this difference between the two money-creators?

      • Vinezi wrote: “1) We know that the US government can create money out of thin air by arbitrarily expanding its balance-sheet. This is why it is said, and correctly so, that the US government can never fail (i.e. default on its debts).

        2) If banks can ALSO create money out of thin air by arbitrarily expanding their balance-sheets, then why do people worry about banks failing (i.e. defaulting on their debts)? Why did WaMu, for example, fail? Why didn’t WaMu just create money out of thin air and save itself?

        Would you care to explain this difference between the two money-creators?”
        ——————————————————————–

        Perhaps a more axiomatic answer would work best here. Let’s see.

        To your point 1: Yes, the government is be able to *issue* new public debt at will, and thus it is able to *roll over* public debt indefinitely. Here we must remember — and this is one important premise of the Bookkeeping View (BV) — that the government doesn’t *pay* (back) public debt by handing over central bank credit balances (aka “fiat money”) to a bond-holder. What conventionally is considered, in the government’s case, “creating money out of thin air”, could, using the BV language, be termed either “crediting someone’s account by debiting the public account” or “issuing new public debt” — both are the same thing. (Note: Although the government usually “banks” with the CB, we should be careful with conflating these two.)

        Your point 2: First I want to point out that bank failures where creditors (excl. equity-holders) take substantial losses are a rare exception in the monetary systems of all advanced economies today. This is because the CB in cooperation with (other) authorities, taking into account certain political and prudential considerations, can help us avoid this kind of bank failures almost indefinitely. This is because what a commercial bank “owes” (and the BV argues that it would be best, for the sake of clarity, not to view the bank as owing something to its creditors) its creditor is the chance for the creditor to switch credit balances at the commercial bank ledger (aka “deposits” or “bank bills/bonds”) to credit balances at the CB ledger (aka “CB deposits” aka “fiat money”). We are used to view this switch of credit balances, *re-arrangement of debt relations*, as the bank paying its creditors, but this kind of language assumes that one can pay with “money”. When we look at the system from the BV viewpoint, we must abandon this language as it doesn’t make much sense. A “money/cash payment” translates to “crediting an agent’s account”, and when someone’s account is credited, this someone is either *owed* more (assuming a net credit balance) or he owes others less (assuming a net debit balance). Thus, a “money payment” cannot logically have anything to do with a payment in any meaningful sense of the word. And from all this it follows that a ferociously logical thinker must conclude that WaMu couldn’t save itself because it had a *lawful duty* to comply with its creditors’ requests to exchange credit balances in WaMu’s ledger with credit balances in the Fed/other commercial bank ledgers, and too many of this kind of requests came in. (The Fed, as a central bank, has no such lawful duty.)

        Overall, I suggest that it’s best not to talk about “money creation” or “money payments”, or even to think in such terms. It might be that my explanation above sounds complicated (it has been a great struggle for me to abandon the conventional language we are all so used to), but it is based on only a handful of simple rules, which I’m trying to spell out. I’m more than happy to elaborate!

  4. Thank you, Professor, for another enlightening excercise. Maybe one way to help the intuition behind the accounting identities is to think of them as, in each case, two names for one phenomenon. Every “single” economic action is “doubly” named (for example as savings and investment). Humans like single things to have single names, which is part of the reason double entry bookkeeping is such an impressive innovation.

    When I read your essays, I often wonder what you think of work by Perry Mehrling, arguably the best Minsky scholar (not to mention Shaw, Hawtrey, AA Young, and CPK), among the clearest thinkers on the intellectual history of monetary economics, and an indisputable resource for understanding current manifestations of these very old problems. He’s also been at Columbia for decades!

    There is much overlap between your thinking and his – and much complementary material, too.

    I would love to hear what you think, especially where you disagree. I assume you are aware of his work, but anyway here is a brief introduction to his thoughts on money:

    http://www.perrymehrling.com/2015/06/why-is-money-difficult/

    • I met him several times and had coffee and dinner after reading New Lombard and seeking him out, HH. I’ve subsequently read at least two of his other books, and have often recommended New Lombard. I think he is a terribly smart guy.

    • I think Perry Mehrling has done good work with his “Money View”. My “Bookkeeping View” as a name is a reference to Mehrling. If you’re a fan of Mehrling, you might find the view I have adopted interesting:

      http://clumsystatements.blogspot.com/2015/10/pure-credit-economy-or-bookkeeping-view.html (A slightly modified version of my comment here.)

      This view, to me, is kind of the next logical step one can take after the Minsky/Mehrling “Money View”. (I say this based on the evolution of my own thinking.)

    • I actually found Mehrling’s “Money View” pretty straightforward and easy to pick up. For someone from a normal economist background, it’s very difficult. But if you have experience in either dealing with markets or looking at balance sheets, I think it’s easy to understand.

  5. Steve Keen’s assertion that aggregate demand equals previous period output plus the change in debt has prompted discussion in the Post-Keynesian literature. A recent special issue of Review of Keynesian Economics was devoted to the issue: http://www.elgaronline.com/view/journals/roke/2-3/roke.2014.2.issue-3.xml
    Lavoie’s response, available as open access, is well worth reading:
    http://www.elgaronline.com/view/journals/roke/2-3/roke.2014.03.04.xml

    • Thanks, Jo. I’ll check it out.

    • Thanks for the Lavoie link, Jo!

      He writes: “Thus Keen’s revolution seems to rely on the claim that investment is equal to saving plus the creation of money.”

      When it comes to describing the real world, I don’t see any meaning in Keen’s claim (as explained by Lavoie). At best it is a claim concerning economics, not the economy.

      Let’s say Company A uses an overdraft (with Bank C) to purchase an investment good from Company B which has an overdraft account (with a negative/debit balance) in Bank C. Let us further assume that the price of the good was $100, and that before the transaction Company A had a zero account balance while Company B had a debit balance of $100. After the transaction Company A has a debit balance of $100 and Company B has a zero balance.

      Let’s stop here, right after the transaction took place, to analyze the situation. How much did investment increase (ceteris paribus) as a consequence of this transaction? How much did saving increase? How much “money” was “created”?

      • Savings increase = 0, investment increase = 0, “money” created = 0. Not sure the point of this exercise??

        • ^G. Stegen WROTE: “Savings increase = 0, investment increase = 0, “money” created = 0. Not sure the point of this exercise?”
          ————————————————

          The “point of the exercise” is to convert idle inventory into productive fixed-investment.

          Savings = Investment = Fixed-investment + Change in Inventory
          Savings Increase = 0$
          Investment Increase = 0$
          Fixed-investment Increase = 100$
          Inventory Change = -100$

          Money Created (i.e. ‘borrowed by A’ or expansion of bank balance sheet) = 100$
          Money Destroyed (i.e. ‘paid back by B’ or shrinking of bank balance sheet) = 100$
          Net Change in Money (i.e. net change in length of bank balance sheet) = 0$

    • Thanks for the links!

    • Let me think out loud about this “Aggregate demand = Income + Change in Debt”.

      Which came first: demand, income or debt? If I buy (Demand) with credit (Change in Debt), the purchase creates Income for the seller. All three are created simultaneously. If I buy using credit balances (“deposits”) I have acquired previously, there is simultaneous increase in Demand and in Income, without Change in Debt.

      It is important to notice how a monetary economy doesn’t exist without debt. Let’s assume a “total reset”, so that all debts and so all credit balances (“money”, “near money”, etc) disappear. Where does the first Monetary Income (i.e. income recorded in a common unit of account) come after this reset? From someone incurring a debt (debit balance) when this someone makes a purchase, of course. To say that this Demand and Income (for the seller) came from Thin Air, doesn’t make sense, does it?

      We need to recognize how debt is not “money borrowed” or even “money created” *. Debts arise as part of trade all of the time. They are an indispensable part of people’s transactions with each other, and it is futile to try to separate debt from income on aggregate (macro) level.

      (* This is why I like to think in terms of overdrafts instead of traditional loans. Traditional loans give us a misleading picture of “money” being “created” when a loan is made. The “money” (a credit balance) that matters is only created when a purchase is made (an account is debited) and the buyer doesn’t possess a credit balance that would cover the purchase price. In other words, the buyer incurs a net debit balance when he buys.)

      • ** “It is important to notice how a monetary economy doesn’t exist without debt.” **

        That’s not true at all. The monetary medium can exist absent debt. If the monetary medium can exist absent debt, then a monetary economy, and trade can also exist absent debt. Credit with its attendant Debt, is not money or a currency or even a medium, it’s a ledger book entry denoting, in both instances of its existence, a debt owed.

        In all honesty, about the only thing you got right was “debt is not “money borrowed” or even “money created”, which is absolutely true; debt is money OWED, period.

        The only ones who benefit from the conflation of money and credit are the issuers of credit with no money, and economists.

        • In all honesty, Dwain, you are giving me the conventional view of things, and you think I need you to educate me on it? This “monetary medium” you talk about doesn’t correspond with any widely accepted “currency”. Are you talking about Bitcoin or gold? The “money-things” we call “dollars” or “euros” are nothing but a credit balance in a ledger “denoting a debt owed”.

          Try to understand that what I’m saying is that “monetary medium doesn’t exist absent debt” and that “debt is not money owed”. I don’t only say this, but I try to back my view, explain what I mean. And then you come, smugly stating that “You’re wrong”, and you prove this how exactly? By stating that “monetary medium does exist absent debt, therefore bla bla” and that “debt is money OWED, period”. That’s the way a simpleton would argue. I know you can do better.

          • I didn’t say you were wrong the first time you erred, however, I will say it this time: You are wrong. The Federal Reserve note, as well as U.S. coin, circulate independent of debt. They represent the legal tender monetary medium, with which debts, public and private, can be paid.

            There is a difference between Money and Credit.
            Money as defined by law. Section 31 U.S.C. 5103, defines legal tender as “United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues.

            Congress has specified that a Federal Reserve Bank must hold collateral equal in value to the Federal Reserve notes that the Bank receives. This collateral is chiefly gold certificates and United States securities. This provides backing for the note issue. The idea was that if the Congress dissolved the Federal Reserve System, the United States would take over the notes (Fed liabilities). This would meet the requirements of Section 411 (Federal Reserve Act), but the government would also take over the assets, which would be of equal value. Federal Reserve notes represent a first lien on all the assets of the Federal Reserve Banks, and on the collateral specifically held against them.

            The Fed defines credit as such: “Credit dollars are a debt generated currency that is denominated by a unit of account. Unlike money, credit itself cannot act as a unit of account. However, many forms of credit can readily act as a medium of exchange. As such, various forms of credit are frequently referred to as money and are included in estimates of the money supply.”

            As an aside; why does the Fed count ‘credit’, which is primarily BANK DEBT, as if it were money and include it, even though they admit it isn’t, as being part of the ‘money supply’? Also noteworthy is the Fed’s use of the term “credit dollars”, which is a fiction, the credit/debt the Fed and the banks generate is neither dollars, money or even a currency.

            There is no law anywhere that grants to either the Federal Reserve or the banks the authority to create money. There is no law anywhere that designates or acknowledges the credit/debt they do create as being money or even a currency.

            Deposit accounts are a fiction. There is no money in any ‘deposit account’ of any type anywhere in all of westernized banking, they are all Credited Accounts, they are all Bank Debt. This means that the richest amongst us have exactly the same amount of ‘money’ in their deposit accounts as the poorest amongst us have in theirs, $0.00.

            That a bank maintains some ‘money’ on hand to placate a few requests for the actual monetary medium, does not negate the fact that all deposit accounts maintain a zero monetary balance. A ledger book entry denoting the amount of ‘money’ the bank owes to (stole from) the depositor, is not ‘money’, regardless of your ability to ‘spend’ that ledger book entry with a debit card. Passing around bank debt from one recipient to another, is not payment for anything. Crediting an account with the amount and actual payment are two different things.

            It’s really not that hard to understand. Let’s say you go down to your corner store to pick up a few things. You don’t have any money with you so the store owner lets you take the stuff after he totals it and you sign for the amount, promising to pay later. Did you just use a ‘currency’, or ‘digital credit’, or ‘dollars’ to pay for the stuff you got from the store? No, you incurred a debt obligation that requires payment at a future date.

            It works the same way when you use your debit card. All you’re doing when you use a debit card to make a purchase is, transferring your obligation to pay the store owner, to the bank, payment has yet to be made. The bank deducts the amount from its debt to you, as represented by your account with them, and adds that amount to the debt it owes to the store owner, as represented by his account with the bank. There was no money or currency of any type, digital, electronic or otherwise, used or exchanged in that transaction, just a transfer of an obligation to pay.

            The notion that we’re using a ‘digital currency’ as a medium of exchange is nothing more than a trick of the mind, a deception, it’s how we rationalize the transaction. Also, because we believe that we can go to the bank and withdraw the amount credited to our account, in cash if we wanted to, and the fact that we can successfully do this on occasion, reinforces that deception.

            Credit, an obligation to pay vs. Money, payment.

          • “Credit, an obligation to pay vs. Money, payment.”

            This is really arbitrary and kinda useless. If I give someone a banknote for a beer, that’s a form of payment. Money has hierarchies. What’s money for one group is not money for another. To say there’s one universal definition of money for all is stupid.

            “Deposit accounts are a fiction.”

            This is complete garbage. Deposit accounts exist because we simply think them to exist. If we construct them in our heads as exist, they exist. They may not physically exist, but our physical being is simply a manifestation of what we perceive it to be.

            “The notion that we’re using a ‘digital currency’ as a medium of exchange is nothing more than a trick of the mind, a deception, it’s how we rationalize the transaction.”

            Why are all of these things deceptions? Finance is about trust. If you don’t have trust, none of this stuff matters. This isn’t about deception because it’s not physically there (this is why many traditional Hindus consider money sacred BTW). To say that is simply absurd. Ultimately, our physical world itself is a mental construction. So to attack something for being a mental construction instead of something physical or “tangible” or “real” is plainly stupid.

            “There is no law anywhere that designates or acknowledges the credit/debt they do create as being money or even a currency.”

            Who cares if there isn’t a law? Does that mean I don’t trust the person who I do business with every day to not give me a garbage piece of paper? Do you need a law backed by force for every little thing to operate? This is patently absurd.

        • ^D.D. WROTE: “….debt is money OWED, period.”
          ————————————————

          Debt is goods/services owed. Debt is goods/services borrowed.

          DEBT exists because someone either consumed or invested goods/services in excess of the goods/services they produced (‘savings deficit’, e.g. US). This is only possible because they BORROWED the said goods/services from someone else who did produce them but did not either consume or invest them (‘savings surplus’, e.g. China).

          • V.K, you’re absolutely right! Because the producer most likely produced the goods/services for sale, I prefer to take a slightly different view, though:

            Debt exists because someone bought (=’debited’ his account) for more than he had cumulatively sold (or in other ways had got his account ‘credited’). This is only possible if someone else’s account has been cumulatively ‘credited’ more than it has been ‘debited’.

            Do you find anything wrong/problematic with this view?

          • “Debt is goods/services owed” if you are in a barter system. But in a currency based system where money is exchanged for goods and services and accounting is conducted in monetary units of exchange, debt is money owed. It’s idiotic to believe that you are owed goods and services because you have money.

          • “P.G. WROTE: Do you find anything wrong/problematic with this view?”
            —————————————

            No. It’s fine. After all, all of us have own unique way of looking at the world. Some people are word learners, some are picture learners. It is good that you are finding your own model of understanding things. As long as it works for you, it is all good.

  6. Giancarlo Bergamini

    How worthy of Prof. Pettis that he has taken the comments of some brilliant blog participants into consideration in writing a new post. And very apposite too. I am sending this very explicative essay to my (post-keynesian) friends who until now have objected to Prof. Pettis’ otherwise sensible points on the grounds that they rested on the (flawed) loanable funds theory and neglected the (rightful) endogenous money process. Another friend, a former politician, used to take exception at prof. Pettis’ use of account identities to accuse him of being deterministic.
    I am confident that this post sets the record straight on both counts. Thank you.

    • Thanks, Giancarlo. The criticisms never vary even though they are easy to refute, but if I am accused of the same sins as Keynes, I really don’t mind, I guess. Keynes was a brilliant mathematician and a monster of logic.

      • This is why leftists either hate him or have to distort him to “agree” with them. Of course, Keynes had the best critique I’ve ever seen on leftism. I said this to Cullen Roche at some point and Cullen responded by saying that he thought Keynes was pretty “conservative” (in the American sense) which seems pretty obvious to me. I don’t get how leftists who think Keynes was cool actually think that. I just assume they’re idiots who haven’t read him, which is usually the case.

        I find it absolutely pathetic how leftists distort him in the way they do. Keynes was the man and I think his perspective on probability was more revolutionary than his views on economics. Everything he said on math is essentially the basics of modern day numerical analysis. He was a mathematician, not an economist.

        He also ran the modern version of a hedge fund. He was kinda crazy though. The guy used to trade on 10% margin! That takes balls (way more than I have) and elevates him to baller status IMO.

  7. Having had the pleasure of sitting in on your Central Banking Seminar, this comment warms my heart. “As one of my exasperated PKU students asked me after class last Saturday when we discussed the president’s trip: “So everyone agrees that it is good for England to get much more foreign investment, and everyone also agrees that it is bad for England to have a much bigger trade deficit. Don’t they know it’s the same thing?” Your students are much sharper than the chattering classes….

    • It can be done if the UK gets a lot of foreign investment, but does even more investment overseas. That is exactly what China has been doing. Not so sharp after all.

      • No one said whether or not it could or could not be done. The observation was quite astute, that the same thing , given that a capital acct increase necessitates an increase in the trade deficit, was both good and bad

  8. re para 4 of point 2 under heading : “Creating demand out of thin air”: Shouldn’t: “Because the increase in GDP exceeds the increase in investment by $100, total savings will have risen by $100″ actually say: .”Because the increase in GDP exceeds the increase in consumption by $100, total savings will have risen by $100” ? (GDP being $400).

    Many thanks for the blogging. Your insights and explanations are much appreciated.

  9. I will have to read, again and again, this master class. Thanks a lot Michael. It seems to me that the IMF is always using the same models in their economic analyses and forecasts for different countries regardless those countries are in very different economic situations and have very different balance sheet structures. They also seem to have only one recipe for indebted economies that is not precisely the one that should help the most.

    My naive question is why?

  10. The economic aspects of this post are excellent and provide great clarification towards things I was a bit muddled about.

    With that being said, I’d dispute a few things about your post. The first thing I’d dispute is when you said it was Minsky’s insight that allowed him to characterize an economy as interlocking balance sheets, other economists have done this before Minsky including Murray Rothbard. I don’t particularly agree with or like Rothbard, but he does this before Minsky.

    Secondly, when you discuss how accounting identities and about whether Keen understands that they come out by definition, he certainly does. Keen, to his credit, understands accounting identities don’t need to be shown to be true by research or models; they’re true by definition. With that being said, I’d characterize Keen as being an average mathematician at best–maybe below average. His understanding of concepts in chaos theory or dynamical systems really aren’t that good. For example, he caricatures the idea of “free markets” without realizing that self-organization is THE most basic concept in any dynamical systems class for a mathematics grad student. Self-organized systems are robust because they’re completely decentralized and rely of exploitation and exploration, which very few people seem to grasp.

    Thirdly, I don’t find much of what I’ve seen or heard from Michael Hudson particularly insightful. For example, his insights into protection being necessary is something that pops up in any sort of financial history book that discusses colonial history, economic development history, military intersecting finance, or a whole host of other things. On the other hand, I’ve seen a lot of things Hudson says that seem to be either erroneous or could lead to erroneous conclusions if you don’t have a sound understanding of what’s going on.

    For my critique on Hudson, I’ll simply cite what he says in Super Imperialism. In that book, he cites the Leninism imperialism theory, but that didn’t come from Lenin. It came from Charles Arthur Conant and the purpose was to secure capital flows for both developing countries and the US that came under the territory of empire. From my perspective, the primary purpose of empire is to secure capital flows and I don’t really know if I have a huge problem with the basic idea.

    Hudson also says in Super Imperialism that the Civil War was about slavery, which I’m not so sure about. Slavery certainly was a factor, but there haven’t been a whole lot of wars over slavery in the world in the 19th century although there were lots of wars over control of trade routes. With that being said, I view control over the Mississippi and preventing the fracture of the Union as the two biggest issues in the Civil War. For any industrial or agricultural production in the Midwest, it was built on getting goods to the Greater Mississippi Basin and using those routes to ship it. Even in the Civil War, the control over the Mississippi was the biggest military factor in the war. Once the the Union secured the Mississippi, the War was over.

    Speaking of Michael Hudson, I just realized he has a website where he writes stuff so I’ll just cite the last post he did to criticize flaws that I find pretty obvious. A link from the post is shown below.
    http://michael-hudson.com/2015/10/the-paradox-of-financialized-industrialization/

    From that post, this is what he says:
    “In retrospect, Marx was too optimistic about the future of industrial capitalism. As noted above, he viewed its historical mission as being to free society from rent and usurious interest. Today’s financial system has generated an overgrowth of credit, while high rents are pricing American labor out of world markets. Wages are stagnating, while the One Percent have monopolized the growth in wealth and income since 1980 – and are not investing in new means of production. So we still have the Volume II and III problems, not just a Volume I problem.”

    Okay, so I’ve seen kids walk out with computer science degrees that’re making $80,000 a year coding that look like skateboarders who barely work 30 hours a week and pay their student debts off in <1 year. I fail to see the pricing out of American labor, at least in the way he's speaking.

    "Industrial economies are being stifled by financial and other rentier dynamics. Rising mortgage debt, student loans, credit card debt, automobile debt and payday loans have made workers afraid to go on strike or even to protest working conditions. To the extent that wages do rise, they must be paid increasingly to creditors (and now to privatized health insurance and drug monopolies), not to buy the consumer goods they produce. Labor’s debt dependency thus aggravates the “Volume I” problem of labor’s inability to purchase the products it produces. To top matters, when workers seek to join the middle class “homeowner society” by purchasing their homes on mortgage instead of paying rent, the price entails locking themselves into debt serfdom."

    I didn't know that things were so similar to when "America's protectionist take-off" occurred. Gee, such similarities to so many times in American history when the collapse was imminent so many times. Of course, that's just a coincidence. Marx must always be correct by definition because his view of the world is the only way things can "feel good" (for lack of a better word).

    Hudson goes on to say:
    "Industrial companies profit from labor not only by employing it, but by lending to customers. General Motors made most of its profits for many years by its credit arm, GMAC (General Motors Acceptance Corp.), as did General Electric through its financial arm. Profits made by Macy’s and other retailers on their credit card lending sometimes accounted for their entire earnings."

    So I wonder how GM and Macy's are doing right now? Oh, that's right! GM almost went bust and if Detroit wasn't bailed out, cars would be made in Silicon Valley right now. Macy's is completely bust. Hell, all departmental retail stores are gone because they charge double the cost for stuff that's below par.

    As Hudson is clearly unaware of, people who don't buy their clothes online usually go to some sort of an outlet mall where there's lots of individual companies that sell clothes straight from the manufacturer for cheaper prices where I can spend $15-20 on a NICE, high-quality shirt that can last as much as (if not more than) a decade. The funny part is the labor unions try to prevent this.

    Further in the article, Hudson talks about how "the failure to socialize banking", but that's exactly what most of the world has done. In almost all nation-states, capital is viewed as a national asset, which really developed as a way to fund large-scale industrial warfare that doesn't even really exist any more (at least not in the same way). Secondly, I've seen socialized banking absolutely ransack entire countries like India during development. Stuff like the socialization of finance and centralized implementation of industrialization (in large part coming from the thinking of people like Marx and Lenin) absolutely destroyed the land and environment. What happened was that you allowed a country that has very fertile soil to have an explosion in demand that supported an explosion in population growth while overall production remained flat. It increased the cost of basic social services like health care (again, something that Hudson says should be socialized) and education while making it impossible for the country to develop capital.

    Don't even get me started on how "labor unions" (he speaks very approvingly of "labor" and "strikes" in this article) literally sucked these companies dry and ran them into the ground. I've seen teachers unions do the same thing to sound educational systems while preventing competition in schooling where the people who get hurt most are the poor and lower middle class.

    I would also be careful to lump Kindleberger into the same camp as the "Post-Keynesians" or even as Minsky. Across many of his works, Minsky talks highly about labor unions as helping to sustain high wages. In World Economic Primacy, Kindleberger talks about how the rise in labor unions is one of the quickest paths to leaving economic primacy behind you. Many of the flaws that I cite in Hudson's (most recent published less than a week ago) article were issues that Kindleberger talks about as being very dangerous threats that can come from strongly entrenched interests that prevent social mobility–like labor unions.

    • My comment wasn’t supposed to be this angry or long, but I started reading Hudson’s most recent article and I ended up going into a fit of rage. There’s so many things that seem like obvious errors and other things that just can’t be true.

      I’d like to add that I do see the pricing out of American labor on some stuff. Also, more nonsensical stuff coming from Hudson’s article:
      “In retrospect, Marx was too optimistic about the future of industrial capitalism. As noted above, he viewed its historical mission as being to free society from rent and usurious interest. Today’s financial system has generated an overgrowth of credit, while high rents are pricing American labor out of world markets. Wages are stagnating, while the One Percent have monopolized the growth in wealth and income since 1980 – and are not investing in new means of production. So we still have the Volume II and III problems, not just a Volume I problem.”

      I did not grow up in a rich or “one percent” family and wages have stagnated, but isn’t it just more natural to have winner-take-all effects in wealth creation. In any complex system, winner-take-all effects are just the norm and we saw massive winner-take-all effects in the late 19th century as well when we had large increases in the standard of living.

      Here’s another quote from the article:
      “It seemed that the banking system’s role as allocator of credit would pave the way for a socialist organization of economies. Marx endorsed free trade on the ground that industrial capitalism would transform and modernize the world’s backward countries. Instead, it has brought Western rentier finance and privatization of the land and natural resources, and even brought the right to use these country’s currencies and financial systems as casinos. And in the advanced creditor nations, failure of the U.S. and European economies to recover from their 2008 financial crisis stems from leaving in place the reckless “junk mortgage” debts, whose carrying charges are absorbing income. Banks were saved instead of industrial economies, whose debts were left in place.”

      These economies aren’t industrial and the industrial world is over. Explosive population growth that’s resulted form industrialization is gone. Marx’s view of “backward countries” was racist and wrong. What Marx advocated for was the destruction of ancient rites, ancient traditions, and ancient ways of life that were perfectly adapted to the needs of each of those countries.

      Secondly, the socialization of land and natural resources has done far more harm than their privatization. The problem isn’t that they’re privatized, but HOW they’re privatized. If they’re privatized to foreign business magnates by selling them to the highest bidder of a political campaign, of course that’s not gonna end well. If this is a great insight, I’m speechless. If they’re privatized in such a way where there’s clear incentives against pure extraction while there’s incentives for genuine innovation and the development of real capital, it will be different.

    • Here’s an interview with Hudson I found on his blog/website. Yet again, more nonsense. For example, take this quote:
      “That’s right. Neoliberals say they’re against government, but what they’re really against is democratic government. The kind of governments they support are pre-referendum Greece or post-coup Ukraine. As Germany’s Wolfgang Schäuble said, “democracy doesn’t count.” Neoliberals want the kind of government that will create gains for the banks, not necessarily for se the economy at large. Such governments basically are oligarchic. Once high finance takes over governments as a means of exploiting the 99 Percent, it’s all for active government policy – for itself.”

      ALL GOVERNMENTS are essentially oligarchies. How can everyone be a member of the ruling class? That makes absolutely no sense.

      The US wasn’t born as a democracy, but apparently, Hudson ignores history as a person who claims to have such credibility over it. It was Andrew Jackson that turned the US into a “democracy” when he basically made it so that all white males could vote. It was very successful, except for the Civil War it led to when one entire populace felt their “culture” was threatened by “industry”, “finance”, and “banks” (this is actually what many people in the South feel to this day and how they’ve always felt about the Civil War).

      I wonder if Hudson realizes that about 30% of the Union population supported the Civil War at the time. The only people who were really pushing the Civil War were Union religious leaders, philosophers, and capitalist elites.

      Then, Hudson keeps going:
      “To prevent such price gouging and to keep economies competitive with low costs of living and doing business, European kept the most important natural monopolies in the public domain: the post office, the BBC and other state broadcasting companies, roads and basic transportation, as well as early national airlines.”

      First off, the deregulation of airlines has actually reduced prices and made things better. Secondly, why would you want “state broadcasting companies”? That’s gonna distort things quite a bit by giving the rulers a way to control the populace. This has been one of the biggest issues that’s allowed a few people to gain a massive amount of sway in the political system that’s “democracy”. Is Hudson really missing something this obvious.

      Here’s another piece of nonsense from Hudson:
      “The key to the Austrian School is their hatred of labor and socialism. It saw the danger of democratic government spreading to the Habsburg Empire, and it said, “The one thing we have to stop is democracy. Their idea of a free market was one free of democracy and of democratic government regulating and taxing wealthy rentiers. It was a short step to fighting in the streets, using murder as a “persuader” for the particular kind of “free markets” they wanted – a privatized Thatcherite deregulated kind. To the rentiers they said: “It’s either our freedom or that of labor.”

      Kari Polanyi-Levitt has recently written about how her father, Karl Polanyi, was confronted with these right-wing Viennese. His doctrine was designed to rescue economics from this school, which makes up a fake history of how economics and civilization originated.

      One of the first Austrian’s was Carl Menger in the 1870s. His “individualistic” theory about the origins of money – without any role played by temples, palaces or other public institutions – still governs Austrian economics.”

      So Hudson is talking about things he clearly doesn’t understand. The Austrians emphasize the importance of tradition in governance of such things, so why does he say that “temples” don’t play a role?

      I just got into reading him and he’s very controversial and I can’t stop reading him, even though he makes me very angry and the stuff he says is obviously stupid. Am I missing something? If I am, please point something out to me because I’ve lost all respect I ever had for the guy.

    • For anyone who sees these set of comments and can explain to me where I’m wrong or what I’m missing, please explain it to me. I’m really trying to see where he’s coming from and trying to understand the points he’s making, but I’m having lots of difficulty doing so. If I get no response, I’m just gonna keep operating with the assumption Hudson is an idiot unless someone can prove me wrong.

      I’ve asked others this question (on online forums and stuff like that) and the usual response towards me is anger, which doesn’t help anyone involved. Can someone please point my errors out? I’m incapable of seeing them.

      • Instead of Hudson, read Keynes (or Marx) again. Keynes is coherent on the gains of socializing production, monoply rents, liquidity traps, and all the evils of an uncertain economic machine. He is a much better writer than Hudson. If you are as smart as Keynes (Draghi, Yellen and Carney are all smarter) then you can engineer credit flows, and grow an economy with less inequality.

        Then re-read the fatal conceit by Hayek, and realize the the economic machine is not a closed system with econometric identities and measurable variables. Instead the economy is a chaotic dynamic system with probabilities, uncertainty and non-rational human desires.

        Hudson is worse than a crank weather forecaster, who thinks he can forecast the economy better than General Circulation Models that come from the Central Bank.

        • I’ve read Keynes. I love him, he’s excellent. One of the best critiques on leftism that I’ve ever seen.

        • Let me restate that: Keynes had one of the most ruinous critiques on leftism I’ve seen. He’s absolutely brilliant.

        • Let me restate that: Keynes had one of the most ruinous critiques on leftism I’ve seen. He’s absolutely brilliant. By leftism, I mean Marx-based nonsensical jargon, much like Hudson is preaching.

        • Michael
          Many years ago I was a student of Peter Kennedy when he was writing his “Econometrics” textbook. My comments are based solely on observation and available yardsticks as I see them.

          1. While economics shamelessly applies math and bookkeeping to its’ profession, it also hides the fact that it was born and remains an art.
          2. Banks, in and of themselves don’t create demand for investment, rather they provide funding and pricing of money under defined conditions and the borrower creates the demand for money.
          3. While you can elegantly argue that savings equals investment, a portion of savings is in currency or its’ electronic equivalent. With ZIRP and NIRP, these monies can hardly be considered investments.
          4. My econometric lessons taught me that GDP was balanced with GNI. Savings and Investments always were on opposite sides of the balance sheet- distinct entities.
          5. A balance sheet is a construct- it does not exist in nature. Savings depend on Investment and Investment depends on Savings. Interdependence in a tautological loop. A mathematical conundrum. They balance as part of your construct, your premise.
          6. As governments force NIRP onto the economy, the best return can become hiding cash, or its’ equivalent, in the mattress. After all, if a dollar in the bank today becomes 99 cents a year from now, it is still a dollar if you take it out of circulation and hide it for a year.
          7. And economics and econometrics depend on honesty and especially an honest referee- another reason economic models and predictions fail in our contemporary world.
          8. Setting aside the concept of debt jubilee, money creation (usually by dilution) and credit creation under fractional reserve banking are predicated, wittingly or not, on future incomes, greater or not. This is the “post-it note” glue connecting Investment and Savings. That is the spinning top, the dynamic balance, upon which we have gambled our children’s and grandchildren’s futures.

          • 1. Economics uses zero math, which is actually the problem. The mistake is in thinking math is about number-crunching, but mathematicians don’t begin with numbers. They begin with charts, graphs, and pictures. Mathematics is thinking rigorously. Economists don’t ever check their assumptions and are not rigorous (you’re not either).

            2. Savings=investment it’s true by definition. It can’t be argued unless you use different definitions. Savings=investment in both fractional reserve and full reserve banking. If A+B=A+C, then B=C.

            3. Econometrics is almost entirely a BS study. It’s a complete waste of time.

            4. Of course balance sheets exist in nature, you just don’t see them but they can be used in any system. It’s a collection of assets and liabilities which basically says how you pay for things. It’s true for an ecological or biological system as much as it an economic system.

            5. You use economic models and theories BECAUSE they’re wrong. They’re obviously wrong because they’re simplifications that require simplifying assumptions. You need to be wary of the assumptions and how shifts in the assumptions shift the conclusion.

            6. Prof. Pettis also does no economics. He does finance. If you want to discuss economics, I think you’re really in the wrong place.

            7. The entire point of finance is dedicated on future incomes. Finance runs purely off of trust.

      • – One more idiot, right ? Hudson, Wilson, Keen, Marx. Who’s next ?
        – I learned that Hudson is very “left leaning” and that is ONE reason why he has refreshing view on a number of things. Since he worked for Chase Manhattan in the past he knows the financial beast from the inside (he’s a balance of payment expert). But he also is missing one or more important points.

        • When did I call Keen an idiot? I don’t think Steve Keen is an idiot. I think he talks with authority about things he clearly doesn’t understand and has no authority to talk about, but I never said he was an idiot.

          I did call Marx and Hudson idiots because, well, they are. I suspect Hudson’s probably a guy who has no technical skills at all and comes from either a humanities or social science background that doesn’t include history. He lacks the capacity to think logically. I bet I could show his stuff to a bunch of sociology kids at my college and they’d eat this shit up. Of course, I’d consider many of them suckers, but that’s a different story.

        • Hudson wants to socialize the financial system. This guy is bat shit insane.

          Oh yea, my suspicions on Hudson having no technical skills was right. He studied linguistics and he translated Trotsky’s writings. Anyways, I don’t think people who study things like sociology or linguistics should be publicly funded to study those things. You’re giving a kid a bunch of debt-based financing to go read some revolutionary bullshit coming from some guy like Marx or Lenin. Keep in mind that these people have no technical skills, logical skills, and most have no clue how to deal with money. You’re literally creating a bunch of people who think that this kind of thinking is the hallmark of civilization when it’s really as barbarian as it gets.

          I’m also starting to think of Bernie Sanders as a demagogue, because that’s what he is. He’s such an idiot. This guy is actually trying to convince people that the US needs to be more like Europe, particularly mainland Europe, because of “equality”. This is the epitome of sucker thinking. He actually thinks nation-states are cool.

        • Also, this is a new post from Michael Hudson I’m citing.
          http://michael-hudson.com/2015/10/how-the-u-s-treasury-avoided-chronic-deflation-by-relinquishing-monetary-control-to-wall-street/

          He then continues:
          “President Andrew Jackson (1829-1837) of Democratic Party starved the economy of credit by his war on the Second Bank of the United States and removal of government deposits to sub- treasuries around the nation. His Democratic Party policy was backed by Southern plantation owners opposing Northern industry, seeing that its growth would increase urban industrial demand for food and other consumer goods. This would raise prices for the crops that plantation owners needed to feed their slaves.”

          Now here’s a map of the election of 1832, which shows that Hudson couldn’t possibly be correct.
          https://en.wikipedia.org/wiki/United_States_presidential_election,_1832#/media/File:ElectoralCollege1832.svg

          Oh yea, these are my sources on the facts I’m citing about the Jacksonian era.
          http://www.amazon.com/Liberty-Power-Politics-Jacksonian-America/dp/0809065479/ref=sr_1_1?ie=UTF8&qid=1446566851&sr=8-1&keywords=liberty+and+power

          http://www.amazon.com/Financial-Founding-Fathers-Made-America/dp/0226910687/ref=sr_1_1?ie=UTF8&qid=1446566931&sr=8-1&keywords=financial+founding+fathers

          http://www.amazon.com/Money-Men-Capitalism-Democracy-Enterprise/dp/0393330508/ref=sr_1_1?ie=UTF8&qid=1446567665&sr=8-1&keywords=the+money+men

          http://www.amazon.com/History-Money-Banking-United-States/dp/0945466331/ref=sr_1_8?ie=UTF8&qid=1446566944&sr=8-8&keywords=rothbard

          I’ve got way more sources than this too, but my point is clear.

          • As I said in a previous post, Jackson was never against tariffs or internal improvements. He actually understood the importance of both in having the ability to procure arms. He even went after South Carolina during the Nullification Crisis.

            Jackson was also clearly supported by the masses and was loved by the people. And when Hudson talks about Biddle, he’s completely wrong. Biddle purposefully threw the entire economic/financial system into a tailwind to try to maintain the Bank of the United States by forcing Jackson’s hand. Jackson’s response was: you just made my point, which is why he ended it.

            Secondly, the usual way the US has gotten infrastructure bills through Congress was by getting a bunch of elites (usually, but not always, Yankees) and buying out Congress.

            I also wonder about the Treasury’s success at “monetary control”. In the 30 years before the Federal Reserve, the most powerful man in the country was John Pierpont Morgan. This was a guy who was basically taking down democratically elected Presidents at will. Again, I have no problem with this, but I wonder why Hudson doesn’t say this.

            Rothbard argues the same thing when he talks about the creation of the Federal Reserve (that it didn’t reduce the power of the banks and New York), but I’m not so sure. Before the Fed, every 7-10 years you had the Treasury being blackmailed by JP Morgan where it was about to default on its obligations to redeem gold at par. The guys in the White House (ex. Grover Cleveland) had no clue what was going on. During Reconstruction, the entire idea of the US being a “democracy” was a total sham (as Rothbard understands and dislikes, although I have no problem with this). The “democratically elected leaders” were complete buffoons who were completely incompetent during that period.

            As for all the hate that Michael Hudson has towards the libertarian economics of the United States, he’s wrong when he claims that the federal economics were the ones supported by the people (as he implies several times in many of his articles and probably his books too). I also think the libertarian economic theories in the US, even though I don’t agree with them, have provided a lot of value to the economic/financial development of the US. They limited the power of the centralized government in picking winners and losers while making the American mode of development more market-based. They actually eliminated many of the negative elements of Hamilton’s line of thinking.

            It also seems to me like Hudson takes this revisionist view of history where everything is basically predictable. He really just assumes away the importance of credit bubbles and the idea of people taking ridiculous risks while seeming to make this seem “bad”, but this is really important for a developing country. We really don’t know what’ll work and what won’t. So in winner-take-all domains, the most important thing is to have lots of trials–as many as possible. Libertarian economics in the US kept this kind of stuff at the forefront and limited the top-down control by the Hamiltonians (guys like me). As a Hamiltonian, I really value the libertarian economic/financial aspects of the United States because they’re the ones that made sure Hamilton survived.

            Of course, Hudson refuses to think about these things because they make people “feel bad”. Unfortunately, facts are stubborn things.

          • @Willy2, this is directed at you.

          • I also shouldn’t say that Jackson was never against tariffs or internal improvements, but it is wrong to say he was against them. He viewed many of them as very important.

            Above all, Jackson was effectively a military general and a soldier. And he understood, better than many others, on the importance being able to procure your own arms and preventing internal divisions within the empire from breaking it up and providing foreign imperialists an advantage. You can dislike Andrew Jackson (and I actually do), but that doesn’t give someone the right to paint him as some elitist nutcase who was a complete moron on all things. Doing so is just wrong and intellectually dishonest IMO.

          • FYI: There is no such thing as “Libertarian economics”. Libertarianism was cobbled together from the failed Marxist Anarchist movement of the 1920/30’s and a dime store western novel concerning the lone hero and became a formal ideology in the 70’s. The economics it follows is a hybrid version of Austrian Economic theory crafted by Ludwig von Mises, which is more of an ideology than an economic theory. Libertarians are little more than cultist following the ideology of Capitalism (crafted by Mises, and adapted to Libertarianism by Rothbard) and they have been backdating themselves and capitalism into history for the past 40 years.

          • Libertarianism existed in the US since its founding. It goes very far back. The financial sophistication of the US (on both sides of the axis) was quite high in the 19th century.

          • And what the hell does a “formal ideology” mean? It’s an ideology. How can it be formalized? That makes absolutely no sense.

        • Also, I don’t dislike Hudson because he’s “left leaning”. For example, I find Perry Mehrling extremely intelligent along with other “left leaning” people (like Varoufakis, although he is absolutely naive).

          I dislike Hudson because when a 24 year old male who studies mathematics is debunking your view of “history” and basically wiping out everything you said within a few minutes, that’s a MAJOR red flag. And my understanding of history is average at best IMO (probably sup-par honestly).

    • This quote from that Hudson article (with an added parentheses) seems to apply to contemporary China:
      “The aim of finance (in China) is not merely to exploit labor, but to conquer and appropriate industry, real estate and government. The result is a financial oligarchy, neither industrial capitalism nor a tendency to evolve into socialism.”

      • That kind of thinking is why I consider Hudson an idiot. He doesn’t understand geopolitics. The Chinese financial system isn’t designed for economic reasons because the Chinese government wasn’t constructed for purposes of political economy. The Chinese government uses the financial system to accomplish its geopolitical goals, which means that the financial system is primarily a power brokering mechanism to build support and momentum to maintain geopolitical stability.

        The problem with Hudson is that he simply assumes you can impose Western style political institutions (nation-state democracies) in regions that have no capacity for such institutions. And I’d argue that the kind of system China has can actually work well for China. Non-democratic systems can work well while democratic systems can lead to demagogues and tyrants.

    • Suvy.

      I have no brief to defend Keen’s mathematical prowess.
      But you need to understand that mathematics grad school is a really terrible place to learn about systems.
      Go find some engineering classes on systems.
      (The problem with the “self-organising systems” model is that it’s an abstraction, great for physics/chemistry/biology, but human reality places constraints on decentralization, which is why SOS creates flawed models for the study of humans, whether it be in economics or other disciplines.)

      • “Go find some engineering classes on systems.”

        I’ve done more engineering classes on systems than you could imagine. My first class was a control theory class when I was 17. I’ve done graduate research in systems such as surface acoustic waves being modeled by PDEs with various boundaries in anisotropic substances. Most of the stuff I’ve done in math, up until the past 1.5 years or so, was integrated with engineering (my main field of study was “Operations Research” which is basically a cross between math and industrial engineering).

        “human reality places constraints on decentralization”

        When did I deny this? And why do you simply assume self-organizing systems don’t have any capacity for centralization. They’re decentralized systems, but they usually have hierarchies for the purposes you outlined.

        Also, if you’re attacking me based on what I’ve said, I don’t know how anyone could say I favor unconditional decentralization or advocate it or even think that’s good. On the contrary, I think that’s a way to guarantee you and your entire society gets your head blown off (closer to the literal side over the figurative side).

        BTW, economies are FAR CLOSER to ecosystems than they are to any sort of engineered thing. They’re layered and hierarchical while having to integrate across layers with other systems. Economies need to develop in accordance with social systems, ecosystems, political systems, physical constraints, and a whole host of other things.

  11. – “Loanable Funds Model” (Krugman) vs. “Endogenous Funds Model” (e.g. Keen):

    These 2 models only describe “How much” credit can be created. To explain the credit growth (e.g. after 1981) Krugman & Co. have to invoke the “money multiplier”.
    Steve Keen’s computer simulation model (“Minsky”) shows that if we use the “loanable funds model” there’re won’t be any GDP growth at all.

  12. ” Notice then, once again, that at no point is the identity between savings and investment ever violated.”

    Start at an initial equilibrium position.

    Let I = S = 100,

    Increase investment by 100. Income/output increases by 100. I = 200, S = 100. I > S,

    Y increasing will increase C and S. The increase C will increase Y etc etc ,

    When a new equilibrium position is reached then I = S =200.

  13. Thanks so much for the great essay, Michael. I have two clarifying questions:
    First, balance sheet identities such as S = I must be true at every moment in time. (e.g., the second a person raises debt, he possesses a corresponding deposit–i.e., ‘cash’). Referencing your example #2 above, in which you show S = I in an economy with slack, the moment an investment (in this case, in wages) is made, a deposit balance is transferred into a worker’s account, and so is savings (makes sense). And when the worker converts said savings into consumption (i.e., say, buys groceries), the worker’s consumption becomes the grocer’s savings (until the grocer spends, and it becomes someone else’s savings, etc.) So, investment is savings, which travels as deposits between / among account holders, all the while spitting off consumption? The money multiplier, then, simply measures the velocity of the savings transfer. If this is true, the misunderstanding may be one of timing. It seems that when a loan is made (i.e., a deposit is created), it is not immediately crowned investment; it is only so once transferred (I.e., spent / invested’). The deposit, which only becomes investment at the moment it is transferred (i.e., ‘spent’), similarly becomes the counterparty’s savings at the same moment . Savings is simply consumption chips taken ‘off the table’, and consumption is simply transferred savings. Such that consumption can actually be calculated as a function of the velocity of deposits (‘savings’) changing hands.

    I’m finding the logic a bit more challenging if we assume a bank creates a deposit (I.e., makes a loan to) for a consumer who uses the proceeds to fund consumption. Say the consumer purchases bread from a baker, who, to keep things simple, has no variable cost, and lives in a world without taxes. The baker then elects to hold his savings as a deposit, i.e., as savings. What compels these savings to automatically equal investment? Is your point that this is the same as Example #1 above, in which the increase in savings is equaled by a commensurate increase in the total nominal value of the productive assets (‘investment’) in the economy (i.e., inflation)? You’ve increased the monetary base without a corresponding increase in the capital base, and so have effectuated a tax on depositors. Is that correct? If this is true, isn’t there a corresponding need to differentiate between borrowing for consumption and borrowing for investment (where the former is likelier when there is no slack in the economy?)

    • I believe your problem is that you are confusing the definition of savings and investment. Savings is defined as the difference between production and consumption i.e. Savings = production – consumption. Investment is the production of goods used to meet future consumption.
      All production is either 1) consumption or 2) investment (in a closed system it means that production – consumption – investment = 0).
      Therefore, if production > consumption we know that the excess production (i.e. savings) had to go to producing investment. Or if production < consumption then the excess consumption came from a reduction in investment.
      Your baker ex is missing a big step. If the baker sold a loaf of bread where did that loaf come from? Lets assume the baker had existing stock of bread (i.e. investment) rather than producing it. In this case consumption exceeds production (i.e. savings is negative) by an amount exactly equal to decline in investment. So in your example savings didnt rise but instead fell.
      Also, the increase in the bakers "savings" account is exactly equal to the increase in debt used to buy the loaf of bread.

      • Please, where is that definition written? I see definitions like this, “Savings is income not spent…” and similar things.

        Also have seen this:
        Y = S(desired) + C(desired) + G. Unfortunately, desired does not equal actual. And so depending on how S(real) and C(real) vary, then S won’t equal I (Y=C+I+G).

        Problem is, all production is not necessarily sold. Inventory build can result, which can depreciate. Investment (in this case inventory,) can go bad, while the savings from wages stay in place. And so unspent income can become unequal with inventory &/or investment. And so production – consumption doesn’t have to equal savings. In other words, the producer can become victim of margin squeeze, if consumers decide to spend less. Value of inventory can decline. So S does not have to equal I.

        So I would like to thank all the people who have commented on the blog, because the issue has clarified for me, even if we are disagreeing. It is because in actual practice, there can be variance in production and consumption, and at the very least, with depreciation of inventory, that leads to inequality between S and I. So time is of the essence in this equation. It is not a real identity.

        • ^Tim WROTE: “I see definitions like this, “Savings is income not spent…” and similar things.

          Also have seen this:
          Y = S(desired) + C(desired) + G. Unfortunately, desired does not equal actual. And so depending on how S(real) and C(real) vary, then S won’t equal I (Y=C+I+G).”
          ————————————————

          Savings = Income not consumed
          Surplus Savings = Income not spent (either on consumption or investment)

          For closed economy, using subscript ‘p’ to denote private (non-government) activity, we can write the following:

          A) Y (potential) = Cp (desired) + Sp (desired) + G
          https://research.stlouisfed.org/fred2/graph/?g=2jch

          B) Y (actual) = Cp (actual) + Ip (actual) + G
          https://research.stlouisfed.org/fred2/graph/?g=2hKt

          (i) Ip (actual) = Ip (desired) = Ip
          (ii) *IF* Ip < Sp (desired)
          (iii) THEN Sp (actual) < Sp (desired) [Rising unemployment]
          (iv) THEN Cp (actual) < Cp (desired) [Downward spiral]
          (v) THEN Y (actual) < Y (potential)
          https://research.stlouisfed.org/fred2/graph/?g=2k5E
          (v) Y(potential) – Y(actual) = "Potential Output Gap"
          https://research.stlouisfed.org/fred2/graph/?g=2k5J
          (vi) "Potential Output Gap" ~ "Employment-potential Gap"
          https://research.stlouisfed.org/fred2/graph/?g=2k6a
          https://research.stlouisfed.org/fred2/graph/?g=2k6g

          C) Y (actual) = Cp (actual) + Ip + G
          (i) Y (actual) = Cp (actual) + Sp (actual) + G
          (ii) Ip = Sp (actual)

          SUMMARY: Even though investment may not be equal to DESIRED savings, investment is always and everywhere equal to ACTUAL savings– this is the 'accounting identity' of which Michael speaks.

          Let me know if this is insufficiently lucid or if you disagree.

    • Lets use a two person model of the economy. There is the baker and the “dough boy”. The baker only sells bread and the dough boy only sells dough.
      Step 1:
      Baker borrows $10 from the bank to buy dough. This represents an increase in investment.
      Simultaneously, the dough boy’s bank account rises by $10 (i.e. savings increases by $10)
      In this case, the act of borrowing for investment created an exactly equal amount of savings.
      Also, $10 of production of dough = $0 of consumption + $10 of investment in dough
      Step 2:
      Dough boy takes his $10 from his bank account to buy $10 in bread from the baker. This represents consumption.
      Baker sells bread from his previous investment in dough and uses it to pay off his debt to the bank.
      Here $0 of production of bread = $10 consumption of bread – $10 reduction in investment

      • Mjm123, could you help me and everyone else here with these scenarios?

        Production = consumption = $10,000.

        S = I = 0.

        Next, I save $1,000 in currency (take it out of circulation from the real economy). It goes “under the mattress” for now.

        What happens if:

        1) Production continues at $10,000.

        2) Production falls to $9,000.

        3) I lend the $1,000 to someone else for consumption.

        4) I start a bank and lend $10,000 to others for consumption.

        Thanks!

      • 4) should be:

        4) I start a bank with the $1,000 as equity and lend $10,000 to others for consumption.

        • Baker sells $10 of bread to consumer and keeps his $10 under the mattress
          $0 = Production – Consumption – Investment
          $0 = $10P – $10C – $0I
          In this case income in the economy = $10
          and savings = $0 bc savings = Production – Consumption
          and investment = $0…remember savings = investment
          1) In your scenario you cant just have $10 of production, there must be a “balancing” transaction. This means that if the baker produces $10 of bread it either must be consumed or if it is not then it will be classified as investment.
          If consumed:
          $0 = $10P – $10C – $0I
          If it is NOT consumed:
          $0 = $10P – $0C – $10I
          in this case income = $0 bc while their was production there was no spending.
          savings = $10 = $10P – $0C
          and investment = $10…so savings = inv
          2) I’m going to take liberty and change your examples a little for explanation purposes.
          So next lets assume that the baker produces $10 of bread and “dough boy” consumes $9 of bread.
          $0 = $10P – $9C – $1I
          so the baker will be left with $1 of bread he produced but was not consumed by dough boy so investment = $1
          total income = $9
          since the dough boy didnt sell anything his income = $0 but he bought $9 that means his savings = -$9. Since bakers saved his entire income his savings =$10. Therefore total
          savings = $1 which = investment = $1
          3) If the scenario is the same as above except the baker now takes his $9 of income and lends $9 to “dough boy”.
          > Lets say the dough boy first buys the bread out of his income:
          $0 = $10P – $9C – $1I
          So total income = $9 (baker inc = $9 and d.b. = $0)
          > The baker lends his $9 of income to dough boy. When dough boy borrows he must either use it for consumption or for investment in goods that he will later sell. Since dough boy has $0 income then he uses the $9 of borrowed money to consume more bread. And the baker only produces $8 of bread.
          $0 = $8P – $9C – (-$1I)
          here d.b. consumed more bread than the baker produced but thats ok bc the baker had $1 of investment.
          so income = $9; savings = -$1; investment = -$1

          • I think we are close. I may not have stated my scenario(s) clearly.

            “1) Production continues at $10,000.” while consumption is $9,000.

            I mean $9,000 keeps on circulating between the two of them. Income = $9,000. S = $1,000 in currency and I = $1,000 of bread inventory. I believe we are the same page here.

            “2) Production falls to $9,000.” while consumption is $9,000.

            I mean $9,000 keeps on circulating between the two of them. Income = $9,000. S = $1,000 in currency and I = ?????.

            “3) I lend the $1,000 to someone else for consumption.” so consumption remains at $10,000.

            I mean $10,000 keeps on circulating between the two of them. Income = $10,000. S = +$1,000 plus (-$1,000) = 0. I = 0. I believe we are the same page here.

        • 4) Lets say that a bank creates money by issuing debt. So dough boy borrows that $10 and uses it to consume bread and the baker produces $10 of bread.
          $0 = $10P – $10C – $0I
          total income = $10
          The baker can either spend his $10 income or can put it in the bank or under mattress (doesnt matter which).
          > If the baker chooses to put $10 in the bank then his savings =$10 but since dough boy borrowed $10 his savings = -$10, so total savings = $0 which is = $10P – $10C and it is also = $0I…as seen in the equation above.
          > If the baker instead uses his $10 income to buy dough from dough boy and dough boy produces $10 of dough
          $0 = $20P – $20C – $0I
          total income = $20
          Baker does not save any of his income and dough boy initially borrowed $10 (d.b. savings = -$9) but then when he sold the dough to the baker his income went back to the bank and wasnt spent (+$10 savings) so it nets out to $0 savings for the dough boy. It also means total savings = $0 which = $20P – $20C and also = $0 investment.

        • ^^^
          The most important point to understand is that when someone borrows they are using those funds to make a purchase with that money (either consumption or investment) but when they do someone elses income simultaneously goes up by that exact amount. Since they dont spend the income immediately that means their savings go up by the amount the was spent (and borrowed in this case). That’s what we mean when we say that investment creates its own savings.
          This is what Steve Keen’s fails to understand when he says that current aggregate demand = previous period income + change in debt. No Steve, current aggregate demand (i.e. spending) = current income. The difference bw previous period income and current income, as well as previous agg demand and current agg demand, may = the change in debt but current agg demand will always = current income.
          This is because when someone spends (even if its with borrowed money) it immediately becomes someone else’s CURRENT income.
          Later i will make a larger post explaining this point and reconciling Keen and Prof. Pettis

          • Thanks for the examples, Mjm123!

            You write: “Since they dont spend the income immediately that means their savings go up by the amount the was spent” and “The difference bw previous period income and current income, as well as previous agg demand and current agg demand, may = the change in debt but current agg demand will always = current income.”

            Exactly! You put it very well. And that makes me think that you might be able to clarify a couple of things to an accountant (and an amateur economist) like me:

            When we do macroeconomics, why do we mix “cash flow” thinking with what to me looks like something that has nothing to do with “cash flows”, and thus introduce an unnecessary element to be considered? Let me try to explain.

            Take your Scenario 3: “the baker now takes his $9 of income and lends $9 to “dough boy”. (I don’t in any way want to criticize your examples in particular; quite the contrary. You seem to be an exceptionally clear thinker. Still, there is one problematic element in your examples which seems to be present in all such examples).

            As you know, “income” and “cash flow” are two different things. We record income when something is sold, whether in exchange for “cash” or credit (and, as I argue elsewhere, “cash” is credit, too). In your third scenario, the baker’s earlier income had nothing to do with his ability to extend credit to the dough boy and thus increase db’s spending and his own income. This is what he effectively did, and thinking in terms of “money” being “lent” tends to cloud that fact (I’m speaking for myself, perhaps not for clear thinkers). There was no need to introduce “money”.

            If we look at Steve Keen’s thinking, it looks likely that it, too, is clouded by thinking in terms of “cash flows”. (After all, he is a “Monetary Circuitist”?) Suddenly, “velocity” of new debt makes an entrance and forces us to think in terms of the Quantity Theory whether we’d like to or not. How about changing the “velocity” of previous period’s Income to arrive at higher aggregate demand? Well, I don’t think Income or “money” has a “velocity” (other than in the framework we have established).

            I repeat my question to you: Why think in terms of “cash flows” when all we seem to deal with are variables that are quite independent of “cash flows”?

            I’m really looking forward to you “reconciliatory post”. Keep up the good work!

          • “4) I start a bank with the $1,000 as equity and lend $10,000 to others for consumption.”

            Notice the flow of saving was $1,000 and the flow of “dissaving” was $10,000.

            I believe income goes to $19,000 (income goes up by $9,000). How does S = I work there?

          • Peter,

            Isn’t aggregate demand related more towards cash flows than towards income? Am I missing something here. The amount of demand I can add isn’t my income, but my net cash flow because I can borrow and it’ll add to demand (assuming slack).

          • Suvy,

            What is a “cash flow” to you? My point is that we tend to see cash flowing where there is no cash flowing, but only account entries made. Like in Mjm123’s example, where any handover of “money” from baker to dough boy (as a loan) and back (as a purchase) had no substance at all: the outcome would have been exactly the same had we just stated that the baker sells bread for $9 against dough boy’s promise (recorded as a $9 credit balance for baker, $9 debit balance for dough boy).

            No “cash flows” here, only bookkeeping? If you would like to view this debt as first “borrowing cash” and then “paying” with it, then it is exactly the view I suggest we might want to abandon in order to get a clear picture of the situation. As I said, we tend to see “money” existing and flowing, but is it really there if we look closer?

          • Of course the US economy has cash flows. There are cash commitments and cash inflows at any given point. The net cash flows will be income plus the net change in the assets/liabilities (the net asset turnover). It’s just like a cash flow statement for a firm, except instead of a firm, we have an empire.

          • Suvy, you and I just take two different views. You seem to adopt Mehrling’s “Money View”, whereas I suggest that taking a “Bookkeeping View” (see my latest blog post by clicking on my name) would, eventually, greatly clarify our thinking around “money” and debt.

            Where you see “cash flowing”, I see only accounting/bookkeeping entries made. I know it is very hard to get rid of the image of cash flowing. All I say is that you will have hard time to prove that in reality there is cash that flows. Do I need to prove that debit and credit entries are made in the process — in reality? I doubt it.

          • ^P.G. WROTE: “How about changing the “velocity” of previous period’s Income to arrive at higher aggregate demand?”
            ————————————————

            Income cannot have a velocity. Only debt-claims (e.g. money) have an associated velocity of circulation. What you meant to say, presumably, was: “How about increasing the “velocity” of the previous period’s DEBT to arrive at higher aggregate demand?”

            Income = Debt-stock X Velocity of Debt — (I)
            Change in income = Velocity of Debt X (Change in Debt-stock) + Debt-stock X (Change in Velocity of Debt) — (II) [NHOE]

            If there is no increase (no change) in the Debt-stock, we can re-write (II) as:
            Change in income = Debt-stock X Change in Velocity of Debt — (III)

            As seen in equation (III), an increase in the velocity of circulation of the EXISTING debt (i.e. intensity of activity on the RHS of balance sheet) can certainly generate higher aggregate demand, even when there is no increase the stock of debt itself. This is a key point Krugman makes in his response to Steve Keen (quote): “[Keen] seems to assume that aggregate demand can’t increase unless the money supply rises, but that’s only true if the velocity of money is fixed; so have we suddenly become strict monetarists while I wasn’t looking?”
            http://goo.gl/Yv0jnr

            Let me know if you disagree.

          • Actually, I totally see where you’re coming from. Cash flows are basically just shifts in balance sheets, so if you wanna say that, it’s perfectly fine. It’s just a different way to think about it, but it’s perfectly sound.

          • Vinezi Karim: I don’t disagree. As I wrote: “Well, I don’t think Income or “money” has a “velocity” (other than in the framework we have established).”

            I would only question the usefulness of thinking in terms of “velocity of the debt stock”. I cannot yet find any clear argument to back this, other than that if we avoid that kind of thinking, it seems to eventually lead to clearer thinking. Or in any case that’s my own experience (I have divorced my thinking fully from anything that smells like Quantity Theory).

            Is there a difference between “debt stock” and “money stock”?

          • Suvy wrote: “Actually, I totally see where you’re coming from.”

            Good to hear, Suvy! Thanks. I have written some new posts where I explain my Bookkeeping View. If you have time, I greatly appreciate help in form of critique/tough questions from independent thinkers like you.

  14. I think it helps to think of “Thin Air” as being , in reality , “Borrowed , From The Future”.

    We seem to have little difficulty in accepting that income from the past that has been stuffed in the mattress can be used to generate consumption or investment in excess of current income flows , but have great difficulty in imagining that the time sequence can be flipped , and that it is indeed possible to consume or invest in the present the proceeds of future income generation. What allows us to do that is simply the promise ( the IOU ) that guarantees the delivery of that future income on some agreed-upon terms and schedule. That IOU completes the other side of present-day balance sheets , offsetting the income ( or , you could choose to say , savings ) brought forward.

    I think every central banker knows that monetary stimulus is almost entirely about “bringing demand ( or investment ) forward in time “, but damn few of them will say it in so many words. A few have , however , and I have great respect for those few.

    • Marko, for the past 18 months I’ve been trying to work out the mechanics of what you’re saying. You and I, and many others, think it works like that, but we obviously haven’t been able to prove it. Have a look at my longer comment above (I have also posted similar explanation on my own blog) and keep in mind that what I say is connected to this “borrowing from the future” (even though you might not see any clear connection yet)? I used to talk about IOUs all the time, but adopting pure bookkeeping language has clarified my thinking.

      • There was a great post on the FT about how QE is in fact “future money” and not money out of thin air. Unfortunately I can’t remember when that actually was, but i think it may have been last autumn or the autumn before.

        • ^Jack WROTE: “There was a great post on the FT about how QE is in fact “future money” and not money out of thin air.”
          ———————————————————

          What happens when the trillions of dollars of government bonds that the central bank has purchased from the market with “freshly-printed” money (QE) MATURE (expire, come-due)? Here are the options:

          Option (1) The government prints NEW BONDS and hands them over to the central bank to replace the expired ones and gets no currency in exchange (i.e. simply a ‘roll-over’ or ‘maturity-extension’). The government then tears up the expired bonds, but the balance sheet of the central bank remains unnaturally bloated.
          Option (2) The government prints NEW BONDS, exchanges them in the marketplace for currency and then simply hands that currency to the central bank to redeem its maturing bonds. The government tears up the expired bonds and the central banks tears up the currency received. The balance sheet of the central bank shrinks back to normal.
          Option (3) The government runs a BUDGET SURPLUS by spending less than the revenue it receives and then hands the surplus currency to the central bank to redeem its maturing bonds. As the government ‘tears up” the expired bonds and the central bank tears up the currency received. The balance sheet of the central bank shrinks back to normal.

          Option (1) is merely a postponement of the issue (i.e. ‘kicking the can down the road’).
          Option (2) is merely a reversal of QE.
          Option (3) is merely a way to goad Herr Krugmann into a paroxysm of screaming rage.
          http://goo.gl/kiVeKu

          As a side-note, you can compare these three options to what you would face when your own obligation comes due:
          A) You can approach the lender and ask for a maturity-extension or ‘roll-over’.
          B) You can go to another lender and borrow the money needed to repay your maturing obligation.
          C) You can spend less than your income and use that surplus-saving to repay the maturing obligation.

          • Impressive, V.K! I’m not sure if I have encountered anyone as close to my way of thinking as you are (judging by your various comments here; though I must admit that you know economics much better — I’m an accountant). I have written a blog post which has to do with what you say above: http://clumsystatements.blogspot.com/2015/06/shrinking-fed-balance-sheet.html . Feel free to share your opinion! I greatly appreciate the comments I’ve received from you here.

          • P.G. WROTE: ” Feel free to share your opinion!”
            —————————————————————-

            I saw the article. Looks quite accurate to me. However, I must say I was disappointed in Gillian Tett. She did speak of the possibility of a Budget Surplus as an option, but failed to prepare her readers for the uncontrollable rage that Herr Krugmann would inevitably unleash on the world if that were to happen. That was poor journalism on her part. But still, she is very photogenic will probably manage to hold on to her viewers.

      • The issues with “borrowing from the future” as a concept are:

        “when is the future”? and “why can’t the chain progress infinitely”?

        There are answers to these, but you end up having to specify down to particulars to find the limits. And really, finding those limits is the key question.

        • Metatone, you’re absolutely right about the issues connected to the “borrowing from future” concept. And it is the questions you pose I’ve been trying to answer, and that has led me to the “Bookkeeping View” I’m suggesting.

          My initial thought two years ago was that we could study the length/maturity of the debt contracts, but that of course leads to your second question, as the debt can usually be rolled over, and that is often what the debtor has actually planned to do. But like you say, there has to be a limit to this.

          Obviously, there is no clear “threshold”. Like Mr Pettis and many others point out, what matters, too, is how the “balance sheets” look like (how these debt relationships are arranged; institutions matter a great deal), not just some total amount of debt. But instead of going into details, I have rather “zoomed out”.

          My view builds on the following premises:

          1. What debtors owe to creditors is not “money”, but is only denominated (priced) in an abstract unit of account (eg, USD). The “thing” of substance which is owed is not defined in these contracts, but will be decided in due course “on the market” as transactions between creditors and debtors take place.

          2. (This follows partly from 1.) We should look through banks, in the sense that debtors don’t owe “money” to the bank and the bank doesn’t owe “money” to its creditors; instead, the debtors (as a whole) owe something to the creditors (as a whole), and we find these debtors and creditors each on their side of the bank balance sheet. This leaves the banking system with a bookkeeper role (banks occupy neither side of their balance sheets, but the “middle line”). This is not to say that risk considerations are not important; but the bank itself doesn’t bear risks, only its equity-holders and other entities on the liability side of its balance sheet do.

          Adopting this point of view, we see how “money” (credit balances) embodies some expected value/utility an object of a future sale by a debtor will deliver to the creditor-buyer. When the transaction finally will take place (the timing is impossible to predict), the credit balance held (and “valued”) by the creditor will altogether disappear from the economy (“money is destroyed”). Of course there will be some marginal increase in utility (say, the creditor considers a good he buys for $100 as being of more utility to him than the credit balance with a nominal value of $100).

          From all this it follows that an increase in total debt in our economy translates to us anticipating — in an extremely concrete way — more and more of “utility an object of a future sale by a debtor will deliver to the creditor-buyer”, i.e. “future utility”. As you see, psychology is involved here. Humans are the only animals that (actively) anticipate the future. And usually, the more we anticipate some positive future outcomes, the less chance the future has to suprise us positively.

          You might now rightly point out that we should consider the other side of the coin, the debtor anticipating, in the form of his debit balance, some future “disutility” (in the case of household debt, the disutility is usually connected to future work effort). But are these two concepts comparable? In other words, does *anticipated* utility in the form of “money” (which seems to any individual as having very present, very real value — for a good reason, because anyone accepts it against goods or services) net out against *anticipated* disutility from having to pay back debt?

          This is the inherently unknowable, subjective world I currently inhabit 🙂 But then again, that’s the real world? I appreciate any feedback!

        • ^Metatone WROTE (in comment section above): “The issues with “borrowing from the future” as a concept are….”
          ————————————————

          Debt is a form of “current-income transfer” that allows some people to consume & invest (i.e. spend) LESS than they produce (i.e. their income) in the PRESENT. This is only possible because other people consume & invest (i.e. spend) MORE than they produce (i.e. their income) in the PRESENT. Or vice versa in real terms. The future has nothing (directly) to do with this balancing mechanism, which maintains equilibrium in the present.
          https://goo.gl/rVxAe7

          • On the topic of borrowing “from the future”, it looks to me that Vinezi is correct but only partially.

            For all economic agents, the constraint is not that current income = current expenditure but rather that present value of current and future income = present value of current and future expenditure.

            Thus, for an agent, borrowing in the current period necessarily means current expenditure > current income. Which necessarily mean future expenditure < future income in subsequent periods by the extent of the debt servicing cashflow paid.

            If the counterpart to borrowing is lending out of genuine savings, there is a symmetry: lending in the current period necessarily means current expenditure future income in subsequent periods by the extent of the debt servicing cashflow received. The initial transfer of purchasing power from the lender to the borrower takes place without any increase in the overall money supply. The transfer of purchasing power back to the lender over time as debt is being serviced also doesn’t affect the overall money supply. This is the situation Vinezi refers to.

            From the point of view of the borrower, if borrowing in the current period is to fund investment with a positive return in the future, future income will be higher by the extent of the value creation from the successful investment. Future income will thus be higher than if borrowing had funded consumption with no return or a loss-making investment. But, future expenditures will always be lower than future income by the extent of the debt service cashflow paid.

            If, however, the counterpart to borrowing in the current period is not the mobilization of genuine savings but the creation of new money by mere accounting entry, i.e. a fractional reserve bank simply credits the account of the borrower by the amount of the loan granted, said amount being then used by the borrower and starting its journey throughout the economy (“loans make deposits”), then the situation is different. Here, there is no transfer of purchasing power but ex-nihilo creation of extra purchasing power by an overall increase in the money supply.

            In this second process (borrowing from new money created ex-nihilo), when the loan is being serviced, it is not a transfer of purchasing power in the opposite way as initially. It is a destruction of money, symmetrical to the initial creation “out of nothing”. Banks balance sheet deflate, after having inflated. Unless the process is indefinitely repeated, which of course it is to varying extent.

            In practice, these two forms of credit (from genuine savings and from new money created ex-nihilo) co-exist and are fungible in the current organization of the banking system. It is not possible to distinguish them directly. However, when the second process (borrowing from new money created ex-nihilo) becomes dominant, the effects start to become quite visible. You start to see the “credit cycle”, i.e. the alternance of phases of fast money creation during which robust activity levels often give rise to enthusiastic commentaries of “economic miracle” ; followed by money contraction and economic recession when borrowers become collectively too stretched and try to deleverage. Such credit cycles amplify economic fluctuations, while it is not proven that they enhance the long-term trend.

            One extreme form of this credit cycle has been the “roaring 1920’s” followed by the “Great Depression”. This painful experience should have suffice to alert policymakers and public opinion that the monetary organization that has allowed it to happen was not the best suited to achieve lasting prosperity. Indeed, some lucid observers like Irving Fisher (he became lucid after the crash, which has in effect made him think and opened his eyes) and the economists of the Chicago School have devised their “100% money” proposal by drawing the lessons of this rather unpleasant experience. They were ignored. Instead, the dominant doctrine has become after Friedman that monetary authorities should have done “whatever it takes” to counter any decline in the quantity of money arising as a consequence of the previous unsustainable credit boom. From that moment, it was clear that money supply could expand during phases of economic growth but was not permitted to decline during phases of economic contraction. Said differently, money supply could only increase permanently, therefore debt could only increase permanently. There was a “put protection” guaranteeing debt, both in terms of deposit guarantee and in the psychology of banks and investors.

            This, by the way, is known for ages. For instance, Amasa Walker writes in his book “The Science of Wealth”: “The more that is issued of a fiat currency, the more will be wanted. The supply does not satisfy the demand, it excites it. […] There are two reasons for this: one, that, as the currency is expanded, prices are raised correspondingly, and more currency is demanded to effect the same exchanges ; the other, that the speculation inevitably following the raise of prices leads to an enormous extension and repetition of indebtedness, which requires, for its discharge, a greatly increased amount of the circulating medium”. Written in 1867 but incredibly accurate to the present situation. This is why the Fed can’t normalize monetary policy, contrary to what the daily barrage of confused speakers try to suggest.

            Please note these two forms of credit – from genuine savings or from new money created ex-nihilo – can equally take place within a domestic economy and / or internationally.

            Thanks to this mechanism, the global economy has for the past 35 years operated like a ponzu scheme. The incentives in favor of debt have been so great, the monetary easing has been so reliably activated to prevent necessary adjustments of imbalances, that unproductive investments have been funded to an excessive extent whereby returns have failed far below the level necessary to pay debt service and leave debt / income levels stable. Global debt has grown persistently faster than global income for the past 35 years, to reach 350% currently. Instead of being corrected gradually as they arose, economic imbalances have been capitalized into debt, i.e. into the future. This is what the expression “borrowing from the future” might mean. Of course, at such elevated debt / income levels, debt service obligations take a big toll on economic activity. Assuming 8 years amortization period and 4% interest rates on average, the service of a 350% debt-to-GDP represents 52% of GDP (principal + interest). If most of this debt initially comes not from genuine savings but from ex-nihilo monetary creation, then this 52% is not someone else income. Net interest ultimately goes to bank shareholders but principal repayment is to a large extent monetary contraction. Banks balance sheet contract. If no one else borrows in the economy – usually the state – to offset this contraction, the recession kicks in and deepens. Hence the continued suppression of interest rates, so that private borrowers have more breathing room for more debt. Hence the transfer of a growing part of the debt burden to the Government which has no constraints in terms of life expectancy, hence more room on the present value constraint. This is also what “borrowing from the future” might mean. That’s all very good. But if it only perpetuates the problem and actually make it bigger, as it has done so far in accordance with Amasa Walker observations 150 yeas ago, these two policy responses are actually harmful.

            The main issue is not to suppress interest rates (to the point of making them negative by administrative decree) and to shift the debt to the collectivity to sustain an unsustainable system. The main issue is to design monetary and credit systems that are compatible with sustainable prosperity, both domestically and internationally. Here, the silence from policymakers has been deafening. Not a single one has stepped forward to “do whatever it takes” or show some “courage to act”. The G20 has been useless.

            At 350% global debt to global GDP, the risk of a possible economic bankruptcy reflects nothing more than a deep intellectual bankruptcy of the recent and current generation of policymakers.

          • The fourth paragraph should read:

            If the counterpart to borrowing is lending out of genuine savings, there is a symmetry: lending in the current period necessarily means current expenditure future income in subsequent periods by the extent of the debt servicing cashflow received. The initial transfer of purchasing power from the lender to the borrower takes place without any increase in the overall money supply. The transfer of purchasing power back to the lender over time as debt is being serviced also doesn’t affect the overall money supply. This is the situation Vinezi refers to.

          • For some reasons, the text of the fourth paragraph that is reproduced is not the text that is being written. Apologies.

          • Bravo, DvD and Vinezi!

            Your lengthy comments here are brilliant, each in their own way. Both are very lucid, and, it seems to me, internally logical. I’m inclined to think that DvD has correctly identified the problem with global debt — a problem which is a pressing one for our generation –, and my “Bookkeeping View”, as I see it, strongly supports DvD’s view. At the same time, I learned a lot from Vinezi’s comment, and I’ve never seen any economist explain the “big picture” in such clear terms.

            I think this calls for a longer blog post from me, where I’ll try to reconcile our views. I’ll let you know when I’m done!

          • DvD wrote: “these two forms of credit – from genuine savings or from new money created ex-nihilo”
            —————————————————————–

            What are these “genuine savings”? They are “money created ex-nihilo” previously. They are credit balances which were created when a credit entry was made simultaneously with a debit entry, a debit entry which created/increased a debit balance — that is, when new debt was incurred.

            What happens when someone “lends out” these “genuine savings”? A credit entry is made on the creditor’s account (*not* deposit account) simultaneously with a debit entry on the debtor’s account (not deposit account) — that is, new debt is incurred. (The account I talk about is often imaginary, as it is a mirror image of creditor’s and debtor’s own bookkeeping where the creditor debits his “accounts receivable” and debtor credits his “accounts payable” — although even these entries are usually imaginary in case of debt between two natural persons. We could envision these imaginary accounts as accounts in a “societal bookkeeping system (ledger)”, following Schumpeter’s terminology.)

            This new credit balance on the creditor’s (imaginary) account is often represented by a more informal “IOU” in one form or another. This “IOU” is part of the bookkeeping system of debts and substitutes for a formal credit balance in an existing ledger (such as a bank “deposit”).

            We can conclude that when “genuine savings” are lent out, *a new credit balance is created ex-nihilo*. The “genuine savings” themselves are existing credit balances which only change ownership when they are lent out.

            Now we can move to the “new money created ex-nihilo”, ie. “bank lending”.

            I’ll cut to the chase: We can rewrite “new money created ex-nihilo” as “new credit balances created ex-nihilo”, because that is what the bank creates — we just happen to call these credit balances in a bank ledger “money”. We instantly see that the outcome for the economy as a whole, a new credit balance — representing new debt –, is exactly the same as in the case of “genuine savings”. There are different types of credit balances, but they are all credit balances nevertheless — all are part of our bookkeeping system for debt relations.

            Conclusion: We have cleared the mystery around “money creation”/”endogenous money” by avoiding the concept of “money” altogether (* see note below). Now we don’t need to use confusing language like “endogenously generated spending” or “endogenously generated financing” (Mr Pettis’s terms). Spending is either financed by an existing credit balance on the buyer’s account or then it is financed by new debt/net debit balance incurred by the buyer. This new debt can be arranged through a bank or through non-bank financial institutions, or directly between the creditor and the debtor. Why should we ever use the word “endogenous” here? Is the direct debt, or indirect debt through a non-bank, somehow exogenous?

            * If “money” is an enigma, perhaps the only way to solve it is to not talk about “money” at all? Not wholly unlike physicist Heinrich Hertz who avoided the concept of “force” in his thinking, we could gain from avoiding the concept of “money”. Ludwig Wittgenstein, referring to Hertz, has said: “In my way of doing philosophy, its whole aim is to give an expression such a form that certain disquietudes disappear.”

    • You can’t borrow from the future in the same way that you can’t borrow from the past stuffing papers in your mattress.

      You only can use the real economy that exist in the present. The confusion disappear when you realize that money is only a technology that we use for organize the economy now.

      Doesn’t make sense to talks about savings in real wealth (not consuming) and then continue talking about savings of money as if it is the same thing. Obviously it’s not.

      Then, the question becomes: how to organize the economy so we have more real wealth (on opposition to more money) in the future. The answers have to be investing now. We can discuss (and we should) about what is the best investment, but any under utilization of the real economy now means a poorer economy in the future.
      Money is just a tool. Real wealth is knowledge and material capital.

      • ^Robert WROTE: “You can’t borrow from the future in the same way that you can’t borrow from the past stuffing papers in your mattress.

        You only can use the real economy that exist in the present. The confusion disappear when you realize that money is only a technology that we use for organize the economy now.”
        ————————————————

        Krugman is correct, but only up to a point, when he says the following:
        http://goo.gl/9yANr2
        http://goo.gl/g68fVn

        Krugman correctly points out debt is merely a form of “income transfer” from one party to another that happens in the PRESENT and has nothing DIRECTLY to do with the future. All that the mechanism of debt does is that it moves current income FROM parties with a LOWER propensity to spend (i.e. ‘hoarders’ or surplus-savers) in the present TO parties who have a HIGHER propensity to spend (i.e. ‘de-hoarders’ or deficit-savers) in the present, such that the equilibrium of overall inventory (i.e. the ‘physical hoard’ of goods & services) in the economy can be maintained in the present.

        However, Krugman seldom speaks explicitly of this INDIRECT effect of the debt on the FUTURE:
        https://goo.gl/XtcPke

        • Vinezi, what I just said above, applies to this comment of yours as well. Even more so.

          What you explain in points (I) to (IV) behind the link, I fully agree with. I also agree with the effect of interest charges/interest income. But I don’t see this as the only, and not even the main, effect of debt on the future. To me, both as a practical and a more philosophical thinker, it seems clear that if increasing debt has effect in the present — and I assume we agree that it usually increases “aggregate demand”? –, then it *must* affect the future as well (and it does, in multiple ways). The effect in the present is not, and cannot be, connected to interest charges/income, and the effect on the future would be there even with zero interest rates all across the board. In my studies which have led me to adopt the “Bookkeeping View”, I mainly assume zero interest rates for clarity’s sake. My starting point a couple of years ago was actually to study an imaginary economy where there was no “time-value of money”, an assumption which to me seemed more and more realistic when both the nominal and real rates approached zero.

          I hope I’m able to clarify my view in my coming blog post, and even more I wish that we can continue our correspondence which has been very fruitful for me. Thank you!

    • ^Marko WROTE: “I think it helps to think of “Thin Air” as being , in reality , “Borrowed , From The Future”. We seem to have little difficulty in accepting that income from the past that has been stuffed in the mattress can be used to generate consumption or investment in excess of current income flows , but have great difficulty in imagining that the time sequence can be flipped , and that it is indeed possible to consume or invest in the present the proceeds of future income generation.”
      ————————————————

      I’m not exactly sure what you mean here. Are you speaking of INDIVIDUALS (or sub-parts of the closed economy)? Or are you speaking about the closed economy as a WHOLE?

      If you are speaking of individuals (or sub-parts of the closed economy) then you are correct. However, just so that there is no confusion, this is impossible for the closed economy as a WHOLE. You can read and critique this somewhat lengthy comment I have put up on google’s public document drive on this issue:
      https://goo.gl/KHhwEp

      Let me know your counter-thoughts.

  15. Wow, I have never expected MMT to be mentioned in this blog. I have always wondered what you thought about it. Good post.

  16. Hi Michael, thanks for ruining my productivity over the past 24 hours!

    So I’ve been mulling this debate, reading many of the links from comments and criticism of Steve Keen’s ideas, and while I am feeling a touch dizzy about it all, I can’t get rid of the feeling the elephant in the room is being missed.

    Nowhere do I see any mention of the eurodollar market, the centre ofglobal shadow banking, and a financial sector that is for many intents and purposes, its own financial state.

    Which brings me to you comment about Wicksell: “This might seem indeed to violate my claim that any model that requires or even permits global investment to exceed savings is logically impossible, but this is only because the difference lies in what economists call the ex ante quantities.”

    So is the eurodollar market – the pool of Bernanke’s “savings glut” – one big global ex ante factor in highly mobile capital markets responding to variable global rates?

    Extending your China rates suppression point, I would argue that US rates have been suppressed for the past two decades, hence excess USD investment in commodity extractive activities, resulting in the eurodollar market ballooning until 2008 and then steadily deflating since then.

    The global deflationary pressures since China began slowing are the adjustment with Steve Keens “lag”.

    “This means that at any given money interest rate (other than the natural interest rate), desired savings may differ from desired investment, but one or the other (or both) must adjust so that in the end they do equate, the result being a sub-optimal amount of investment.”

    This debate took me back to a similar debate about MMT on Steve Keen’s blog in 2009.

    My feeling was that he would not commit to blindly accepting the inviolability of the accounting identities and hence unlimited ability to deficit spend suggested by MMT. I don’t want to mis-represent him, but I distinctly recall him saying he needed to think about it.

    Like him and others I understand the identities and your arguments, but instinctively I feel something is amiss. You point to the 90’s when it was assumed it all worked, but as Jeff Snider points out, the eurodollar market influence soared from 95 onwards after the broad release of VaR measures, allowing global banks to significantly boost lending centred on the eurodollars.

    http://www.alhambrapartners.com/2015/06/24/theres-something-wrong-with-the-world-today-and-its-1995/

    So I guess my question is do you feel confident the identities adequately cover the super-financialised global monetary system?

    • It looks like nobody is interested in discussing the eurodollar market but here we go anyway:

      “The truly tragic part is as FRBNY wrote way back then, namely that there was impetus and effort to make wholesale banking an incorporated whole; to evolve understanding and relationships as banking evolved. Instead, blind ideology stood starkly against it, all in the name of soft central planning that accomplished some illusory control for a time. Recognizing and dealing with wholesale complexity would have muddied, if not outright ended, the fantasy of such control and centralized management. In fact, that is what really occurred, only a couple decades too late.”

      http://www.newyorkfed.org/research/quarterly_review/1979v4/v4n4article2.pdf

      http://www.realclearmarkets.com/articles/2015/10/23/no_amount_of_qe_or_rate_control_can_fix_what_is_sick_101860.html

      The difficulty in incorporating this wholesale system into a traditional framework has been a constant one, intellectually as well as operationally – perhaps even more so the former to the growing exclusion of the latter. For example, in the fourth quarter of 1979, the Federal Reserve Bank of New York’s Quarterly Review examined the euro-currency market along these lines; and found nothing but more questions. That started with serious debate over whether euro-currency and eurodollars were money at all:

      “It has long been recognized that a shift of deposits from a domestic banking system to the corresponding Euromarket (say from the United States to the Euro-dollar market) usually results in a net increase in bank liabilities worldwide. This occurs because reserves held against domestic bank liabilities are not diminished by such a transaction, and there are no reserve requirements on Eurodeposits. Hence, existing reserves support the same amount of domestic liabilities as before the transaction. However, new Euromarket liabilities have been created, and world credit availability has been expanded.

      “To some critics this observation is true but irrelevant, so long as the monetary authorities seek to reach their ultimate economic objectives by influencing the money supply that best represents money used in transactions (usually M1). On this reasoning, Euromarket expansion does not create money, because all Eurocurrency liabilities are time deposits although frequently of very short maturity. Thus, they must be treated exclusively as investments. They can serve the store of value function of money but cannot act as a medium of exchange.”

      That last distinction may have been valid in 1979, (and it was, as FRBNY notes then, arguable) but was annihilated when surely the Fed shifted, as the Bank of England, to interest rate targeting whenever in the 1980’s. No longer controlling for a particular quantity of money (M2 by then), the transition between eurodollar liability and domestic money and deposits was almost seamless. This much we know without doubt by close experience of the housing and dot-com bubbles, with credit flowing into the US without hitch via European bank balance sheet expansion – funded all or mostly by eurodollar liquidity coming from foreign banks and their offshore operations. It is here, I will emphasize one more time, the full weight of Alan Greenspan’s 1996 “irrational exuberance” speech yet again applies; he recognized then that “something” was wrong in monetary behavior without looking to London for it, or if he did look, he didn’t do anything about it.

      In that respect, and for what actually happened in 2007 and 2008 (the geographic revelation of this “dollar” distinction), what FRBNY wrote in that 1979 article has proven disconcertingly and frustratingly correct:

      “One of the traditional responsibilities of any central bank is to act as lender of last resort – to supply funds to a solvent bank or to the banking system generally in an emergency that threatens a sharp contraction of liquidity. This role normally has been framed with respect to commercial banks in the domestic banking system. But the emergence of the extraterritorial Euromarket created ambiguities about which central bank would be responsible for providing lender-of-last-resort support for overseas operations.

      “No final resolution of those ambiguities has yet been reached, and it is doubtful that central bankers will ever codify their respective roles or lay down conditions for lender-of-last-resort assistance.”

      • In the new international monetary system born de facto in 1971 with Nixon unilateral decision and de jure in 1976 with the Jamaica Agreement, the emergence and growth of offshore dollars has been the natural by-product of the emergence and growth of current account imbalances between the US as the main deficit country and the surplus countries (oil-producing countries, Germany, Japan, more recently China) with the USD as main international currency.

        The end of the 1970’s is when banks start opening large trading rooms as the recycling of all these offshore $ balances in a world of floating exchange rates and liberalized capital movements becomes a business in itself. “Euro”dollars because London is emerging as a major hub in this global trading business, especially after Margaret Tatcher becomes Prime Minister in 1979 and pursues a financial liberalization agenda culminating in the so-called “big-bang”.

        The question of whether the global accounting identities adequately cover these extra-territorial $ which constitutes the core of the inflating global debt balloon hanging over the economy is an intriguing one. To which country’s money supply do these offshore $ balances belong? The answer which makes the global accounting book balance is that there is duplication of credit worldwide. Indeed, the foreign exchange inflows into the reserves of the banking system of the surplus countries means that these $ balances have entered the money supply of the surplus countries against which domestic currency is issued and domestic credit can be extended. The fact that the central banks of the surplus countries immediately replace these $ into $-denominated securities, either in the US markets or elsewhere, means that these $ balances are simultaneously re-entering the money supply of the deficit countries as if they had never left and as if the deficit didn’t give rise to any transfer abroad that would tend to correct it. As you say, this result in a net increase in credit worldwide. This is the mechanism at the core of the staggering increase in global-debt-to-GDP over the past 35 years. Trade imbalances have no longer been kept in check and corrected as they arose but simply capitalized into debt, which is a claim on future production and income flows.

        What the collapse of the Bretton Woods international monetary system in 1971 and the uninterrupted series of financial boom-busts thereafter has shown is the fundamental contradiction of using the domestic currency of a participating country as reserve instrument for the international monetary system. This was clearly articulated by Robert Triffin in the US and Jacques Rueff in France in the 1960’s. It may also have been the thinking behind Keynes Bancor proposal in 1944.

        But Keynes, Triffin, Rueff and many others have been ignored. Instead, for the past 45 years, the official US position has considered that it was in its best interests and that “the $ is our currency but your problem” (the clearest expression that the international monetary system is fundamentally uncooperative). The uninterrupted series of destabilizing financial boom-busts since these unconstructive words were uttered has confirmed to all the economies concerned that it was indeed their problem. But, as far as the US is concerned, the official US position has failed to appreciate that this system is sinking the US economy under an unmanageable debt load that is endangering its prosperity. The consistently declining trend of real economic growth in the US, the consistently inflating balloon of debt and asset values diverging from real-life production and income flows ultimately backing them up (the same as during the 1920’s following the failure of the 1922 Genoa conference to design an adequate international monetary system), the rising intensity of cyclical crises when the dilated financial ballon threatens to explode (the 2008-2009 crisis was the most severe crisis since the Great Depression), all that is a clear empirical confirmation that this system is actually not in the best interests of the US. As Michael Pettis explained, this system is an “exorbitant burden” rather than an “exorbitant privilege” for the US. The fundamentally uncooperative nature of the international monetary system is now plainly visible in the currently raging currency wars whereby each domestic central bank is trying to gain for its country / monetary zone an “exorbitant privilege” which corresponds to an “exorbitant burden” for other countries / monetary zones. The recent and pathetic gesticulations of a cornered Fed are simply the latest confirmation of the fundamental contradiction of using a domestic currency of a participating country as the anchor of the international monetary system.

        The solution is largely in the hands of the US: are they finally ready to give up the international role of the USD and the exorbitant privilege to rid itself of the exorbitant burden?

        • The US government is not going to give up that “Exorbitant Privilege” (or “It’s our $ and your problem”) any time soon. But financial markets by themselves will force the US to give up that privilege. How ? Then one has to look at the dynamics between the US CA deficit and the US budget deficit.

          • At some point, it’ll be the US that’ll give up that “privilege” simply because it’ll be too costly to maintain. Thus, the question becomes if, not when.

  17. A great piece of work,but it fails to take the arguments one step further & this is both alarming & annoying,within the accountancy ledger,values change depending on where you stand,ie two glasses one full of water the other empty,having all the water will keep you alive whilst others die,so the value of the water changes,but has the water level drops in one,it value changes,but if the price extracted stops others buying it & you being able to replenishing the water because you have destroyed the ability to build other than to give away rights.So values change & savings & investments can be in the wrong place,so either thin air money is created to re-balance normal economic activity by re-balance values rather than balance sheets in the wrong place or it is a waste of time
    Sorry if it’s muddled but maybe that’s why economist never seem to take the next step! of effect & cause of the dynamics of the creation of money on values & why? that is the solution to capitalism & poverty within in it!
    Although i did think you was actually going to go there in this article
    Good luck !

  18. I love your blog! Your dispassionate and learned analysis, your clear writing – everything. You have certainly helped me learn a lot, and changed my views on a number of things.

    But one question – you state:
    “The important point about accounting identities – and this is so obvious to logical thinkers that they usually do not realize how little most people, even extremely intelligent and knowledgeable people, understand why it matters – is that they do not prove anything, nor do they create any knowledge or insight. Instead they frame reality by limiting the number of logically possible hypotheses. Statements that violate the identities are self-contradictory and can be safely rejected.”

    The problem I have in reading economics, is that someone will say “Chinese government debt is: 100 billion dollars (equivalent to Chinese currency) and than someone else in passing says its 360 billion dollars…and the more you read, the more the numbers seem to be all over the place.
    So if x + y = 100, I accept that by definition the equation must be true.

    So while I accept that an “identity” is a definition like “1=1” what tells me if the “1” on the left is denominated in the same units as the one on the right? Or that fraud hasn’t occurred and that the 1 on the left is really 0.27?
    So can you tell what the “true” amount of Chinese debt is, where you get that number from, and why you think it is the most accurate (i.e., truthful)?

  19. -“Dude, I managed to save some money!…”
    –“What are you going to do with it? Invest it or something?”
    -“No, I’ll just hoard it a while, until some capital idea turns up.”

    It’s an accounting identity you say. Does this mean that the meanings of save and invest are different than people ordinarily, conventionally, take them to mean? In my understanding, saving is not identical to investment.

    If I save money, hoard it, (and neither consume nor invest with it) it does not mean any other economic agent makes up for that shortfall in investment or consumption.

    And then there’s that oddity about endogenous including government printing/creation of money. I may have read incorrectly, but that seems to be what is being said: from second paragraph etc:

    “…This means that when they borrow, rather than repay by raising taxes in the future, all they have to do is monetize the debt by printing the money needed to repay the debt. It seems that governments too can create demand out of nothing, simply by deficit spending.

    There is a rising consensus – correct, I think – that the misuse of these two processes – which together are, I think, what we mean by “endogenous money” – …”

    Endogenous refers to from within the private sector, that is, not based on public sector source of money.
    In a more full multi-sector view, also, foreign credit would be not endogenous. Endogenous means private sector created credit. Excludes government and central bank created credit.

    But then, I may misunderstand all of this, and so please ignore all this, if there are obvious deficiencies in my understanding.

    E.&O.E. !

    • You’re confusing national savings and household savings. Savings is, by definition, income not consumed. High savings rates can occur with high debts.

      • Look it up: http://www.colorado.edu/economics/courses/econ2020/section6/GDP-components.html
        Notice that investment does not include financial instruments.

        From the definition of investment how does it equal savings?

        I believe the definition is rather, savings is unspent income. Spending may be on consumption and/or investment, not simply consumption. Unspent income = investment? I don’t buy it.

        • It’s because they define everything in a nonsensical way. This is the problem with economists.

          They use Y=C+I+G, but government spending can either be government investment or government consumption. The problem is that they treat private investment and private consumption as separate from government spending, but that’s really not the brightest idea.

          Y=C+I+NX=C+S where C=C_p+C_g and I=I_p+I_g. Then, you’ll see that S=I+NX, which means that in a closed economy: S=I.

          Also, financial instruments are assets which show up on the balance sheet. However, GDP is basically a measure of income, which is the income statement. Aggregate demand is the cash flow of an economy.

          Using economist descriptions and labels is really something I find to be a waste of time. I just begin with finance and balance sheets.

          • Thanks Suvy,

            you’re comments are really helpful, I’m still having a problem, because there is a time lag issue, but that doesn’t interfere with understanding your explanation. Thanks a lot for answering.

  20. Miles Kimball recently had a post about Ben Franklin and others printing currency in Pennsylvania in the 1720s/30s that worked to stimulate demand http://blog.supplysideliberal.com/post/125986480647/owen-nie-pre-revolutionary-paper-money-in there was no accounting identity of savings comments, thoughts, or observations

  21. For me, the crux of the issue is the difference between investment, as in tangible capital; and investment, as in intangible capital. And because of equivocation, economists will argue about the savings – investment identity, forever. Because for some, investment in intangible capital, is not investment.

    e.g., if I hold cash, and not spend it, it is saving, and not investment at all, there is no increase in tangible capital.

    • ^Tim WROTE: “e.g., if I hold cash, and not spend it, it is saving, and not investment at all, there is no increase in tangible capital.”
      ————————————————

      Money is nothing but a debt-claim. The very fact that you have money to ‘hold’ implies that your income was greater than your spending (consumption plus investment). This means that you have merely lent your “surplus savings” to someone else in the economy and the money you are holding is merely proof of that lending. There may or may not be an increase in tangible capital depending on what the people who borrowed your “surplus savings” did with them. On one hand, if they borrowed your “surplus savings” to increase their consumption then aggregate saving in this transaction nets to zero (‘capital destruction’) and there is no increase in tangible capital. On the other hand, if they borrowed your “surplus savings” to increase their investment, then the increase in their investment is equal to your “surplus saving” and there will be an increase in tangible capital EXACTLY equal to your “surplus saving”.

      Assume that ‘You’ + ‘All others’ = All the participants in a closed economy, where ‘All others’ includes the government.

      Your income = Your consumption + Your savings
      Your income = Your consumption + Your investment + Your “surplus savings”
      Your income = Your consumption + Your investment + Your “lending to others”
      Your income = Your consumption + Your investment + Your “debt-claims held”
      Your income = Your consumption + Your investment + Your “money held”

      Denoting ‘All Others’ as ‘AO’, we can write
      AO’s Income = AO’s consumption + AO’s savings
      AO’s Income = AO’s consumption + AO’s investment – AO’s “savings deficit”
      AO’s Income = AO’s consumption + AO’s investment – AO’s “borrowing from you”
      AO’s Income = AO’s consumption + AO’s investment – AO’s “debt-claims incurred”
      AO’s Income = AO’s consumption + AO’s investment – AO’s “money issued”

      Note that if we add the above two sets of equations (‘You’ & ‘All others’) to form the aggregate equations (for all participants) for the closed economy as whole, then all the debt-components automatically cancel out and we arrive at the familiar form:
      Income = Consumption + Savings
      Income = Consumption + Investment
      Investment = Savings

      Let me know if you disagree.

      • V.K, I guess you would think I’m a simpleton if I said I disagree. So I won’t say it.

        I just want to stress an important point which often tends to get clouded when we “cancel out debts”: Debt never nets to zero. In a two-person economy, if person A owes person B goods/services worth $10, then net debt in the economy is $10.

        In other words, debt doesn’t net to zero as long as there is one agent who has a net debit balance. If there is, then there of course needs to be at least one agent with a net credit balance. Debt only nets to zero between two persons, A and B, if A owes B exactly the same amount as B owes A; but that would just mean that neither of them is really in debt. ‘Debit’ equals ‘credit’ by definition, and the amount of debt can be expressed as “the sum of debits” or “the sum of credits”, but never as “debits minus credits”.

        I’ll try to put it more accurately: We take all the individuals in an economy; create one “main account” for each of them (one main account per person) where we sum up the various debit and credit balances they might hold on different “sub-accounts” that belong to them; calculate the net balance on the “main account”; pick either all the main accounts with net debit balances or all the main accounts with net credit balances — never both –, and sum up those balances. Thus we arrive at total debt in the economy, and the result should be the same whether we picked the main accounts with net debit balances or the main accounts with net credit balances.

        To repeat (I know you are very intelligent, but I myself learn through repetition): The total net balance never carries information; it is just an identity. What carries information are the net balances of some part of the whole (and this information disappears when we cancel out debts). This part of the whole can be DM/EM(E), a continent, a country, a region, a county, a town, an industry, a business, a non-profit, a household, an individual. But we need to go all the way to the individual’s level (well, household might do?) if we are to understand how much debt there is in an economy. A country might not be indebted towards the rest of the world, but its citizens still are in debt to each other, and this debt matters a great deal.

        • ^P.G. WROTE: “I just want to stress an important point which often tends to get clouded when we “cancel out debts”: Debt never nets to zero. In a two-person economy, if person A owes person B goods/services worth $10, then net debt in the economy is $10.”
          —————————————————–

          Yes, you are stating the obvious. However, “net debt equals zero in a closed economy” is still a true statement. This is because the statement does NOT mean either, (a) that there is no debt in a closed economy, or, (b) that debt does not matter. Here is what it DOES mean:

          (1) Imagine a super-mega corporation (SMC) with numerous separate divisions/subsidiaries. Imagine that division A of that SMC has produced & shipped goods to division B of that SMC, but that division B has deferred payment (i.e. incurred debt) on division A’s invoice. Further imagine that division B pays interest to division A on that debt.
          (2) In the final aggregate balance sheet & income statement of the super-mega corporation that is presented to the public (investors, analysts), there will be no mention of that B->A debt or those B->A interest payments. All that will appear on the aggregate balance sheet is the EXTERNAL debt (i.e. debt owed to entities outside the SMC) and all that will appear on the aggregate income statement are the EXTERNAL interest-payments (i.e. interest-payments made to entities outside the SMC). This is standard practice, which, if changed, would lead to total chaos.
          (3) Equivalently, in the case of the aggregate balance sheet of a closed economy as a whole, where there is no concept of “external” entities at all, the debt will be shown as zero (i.e. RHS is pure equity/net-worth, LHS is capital stock). Similarly, in the aggregate income statement of a closed economy as a whole, interest-payments will be shown as zero (i.e. Income – Expenditure on consumption – Overall Depreciation = Addition to capital stock = Addition to net-worth).

          I hope this is lucid enough to settle the matter.

          • Vinezi wrote: “I hope this is lucid enough to settle the matter.”
            ————————————————————————–

            It is lucid, but I’m afraid it doesn’t settle the matter. Your SMC example is a classical “taking money from your left pocket and putting it into your right pocket” case. Divisions A and B have the same ownership. This means that although there can be “debt” on paper, that debt is not real in the sense that the two parties in the debt relationship are ultimately representing one and the same party. (Lawyers can spend a lot of time finding out who are ultimately the “natural persons” behind certain “juridical persons” in a complicated corporate structure.)

            So, I’m all for netting debts in your SMC example (mainly because I don’t see any real debt there). No disagreement there. But if this is what you mean by “net debts equal zero in a closed economy”, then we have a different idea of a closed economy.

            If you are to extend this thinking to the economy as a whole, then I would expect you to show how all the households in the economy form a big happy family, where “mi casa es su casa”, and everything is shared.

            I think the problem here lies in “the aggregate balance sheet of a closed economy as a whole”. Why do we form balance sheets in the first place? As far as I know, it is because the natural persons (sometimes via juridical persons) on the liability side of the balance sheet — both debt and equity-owners (the latter being a much less fixed liability than the former, to such an extent that many choose to not call equity a liability; see, eg, the “accounting equation”; I gently disagree with them, both on philosophical and practical grounds, pointing for instance to “hybrid securities” which blur the line between equity and debt) — want to see balance sheets. And they want to see balance sheets to keep track of what kind of assets and what kind of liabilities there exist, and how these assets and liabilities are valued.

            Thus, to me “the aggregate balance sheet of a closed economy as a whole” is, to put it somewhat harshly, a mock balance sheet. It is stripped of all the elements that make a balance sheet useful. There is nothing of interest on the liability/equity side of the balance sheet — the whole exercise is about how to value the “capital stock” (“net worth” ends up being just another name for this). One doesn’t need to create a balance sheet to express this. Do you agree?

            But I’m interested in hearing more about how professional economists (you are one?) use this — always subjective — value of the “capital stock” in their work.

            I hope I don’t sound too offensive. I have learned enormously from reading your comments here during the past couple of days. You are a lucid writer and a clear thinker. Thanks to you, what economists say starts to finally make sense to me. My wish is that I could offer you something in return.

          • P.G. WROTE: “Divisions A and B have the *SAME* ownership.”
            ————————————————–

            I think see what you are saying. Correct me if I am wrong:

            1) You are, in effect, pointing out that the equity (ownership) on the RHS of the aggregate balance sheet of the closed economy is held by SPECIFIC individuals (‘OWNERS’) and not by the general public (or by the people at large). In other words, you are reminding us that we live in a Capitalistic world in which the total capital-stock on the LHS of the aggregate balance sheet of the closed economy is actually owned by a small number of specific individuals (‘OWNERS’) and not by the collective. Yes, this is absolutely true.

            2) From this, you are saying that the debt owed by those specific individuals (owners) must be included in the aggregate balance sheet of the closed economy, otherwise it would give us a false sense of their net-worth.

            3) This is not correct. If this were true, all hell would break out in the world, because then the personal debts of the holders of (say) Microsoft shares would have to be included in Microsoft’s balance sheet.

            4) So where are the debts of those OWNERS to be shown? Their debts are shown in their individual balance sheets, in which their holding of their share of the pure-equity of the RHS of the aggregate balance sheet of the closed economy is shown on the LHS (their individually owned assets) and their debt is shown on the RHS (their individual liabilities), with, of course, the difference between the two being their individual net-worth. This is exactly how it is with Microsoft (from 3) share holders.

            5) The debt to be shown on the aggregate balance sheet of the closed economy is the debt owned by the closed economy as a whole to entities outside it. Since there can be no such entities, there can be no debt on that balance sheet. This is why so many economists say “net debt in the world is zero”.

            Let me know if either (a) I have misunderstood you, or, (b) you think that I have made a mistake.

          • Vinezi wrote: “Let me know if either (a) I have misunderstood you, or, (b) you think that I have made a mistake.”
            ————————————————————————-

            You have misunderstood me, for sure. If you have, additionally, made a mistake, at least I don’t see it has anything to do with the internal logic in your “balance sheet thinking”.

            What I suggested is that this “aggregate balance sheet” is a useless concept. It is a mock balance sheet, because it doesn’t contain any information that would justify using the format; the balance sheet format. If we want to abstract from debt and look instead only at the value of “capital stock” in the economy, by all means let’s do it. But we have no use for a balance sheet in this endeavour. (Just like a solitary Crusoe had no use for a balance sheet.)

            As I explained, to me the idea of an entity’s balance sheet is to track (i) claims on the entity, and (ii) the entity’s assets. There are two (or three) main types of claims: debt and equity (and mezzanine). The assets can be either tangible or intangible. Tangible assets include, for instance, fixed assets and current assets. Intangible assets include, eg, financial assets and goodwill. (All this from Wikipedia.)

            As I said, net debt doesn’t equal zero in a closed economy. I can understand how we can make debt disappear through “balance sheet magic” (which to me is misuse of the balance sheet concept), but the net debt is still there in the economy. It cannot be netted out because DEBT as a word/concept doesn’t mean only that “someone owes someone else”, but also that “someone is owed by someone else”. You cannot base your argument of “zero net debt” on the fact that one agent owes and another agent is owed to, because this is nothing more than the definition of debt.

            This might sound more like a philosophical issue, but I cannot see how those can be avoided? Neither do I think they should be ignored.

            What follows is some further philosophizing around the matter. It is no direct critique towards you, but it might help you understand where I come from.

            To try to value in monetary terms the total “capital stock” of a closed economy is quite a futile exercise. Many intangible assets are extremely subjectively valued/”marked-to-unicorn”. Overall, prices of assets are formed on the market when these assets are traded. If the market price of an asset happens to be $100, this gives us no good reason to value the total stock of similar assets in the economy at “$100 x total amount of these assets”.

          • Vinezi, could this be the problem here:

            You want to say that “EXTERNAL debt is zero in a closed economy”, but instead you end up saying that “net debt is zero in a closed economy”? To me what you end up saying is as wrong as saying that “net trade is zero in a closed economy”. But to say, instead, that “external trade is zero in a closed economy” is to tell the truth — no matter how obvious it is.

            One cannot possibly agree with both of these two statements:

            1. “In a two-person, closed economy, if person A owes person B goods/services worth $10, then net debt in the economy is $10.”

            2. “In a two-person, closed economy, if person A owes person B goods/services worth $10, then net debt in the economy is ZERO because there is no external debt.”

            So you choose #2 while I choose #1?

            (In my earlier example I said “two-person economy” instead of “two-person, closed economy”, because I thought, perhaps erroneously, that the former expression implies that it’s a closed economy.)

          • P.G. Wrote: “What I suggested is that this “aggregate balance sheet” is a useless concept.”
            ———————————————-

            If you don’t find it useful, you don’t have to use it. It’s a free country and nobody can force you to do so. However, it is a concept that the USG-Fed tracks and has done so since 1945. Presumably, then, someone out there must find it useful in their own way of understanding things.

            It is just like the concept of “money”. If you don’t find it useful, don’t use it. If others find it useful, let them use it. Different strokes for different folks.

            ———————————————-
            P.G. WROTE: “You want to say that “EXTERNAL debt is zero in a closed economy”, but instead you end up saying that “net debt is zero in a closed economy”?
            ———————————————-

            You could call it that if you like, whatever works for you. But when we hear economists often say “net debt is zero in a closed economy”, all they mean is that there is no debt on the aggregate balance sheet of the closed economy as a whole. Nothing more and nothing less.

            If you ever hear economists say “debt is zero in a closed economy”, let us know as soon as possible.

          • Vinezi wrote: “But when we hear economists often say “net debt is zero in a closed economy”, all they mean is that there is no debt on the aggregate balance sheet of the closed economy as a whole.”
            ———————————————————————————–

            I agree that we are all free to view the economy in a way that seems to make most sense to us. So I’m not pushing my view on others. I’m only introducing it as an alternative that seems to work exceptionally well for me. So well, actually, that I seem to be able to make sense of phenomena that has created much disagreement among professional economists. I have not encountered anyone who had managed to build as consistent (implicit) model of the economy after having adopted the view I’ve adopted and which I’m now trying to introduce to others.

            I continue to argue that we cannot have a BALANCE SHEET for the whole economy, because then there are no LIABILITIES on it. Even EQUITY is a liability of the entity which the balance sheet belongs to. To me, a balance sheet without liabilities is not a balance sheet. But I can’t stop anyone thinking in terms of a balance sheet without liabilities. All I want to do is to warn that if one does so, one has probably crossed the line after which thinking in terms of a balance sheet stops being useful.

            But I don’t need to push you more on this one. All I can ask you is to consider my arguments around debt in my various comments here. I’ve learned a lot from you, and as I said, I’d like to be able to give something back.

            (Your pediatry example gave me a good, long laugh! Thanks.)

  22. MP, once again a well elucidated post- thank you. I want to stretch beyond your exercise however, and state emphatically that wealth IS created out of ThinAir. It is historically self-evident through the enlightenment and industrial revolution, that a high standard of living is derived from ideas. It is ThinAir from the minds of entrepreneurs that make economic growth.

    Savings=Investment and other accounting identities are mind-bendingly difficult for economists who only look at the asset side of an economy. they carefully measure GDP, capital stock etc etc.. – Getting them to understand leverage on the liablility of side of the balance sheet is major advancement for them. [ I think of the Central Bankers who had an ahh moment in 2009 that they did not have liabilities or banking intermediation in their brillant models] But while balance sheet accounting, the accounting identities are better, they are close to worthless when forecasting economic growth, or the limits on economic growth.

    A Ponzi-scheme is unabashedly wrecked by accounting identities and logic- even to simpleton economists. But Ponzi schemes (large and small) exist throughout the economy. They do not fail, or cease to arise because of accounting logic. Instead they are exposed only when the flow of ouputs marginally fails below the tally of all inputs. Enormous imbalances between inflow and outflow can occur and do not expose the Ponzi scheme just because of accounting identities.

    Similarly huge imbalances can occur within an economy, or trade between nations, and not be rebalanced in any sensible length of time. Losses on non-performing loans in Chinese banks can be rolled over ad-infinitum while the PBOC has credibility. The latest communist 5yr plan shows GDP doubling by 2020- which is 8% growth! But why can’t the PBOC and Communist party simply manufacture enough “things” to double the GDP by 2020. Maybe they have to continue financial repression, and the consumer share of GDP drops from 40% to 20%, but heck, the Chinese GDP is 2x the US economy. What a powerhouse.

    Economies rebalance when they are free and transactions are voluntary. But command economies are not subject to rebalancing forces and accounting identities. Instead they can simply keep growing like a cancer – no bankruptcy or rebalancing forces (until the host is dead).

    Back to my main point about Thin Air. Uber has generated a enterprise value of ~$50billion with less than ~$5billion in savings (=investment). As a market-determined price, we have some consensus that $45 billion was created out of ThinAir, Voila!. Theoretically, Uber could sell off their future cash-flows in a bond issuance and collect $45 billion- guaranteeed with credit swap. But in a free market, it would be impossible for Uber to sell bonds for it full enterprise value- More likely a couple billion today, perhaps a convertible etc- but still a few billion of new money from ThinAir- It is a nice gain in a free market. However, if Uber was a SOE in China, then a bureaucrat could determine the likely cash-flows in a mechanical non-greedy manner, and sell a bond (make a loan) for not only for Uber’s full enterprise value, but probably for multiple of it. Chinese GDP is created out of ThinAir!, and the only difference is a market consensus of value versus a Chinese official’s designation of value. I am long the Chinese ability to drive the GDP unrelently forward, create more stock and more jobs -ad infinitum.

    • ^Max WROTE: “Uber has generated a enterprise value of ~$50billion with less than ~$5billion in savings (=investment). As a market-determined price, we have some consensus that $45 billion was created out of ThinAir, Voila!.”
      ————————————————

      1) Go to Google ‘News’ section
      2) Select ‘Past Month’ from the time-field menu in search-options
      3) Type ‘UNICORN BUBBLE’ in the search field
      4) Press the return key
      5) Voila!

      To save space on Michael’s blog (queuing problems), I have put some points for your consideration on google’s document drive here:
      https://goo.gl/M9rLlR

      Let me know your counter-thoughts on the matter.

  23. «Savings=Investment and other accounting identities are mind-bendingly difficult for economists who only look at the asset side of an economy.»

    NO, NO, NO. M Pettis and yourself considerably muddy the discussion here not be cause there is a difference in understanding the accounting identities.

    But because almost nobody understands the difference between “ex-ante” and “ex-post”, or expressed that difference. That;s the really important technical term and concept.

    When M Pettis says that the accounting identities are just a framework and that they are necessarily true, he is really saying that “demand”, “savings”, “investment” as defined in them are “ex-post” quantities, a concept that he obviously understands but cannot express clearly.

    Now what is interesting is:

    * “ex-ante” or “notional” quantities, because these can be unbalanced, and the way they are unbalanced is highly important.
    * How “ex-ante” imbalances in one time period become necessarily balanced “ex-post” quantities in the accounting identities for the next period.

    M Pettis and other Minskians like S Keen have much to illuminate about this, because the usual mechanism for turning “ex-ante” imbalances into “ex-post” balances is changes in the balance sheet. Assets and liabilities are the accounting materializations of accumulated imbalances.

    The other big point that Minskians make is that not just “ex-ante” and “ex-post” inbalances end up in balance sheets, but that the cumulated imbalances on the asset and liabilities sides don’t net out, because they are cumulative imbalances with different other economic actSavings=Investment and other accounting identities are mind-bendingly difficult for economists who only look at the asset side of an economy.

    Therefore both the level *and the composition* of each side of the balance sheet matter greatly.

    Nut explaining this is very difficult without the distinction between “ex-ante” and “ex-post”. One big aspect of “mainstream”, “neoclassical” thinking is that that distinction is *impossible* in those models because they are based on the assumption of an intertemporal auctioneer making impossible that difference by a total process of “tatonnement” implicit in the models they use.

    Because as soon as “ex-ante” and “ex-post” differences materialize and do so via balance sheets there is no meaningful way to talk of “equilibrium” and “pareto-optimality”, and there being a unique optimal distribution of income, which is the central truthiness of Economics.

    • Blissex, you say “but that the cumulated imbalances on the asset and liabilities sides don’t net out, because they are cumulative imbalances with different other economic act”. How was the sentence supposed to continue?

      Anyway, this sounds very, very interesting. To me, it is related to a point I’m trying to make in one of my comments above (see full comment as reply to Jo Michell; for further elaboration, see my latest blog post — you get to it by clicking my name):

      “It is important to notice how a monetary economy doesn’t exist without debt. Let’s assume a “total reset”, so that all debts and so all credit balances (“money”, “near money”, etc) disappear. Where does the first Monetary Income (i.e. income recorded in a common unit of account) come after this reset? From someone incurring a debt (debit balance) when this someone makes a purchase, of course. To say that this Demand and Income (for the seller) came from Thin Air, doesn’t make sense, does it?”

      I’d really appreciate the chance to exchange opinions with you. If I’m not mistaken, you have commented on Steve Keen’s post here: http://www.forbes.com/sites/stevekeen/2015/02/28/what-is-money-and-how-is-it-created/ ? Your view on “money” seemed to match my view surprisingly well, and I actually posted a late reply to you there, asking you to be in contact.

      • The imbalances don’t have to net out, because of time reporting periods, time lags.

        From comment higher up, for example, inventory/investment can go bad, depreciation can occur, that results in investment loss. The corresponding default, that wipes out corresponding savings, can occur in a following year, or much later. Thus for the intervening time, savings does not equal investment. Also, the defaults can be delayed for a looooong time, as we see in some places today.

        So, time is of the essence. And so it is not a strict identity between savings and investment.

        • ^Tim WROTE: “From comment higher up, for example, inventory/investment can go bad, depreciation can occur, that results in investment loss. The corresponding default, that wipes out corresponding savings, can occur in a following year, or much later. Thus for the intervening time, savings does not equal investment.”
          ——————————————————–

          You are confounding an abstract representation of reality with reality itself. If the inventory/investment goes bad, then any debt associated with it simply converts from investment-debt to consumptive-debt.

          Consumptive-debt represents saving for the lender and dis-saving for the borrower, with no increase in net saving (or aggregate saving) for the economy as a whole. Just because the consumptive-borrower destroyed the savings he borrowed by consumption does not preclude the lender from holding-on to his personal debt-claim at all. So why should it be any different if what was originally investment-debt now converts to consumptive-debt?

          I see you REPEATEDLY confusing yourself by not distinguishing between PERSONAL savings (or savings in one part of the economy) and AGGREGATE savings (or sum of all savings in the whole of the economy). In addition, you are now also confounding money (or debt-claims) with real wealth. Money is not savings; debt-claims are not savings. Savings are goods & services produced but not consumed.

          If you are finding it hard to distinguish between reality and its abstract-representation, think about why Moses put a ban on idolatry: In pre-Mosaic times, some people represented divinity with an icon for the sake of convenience in communication. A tendency was seen amongst the masses to confuse that icon with divinity itself. The masses soon began to believe that the icon, which was supposed to represent divinity, was itself divine (fetishism). They began to ascribe magical powers to the icon and started to fear it. To prevent this confounding between divinity and the representation of divinity, Moses decided to ban idolatry. In effect, Moses was banning fetishism, in which people mistake a representational object with that which that object is actually supposed to represent.

          So when you confound money with savings, you are guilty of idolatry in the form of monetary fetishism. You are violating the second-commandment of the Savings God, who is, from what I hear, a jealous god. — Exodus 20:4-6

    • wait, almost no economists understand the difference bw ex ante and ex post? Interesting bc I feel like I see it in my economist friends writing a lot. But then again most of what they write is useless nonsense but I just thought it was because they are weak mathematicians, with a severely limited knowledge of fi./economic history, we’re educated in a system whose curriculum revolves around teaching economic theory that has been debunked for decades, while using economic models, based on wholely unrealistic assumptions and can only work in a fantasy dream world, to justify their preconceived political/social biases yet still try to use these models to make predictions in the real world (and refuse to abandon them despite their repeated failure). So I thought it was unrealistic to expect these economists to ever be convinced to use a systems approach to understand the economy. But if it’s just a matter of explaining the definition of ex ante and ex post then I think that’s a manageable hurdle for…not going to say all but at least most economists.

    • Private creation creates two problems i unless each bank determines if it is demand side or supply side imbalances are easy to create ii in our determining that say supply/demand side is less risky then it creates risk although the demand side,will be a more dynamic economy than a supply side one
      Why?
      If the supply side is over leveraged the money created other than through wages & asset purchased – profit & cost of lending the money doesn’t get into the demand side ,so that profit & lending cost has to be met out of what is already in the the demand side,so whilst paintings ,housing,bonds etc will rise at the top end because these are saving storage areas the money in the actual economy is having to work harder & go further to support the imbalance in the money creation,only tax rises can transfer idol saving storage money back into the real economy,this is why Osborne’s tax credits & cuts to the wealthy is going to be disastrous & with the new fiscal rule he will ONLY be able to offset this disaster by either more cuts adding & making them unelectable or tax rises but only where saving storage will be hit or it will be even more of a disaster or admit his incompetence & acclaim the economy needs to go into special measure to borrow at historical low levels of interest.
      He put a noose around his neck & is now tightening the noose himself but in doing so he maybe forced to act in raising tax against saving storage that in the end could save the economy
      Blissex i think you make some good points! hope I’ve added to it!

      • I Believe but haven’t got a breakdown that all the finance needed to produce a car on all the parts comes to 65% of the cost of the car with the compound of all parts,so only a max of 45% of the created money finds it’s way to the demand side & 65% goes into asset saving storage bubbles,before the demand side has to borrow to buy the car with all that compound built in,

    • This turns out to be easy, I think. The ex post is all the transactions as posted, and for that the S=I logic looks quite clear.

      The ex ante, is about how the balance sheet quantities may evolve. e.g. metal stocks (bars, sheets, ingots etc) bought at specific prices, will have set ex post inventory/investment values, but the real time balance sheet values of those metal stocks will be market dependent. So in real time, S probably won’t equal I, and under conditions of financial crisis, almost certainly won’t. Savings can be destroyed by defaults, while investment can stay in place, tangible capital will still be there . On the other extreme, investments and capital can be wiped by man made or natural disaster, while balance sheet savings and debt can remain in place.

      Gunnar Myrdal sorted all this out in the 20’s, and 30’s. It’s a matter of cases. Which case is one looking at?

      “… Myrdalian ex ante language would have saved the General Theory from describing the flow of investment and the flow of saving as identically, tautologically equal, and within the same discourse, treating their equality as a condition which may, or not, be fulfilled. (Shackle, G.L.S. (1989) “What did the General Theory do?” …” https://en.wikipedia.org/wiki/Ex-ante

    • ^Blissex WROTE: “NO, NO, NO. M Pettis and yourself considerably muddy the discussion here not be cause there is a difference in understanding the accounting identities.
      But because almost nobody understands the difference between “ex-ante” and “ex-post”, or expressed that difference. That’s the really important technical term and concept.”
      ————————————————

      This comment on the “ex-ante” and “ex-post” point made by Blissex may have been a bit long to post here, so I have put it on the google documents drive. Interested parties can read it here:
      https://goo.gl/mlJU4F

  24. Brilliant post.

    I think, however, that you have missed a third possibility, Schumpeterian growth. Schumpeter argued (here: http://classiques.uqac.ca/classiques/Schumpeter_joseph/business_cycles/schumpeter_business_cycles.pdf) that the growth process itself is driven by bank credit creation. (The interesting part starts on page 100 and continues for 70 or so pages.)

    Here’s my precis of his argument: Innovators (“enterpreneurs”) as a rule don’t have the assets needed to innovate. He focuses on genuine innovators whose projects have the ability to increase GDP. That is, when an economy is at full employment, it is at full employment given a certain technology. The purpose of innovation is to change the technology so that the full employment level of GDP is higher.

    Schumpeter argues that innovators are typically dependent on banks to finance their working capital. This financing process has precisely the effects you describe in 1. But, under the assumption that the innovators are genuine, the financing process is also initiating a permanent transformation of the economy including its price structure, as the economy adjusts to the new technology. By the same token, the effect of such bank lending to genuine innovators is to increase GDP — even though the economy was actually at full employment (for a given technology) before the bank financed the innovator’s working capital.

    Schumpeter’s book argues that this core credit and growth creating function of the banking system is accompanied by a lot of bank finance that has the effects you describe in 1. or in some cases actually feeds Fisherian “overindebtedness” based on over-optimistic expectations with adverse consequences that are potentially very severe. Schumpeter argues that both business cycles and depressions are a consequence of the particular realization of the bank credit creation process.

    A favorite quote: “It is important for the functioning of the system that the banker should know, and be able to judge, what his credit is used for and that he should be an independent agent. . . . this is not only highly skilled work, . . . but also work which requires intellectual and moral qualities not present in all people who take to the banking profession. . . . [While it is true that] a majority of would-be entrepreneurs never get their projects under sail and that, of those who do, nine out of ten fail to make a success of them. In the case of bankers, however, failure to be up to what is a very high mark interferes with the work-ing of the system as a whole. Moreover, bankers may, at some times and in some countries, fail to be up to the mark corporatively : that is to say, tradition and standards may be absent to such a degree that practically anyone, however lacking in aptitude and training, can drift into the banking business, find customers, and deal with them accord-ing to his own ideas. . . . This in itself is sufficient to turn the history of capitalist evolu-tion into a history of catastrophes. One of the results of our historical sketch will, in fact, be that the failure of the banking community to function in the way required by the structure of the capitalist machine accounts for most of the events which the majority of observers would call “catastrophes.” ” (pp. 115 – 17)

  25. note; JKH has a comment over at Uneasy Money; he couldn’t post here so he posted there.

    • ^Dan Berg WROTE: “note; JKH has a comment over at Uneasy Money; he couldn’t post here so he posted there.”
      ————————————————
      Is this what you mean?
      http://goo.gl/g5DVRH

      EXTRACTED QUOTE from that commentary on Michael’s blog-post: “Keynes was unable to distinguish the necessary accounting identity of savings and investment from the contingent equality of savings and investment as an equilibrium condition. For savings and investment to determine the level of income, there must be some alternative definition of savings and investment that allows them to be unequal except at equilibrium. But if there are alternative definitions of savings and investment that allow those magnitudes to be unequal out of equilibrium — and there must be such alternative definitions if the equality of savings and investment determines the level of income — there is no reason why the equality of savings and investment could not be an equilibrium condition for the rate of interest. So Keynes’s attempt to refute the neoclassical theory of interest failed. That was Hawtrey’s criticism of Keynes’s use of the savings-investment accounting identity.” <<<ENDQUOTE

      ANOTHER EXTRACTED QUOTE from that same commentary on Michael's blog-post: "In principle, I have no problem with such a use of accounting identities. There’s nothing wrong with pointing out the logical inconsistency between wanting Germany to pay reparations and being unwilling to accept payment in anything but gold. Using an accounting identity in this way is akin to using the law of conservation of energy to point out that perpetual motion is impossible. However, essentially the same argument could be made using an equilibrium condition for the balance of payments instead of an identity. The difference is that the accounting identity tells you nothing about how the system evolves over time. For that you need a behavioral theory that explains how the system adjusts when the equilibrium conditions are not satisfied. Accounting identities and conservation laws don’t give you any information about how the system adjusts when it is out of equilibrium. So as Pettis goes on to elaborate on Keynes’s analysis of the reparations issue, one or more behavioral theories must be tacitly called upon to explain how the international system would adjust to a balance-of-payments disequilibrium.<<<ENDQUOTE

      Another *NEW* post just up at that site: http://goo.gl/Jyxr9I

      EXTRACTED QUOTE from this *NEW* commentary on Michael's blog-post: "As Hawtrey and Robertson explained in their rejoinders to Keynes, the necessary equality in the “classical” system between aggregate savings and aggregate investment of which Keynes spoke was not a definitional equality but a condition of equilibrium. Plans to save and plans to invest will be consistent in equilibrium and the rate of interest – along with all the other variables in the system — must be such that the independent plans of savers and investors will be mutually consistent. Keynes had no basis for simply asserting that this consistency of plans is ensured entirely by way of adjustments in income to the exclusion of adjustments in the rate of interest. Nor did he have a basis for asserting that the adjustment to a discrepancy between planned savings and planned investment was necessarily an adjustment in income rather than an adjustment in the rate of interest. If prices adjust in response to excess demands and excess supplies in the normal fashion, it would be natural to assume that an excess of planned savings over planned investment would cause the rate of interest to fall. That’s why most economists would say that the drop in real interest rates since 2008 has been occasioned by a persistent tendency for planned savings to exceed planned investment.<<ENDQUOTE
      ————————————————

      These are all EXTREMELY INTERESTING points. This comment might be a bit too long, so I have put it up on the google document drive. Interested blog participants can read it here:
      https://goo.gl/ZFHYbt

  26. Mr Pettis,

    If we talk about “banks creating demand by creating loans”, shouldn’t we then talk about how any willing buyer creates demand by “debiting his account” (i.e. by buying; the sentence is tautological)? In can think of at least four distinct cases where one debits one’s account (“account” is a broad concept); in other words, what follows is a list of ways to buy:

    1. To debit one’s “bank account” where there exists a net credit balance that covers the purchase price. (By net credit balance on a bank account I mean “Credit balance on ‘deposit account’ minus Debit balance on ‘loan account'”; an overdraft account would give us this net balance automatically.)

    2. To debit one’s “bank account” and to incur, or increase, a net debit balance on it. (This is the “bank creating demand” part.)

    3. To debit one’s account at a non-bank financial institution (credit card company, a financing arm of a manufacturer, etc).

    4. To debit an account one holds directly with the seller.

    When a sale is made, the seller’s account (in whatever ledger; even a mental one shared by the buyer and the seller) gets credited, and that is what must of course happen in all four cases above (debit=credit). In each case Income is usually recorded when the goods or services are delivered, irrespective of what kind of account is debited.

    It just seems to me that “banks create demand” is a misleading overstatement. Banks are in many cases involved in the process, for sure, but they don’t “create demand”. As I see it, this kind of statement implies the following thought process: Purchases=Demand; Purchases are made with “money”; Banks create “money” -> Banks create Demand. But this is a false description of reality. Purchases are made when the buyer’s account gets debited and sales are made when the seller’s account gets credited. This is what happens in every transaction. Use of “money” is just a special case of this general rule, and actually the whole existence of this special case relies on our convention to call credit balances in CB/commercial bank ledgers “money”.

    How do you see this?

  27. Still working on a lenghty comment. But would much prefer discussion since we are touching on a lot of very fundamental issues.

  28. I believe I can be helpful bc I have spent a good amount of time over the last half decade reading Pettis, Keen and MMT writing. The obvious connection is that all three look at the asset and lia. side of the balance sheet.
    I want to separate the comments about MMT and Keen so i’ll start in this post trying to reconcile the seeming inconsistency between Prof Keen and Prof Pettis.
    Keen’s work is centered around how changes in debt impact aggregate demand. I agree with him the flow of debt plays a crucial role in GDP growth. But a key question that Keen ask is: if spending = income, how can income ever grow? Keen’s answer is the endogenous creation of money. This is where Keen becomes confused.
    While Prof Pettis says in the post that Keen likely does NOT disagree with his accting identities, Keen actually does disagree and spends a great deal of time trying to disprove them. Specifically addressing Keynes “principles”(i.e. the accounting identities Pettis describes), Keen says, they only apply “in the abstraction of equilibrium” and fail to apply “in the normally growing economy in which we live.” In other words, it doesn’t tell us how income can grow.
    I believe that Keen’s problem is that he fails to understand that these acct identities do NOT restrict income from growing over time it just says that every transaction that occurs in the economy will impact one of these variables but it will also have a simultaneous impact on another variable so that at any point in time these variables balance.
    So while Pettis explains that current spending (i.e. current agg demand) = current income, Keen believes this is flawed and says that current spending (i.e. current agg demand) = past income + change in debt.
    What Keen fails to realize is that the act of spending simultaneously creates new income so that current spending always = current income. So while Keen is correct in asserting that changes in debt allow for current spending to exceed past income, he fails to realize that the accounting identities Pettis (and many others) use do not restrict income from changing.
    Its akin to saying that the Assets = Liabilities + Equity equation is flawed because it creates a paradox where assets cannot grow because it can never exceed L+E and L+E can never exceed A. Obviously this is wrong. We can grow assets by taking on debt but both L and A increase by the exact same amount so that they offset.
    I want to emphasize the point that Keen’s equation is not wrong…it is just like saying that the change in assets = change in liabilities + change in equity. What Keen is wrong about is asserting that the accounting identities preclude the growth in income.

    • An excellent reconciliation! Thank you. I will come back later with some comments.

    • I think you have this right MJM123, very well put.

    • But not correct. Steve’s explanation is not vague nor equivocal. The problem centers on the ex-ante question, and has been explored by Mathais Grasselli of the Fields Institute. I have pinged Steve to see if he can read this and comment on it and some other issues. But a very good post in general.

      I personally have not problem with the intuition, because I as Keynes, I believe, see the causal arrow running from investment to savings through incomes. I did not read Keynes as finessing the I=S as “just different words for the same thing.” But the whole issue seems to be of great concern, and I will not speak for Steve.

      Thanks for your work

      • Dear Dr. Harvey,

        I am happy to see your comment on behalf of IDEA (Dedicated to the Reform of Economics). I have been following Professor Pettis’ blog for many years and have never felt the need to comment here before. The only reason I am commenting for the first time is that I feel that something is very wrong here.

        As I see it, the overwhelming majority of the comments here seem to support Professor Keen’s position. In fact, when I look at the discussion in the previous article on this blog, I see that the students/supporters of Professor Keen have mounted a ferocious defense of his work against the naysayers who were challenging his work.

        In addition, Professor Pettis states that he knows Professor Keen well and asks explicitly for a clarification from him if there are any misunderstandings in these discussions. Yet, despite all this, Professor Keen has not yet bothered to comment here. I find this deeply disturbing. Instinctively, I feel something here is very, very wrong. After all, the only thing Professor Keen needs to do is come and write a few lines here, and so I find myself wondering as to why is he suddenly so reticient.

        I am not an economist by training or profession, so it is beyond my intellectual capacity to comment on the veracity of the various claims. However, from what the various commenters here are saying, it seems to me that most of the people here agree with Professor Keen (and yourself) that investment comes first (ex ante) and that the matching savings of which Professor Pettis speaks come only much later (ex poste) once the spending cascade has worked slowly itself through the economy over time. Isn’t this what Professor Keen means when he speaking of “periodic thinking”? Isn’t this what his supporter mentions when he says that Professor Pettis’ article has “no time element in that entire lengthy post”? Is this what you mean when you write of “ex ante/ex post”?
        https://twitter.com/ProfSteveKeen/status/656017519287914496

        Isn’t it your view that investment happens upfront and that the matching savings are only slowly accumulated later over time? Doesn’t this indicate that while investment = savings is true over the long run (or at equilibrium), it is not true over the short-run? So I am left wondering as to why Professor Keen is reluctant to confirm this very simple point in response to a direct request for clarification from a fellow professor & collegue whom he already knows. Why is he relying on his students/supporters to make arguments on his behalf when he could easily do so himself in a few lines? From what I can verify, Professor Keen seems to be all over on the internet, with blogs, videos, conferences, seminars, papers, books and so on. This implies that he is certainly not the reclusive, introverted kind of person who shuns the public gaze. So what is stopping him from clarifying this very simple point here? Why does he not comment in support of his students & supporters who have been valiantly defending his ideas on this blog?

        I hate to say this, but this silence on behalf of Professor Keen suggests that something here is very, very wrong. It does not reflect well on your innovative IDEAS organization, because it raises many questions about what the million$ funds-target that you mention on your website is really going to be used for. It is a common rule that unnecessarily-evasive behavior attracts attention and may eventually lead to the formation of negative conclusions. The way to prevent these things from spinning out of control is to address issues as and when they arise. I hope that you will be able to convince Professor Keen to clarify these issues by writing a few lines here.

        Please forgive me if I have misunderstood the situation.

        Your cordially,
        –A.M. Mitra, PhD

        • Actually Keen wrote to me while I was traveling and said he’d try to comment once he had managed to work through his work load, but I do think it is a little unfair to expect him to respond immediately anyway. We all have our priorities, and we certainly all have our work, and I certainly don’t feel any obligation to respond to other people’s disagreements with things I have said unless I feel there is some value in responding. At any rate I don’t read my comments as challenging or disagreeing with him, and my post is not really about his work so much as it is an attempt to clarify, for me as well as for anyone else who is interested, what it means to say that demand is created out of thin air. Thanks for your comments, AM, but I wouldn’t read too much into any of this beyond the actual logic of the argument.

          • Did you see Cullen Roche’s response to your post? It seems like his disagreements were mostly squabbles, but it seemed like he agreed with most of your post.
            http://www.pragcap.com/creating-demand-out-of-thin-air/

          • I did, thanks Suvy, and I’m not sure I understand the objection at the end, but there was a very wide and generally sympathetic response to this entry and because I’ve been traveling I haven’t had the time to go through them all.

          • Most enjoyable essay, Michael, as usual.

            Even though this piece is not really about Keen’s work, it’s been hijacked by the confusion his change in net debt demand thesis seems to generate. Most unfortunate and, I think, mostly unnecessary.

            To my mind, by not paying sufficient heed to the destination of debt financed spending Keen falls into something very like a category error.

            In the West, certainly, most private sector credit in recent decades has financed the purchase of existing assets rather than consumption or investment. To the extent these credit fuelled asset purchases generate wealth effect spending, there is some leakage into real economic activity but it’s relatively marginal.

            The net increase in debt in any given period isn’t, therefore, a straight addition to real economic demand. Far from it.

          • Thanks, Ingolf. The enthusiastic response towards any of my postings on debt and balance sheets and the debates they always unleash, not just in the comments section of my blog but also in the press and other blogs, makes me all the more determined to get out my next book on debt. It is pretty clear that while academic economists have largely failed to explore the role of balance sheets in the economy largely, it seems, because their models do not allow much of a role, there is a very large group consisting of investors, historians, mathematicians, unorthodox economists, policy-makers, policy geeks, development economists, and young, prospective, or newly-minted PhDs in economics who are fully convinced that balance sheets matter profoundly. I suspect that within the next two decades orthodox economics will have been forced to change its attitude towards debt.

          • ^Roche Cull WROTE (in his own blog): “The key point here is that Pettis is not being very careful when he says:

            >>[The banks and government] never simply create demand “out of thin air”, as many analysts seem to think, and doing so would violate the basic accounting identity that equates total savings in a closed system with total investment.<<

            This misunderstands the way the accounting identities are being utilized in the Post-Keynesian framework and I am afraid Pettis is falling victim to his own narrow definitions of “savings” and “investment” within the context of his own views on the accounting identities."
            ———————————————————

            Somebody is falling victim to something, but it is not Michael.

            (A) What is a "narrow" definition of savings? Is there a "broad" definition of savings? Savings is simply something that has been produced and not consumed.
            (B) What is a "narrow" definition of investment? Is there a "broad" definition of investment? Investment is simply something that has been produced and then either set-aside as inventory or utilized to increase future production ('fixed-investment').
            (C) By definition, savings = investment, because they happen simultaneously and refer to the same thing.
            (D) As seen in the diagram below, the word 'saving' is used when we look at the flow along the direction of the arrow; whereas the word 'investment' is used when we look at the flow against the direction of the arrow.
            https://goo.gl/ZXKDdm

            SAVINGS = INVESTMENT is just as true as SALES = PURCHASES, because the word on the LHS and the word on the RHS are merely describing the same event from two different (opposite) angles. Given that nobody (not even "post-Keynesians", whatever that means) objects to the concept that every sale must have an corresponding equal purchase and that the two must happen simultaneously, why is there this sudden agitation about the equivalence and simultaneity of savings & investment?

        • Bit of a tempest in a tea cup, it seems. It’s simply a confusion of cases.

          • ^Tim WROTE: “Bit of a tempest in a tea cup, it seems. It’s simply a confusion of cases.”
            ———————————————————

            The tempest is a minor issue, the MAJOR issue here is the presence of 800mg of mescaline hydrochloride in that teacup. The lava-lamp next to that teacup has triggered an explosion of transcendental creativity amidst the seeing of music and the hearing of colors. Exactly as Aldous Huxley had described, the windows of consciousness have been cleansed and the doors of perception have been opened wide.
            https://goo.gl/O5iIUM

            “What have you been smoking, Paul?”
            http://goo.gl/phHDZY
            — Matthew 7:1-5

      • ^Alan Harvey WROTE: “I personally have no problem with the intuition, because I as Keynes, I believe, see the causal arrow running from investment to savings through incomes. I did not read Keynes as finessing the I=S as “just different words for the same thing.””
        ———————————————–

        I will not speak for Keynes, as I am not familiar with what he said or did not say. However, the ‘causal arrow’ does not run from investment to savings via income. The ‘causal arrow’ runs from FIXED-investment to savings via income, with savings being exactly equal to investment everywhere and at all times.

        It is essential to note that FIXED-investment is NOT the same as investment:
        DEFINITION: Investment = Fixed-investment + Change in Inventory —- (I)

        Here are the actual STEPS in the ‘casual arrow’ from fixed-investment to savings via income:
        1) New FIXED-Investment made (Intial spending by purchase via credit).
        2) Reduction in Inventory = INCOME (From sales equal to (1)).
        3) Restocking of Depleted Inventory = New SAVINGS generated.

        In steps (1) & (2), as indicated by equation (I), New INVESTMENT made = New SAVINGS generated = ZERO, because all that is happening is that things are being moved out of existing inventory into new fixed-investment. In other words, the activities in steps (1) & (2) are merely a re-assignment of PAST investment (or PAST savings or existing capital-stock) from one category (idle inventory) to another category (productive fixed-investment).

        It is only in step (3) that new SAVINGS & new INVESTMENT are SIMULTANEOUSLY generated by the restocking of inventory (see equation (I). Regardless of what Keynes may or may not have finessed, savings & investment are the same thing– everywhere and at all times. Here is a diagram:
        https://goo.gl/ZXKDdm

        Let me know if you disagree.

    • Mjm123, thanks again for a great reconciliation! (In order to get a grip of the matter, I’ve read this paper by Bezemer, Grasselli, Hudson & Keen: http://debunkingeconomics.com/wp-content/uploads/2012/10/TowardsUnificationMonetaryMacroeconomicsMathArgument.pdf)

      I think you have more or less correctly identified the problem here. In the above-mentioned paper, Keen et al seem to focus solely on “debt-financed spending”, and it seems they become blind to other ways to increase spending because they, well, abstract from these other ways. For instance, the authors quote Minsky who offers “emitting debt” (or, elsewhere, “creation of new money”) as one way to increase spending, but seem to ignore that Minsky mentions (as quoted by the writers) that also “selling assets” or “portfolio changes which draw money from idle balances into active circulation (that is, by an increase in velocity)” can be behind an increase in spending. (This might be connected to the authors’ later use of Minsky’s equations where he has abstracted from the “savings by workers”.)

      I think the writers fail to see how what I would name “Minsky’s condition for growth in spending” (below, I use Minsky’s terms)

      “current spending plans” being greater than “current received income”

      can be translated as

      “current spending plans” being greater than previous (realized) spending (as spending=income)

      which is nothing but a definition of (again, Minsky’s/authors’ terms) “economic growth”, or more accurately “nominal GDP growth”.

      To me it seems that all this leads to a confused suggestion that spending must be greater than income for the economy to grow, and that this can only be attained by increase in debt — or even worse, by creation of new money, as if all purchases were made by using money. Minsky himself was careful to add “or selling assets”, which to me can be as simple as using a previously acquired credit balance (eg, a “deposit”) in a purchase. But I think the biggest mistake is to fail to see how spending can be increased by what in effect is barter, so that there is no new debt and no “asset sales”: for instance, two businesses can provide each other with goods and services. What defines the amount of spending here is really the “value” provided in form of these goods and services, and it is only a formality if there are some “deposits” going back and forth between the businesses (this is just bookkeeping).

      Finally, I would suggest we look at “Figure 2: Debt-financed expenditure and a discontinuity in income” (p. 14) in the above-mentioned paper. I understand how it is tempting to think in the way the authors think, but nevertheless it must be wrong. Picking one point in time where there is a simultaneous increase in debt and in spending and calling this a “discontinuity” misses the fact that income as measured by accountants for *any time period* consists in part of debt-financed spending. So the whole starting point in the figure is wrong. You cannot show “Income” as a curve like that, varying from moment to moment, as if before the “discontinuity” there wasn’t any similar discontinuity and yet income varied (as we see in the graph). Current spending just isn’t defined by previous income in the way the authors seem to suggest.

      I track this confusion to what I have stated elsewhere in this conversation, which is our tendency to think in terms of “cash flowing” or “money being transferred”. I have managed to clarify my own thinking a great deal by starting to think purely in bookkeeping terms, in terms of credit and debit entries (and balances), without needing to use the word “money” or “cash” at all.

      • In a world with no money creation, if you sell an asset to raise cash to pay for purchases of goods and services, someone else must buy this asset from you, ie. someone else must renounce to exercise his / her buying power in the market for goods and services to instead exercise it in the asset market to buy what you’re selling. Thus, in aggregate, spending in the market for goods and services would not grow in value terms : your extra spending funded out of the sale of your asset will be compensated by extra abstinence from whoever bought your asset. Same in the asset market, where the exact quantity sold by you would have been bought by someone else. If, instead of selling an asset to raise cash, you had borrowed the equivalent amount, it would be the same : your lender would have had to renounce to exercise his / her buying power to lend to you. Note that, in such a world of constant aggregate cash balances, there can still be fluctuations as aggregate cash balances can be at a given moment below or above the level desired by the multitude of agents, leading to a slowdown in spending and a drop in interest rates in the first case as cash balances rise (declining velocity) or to an acceleration in spending and a rise in interest rates in the second case as cash balances are depleted (increasing velocity). It’s just that the amplitude of such fluctuations would be small compared to a system with phases of strong monetary expansion followed by phases of credit crunches. Also note that, in such a world of constant aggregate cash balances, there can be income growth, raising standard of living and appreciation of asset values on a real basis via productivity gains. What would be perhaps more difficult in such a world would be to finance large-scale modifications in the structure of the economy, like for instance massive roll-out of railways, unless the distribution of income would already be so unequal that massive pools of savings would be available for the construction of railways that would only substitute the construction of spectacular palaces for the ruling elites for instance. What would be impossible in such a world would be massive variations in asset values compared to production and income values as well as massive aggregate price fluctuations.

        In a world with money creation, however, it would be perfectly possible for you to sell your asset to someone else who would buy it with newly created money. For instance, your asset could be a share of an S&P500 company and a hedge fund might buy it with margin debt procured by its prime broker. It is then possible for you to exercise your extra spending power in the market for goods and services without anyone else renouncing to exercise his / her purchasing power in these markets. Everything else equal, nominal production would grow, in quantity or / and in price terms. Everything else equal, the capitalization of the stock market will not be affected because the funds that you withdrew from it have been matched by newly created money. In fact, the hedge fund in question, perhaps speculating on the expected growth in production and profit that your extra spending will soon generate, might even borrow more to buy more than what you’re selling. In which case, the stock market might even appreciate. If the funding of the securities lending made by the prime broker is ultimately done by attracting genuine savings in the money markets, this might lead to an increase in interest rates, everything else equal. But if, ultimately, this loan was funded by the national central bank creating new reserves or by a foreign central bank placing its own foreign exchange reserves in that particular domestic money markets, no tension on interest rates will be noticed. May be, if new reserves injection by domestic and / or foreign central banks were to exceed the new loan extended by the prime broker of our example, interest rates would even decrease and some puzzled official would wonder about such “conundrum”.

        In other words, in a world with money creation, unlike in a world of constant money stock, it is possible to buy without paying. It is also possible to sell without owning, for instance when hedge funds short securities. Needless to say, in such a world, the mechanisms that prevent imbalances to grow too much and tend to correct them – those adjustments that are taught in every economics textbooks – are far less effective or totally ineffective. The dynamics of the economic system are changed, if not its accounting identities. Imbalances no longer self-adjust but are simply capitalized into increased debt-to-income. They can not only perpetuate but also grow. That’s precisely how global debt has exploded from ~ 100% to ~ 320% of global GDP in the last 35 years. You would think every economist on the planet would be incredibly focused on this situation as running so contrary to all mainstream economics? You would be wrong. The vast majority doesn’t give a damn about stratospheric debt loads, the vast majority did not see 2008 coming and the vast majority is not seeing that, today, global debt continues to rise faster than global income, developing countries – of which not least China – having joined developed countries in the club of over-indebted countries that now includes ~ 75% of global GDP. Of course, not completely coincidently, the vast majority of economists enjoy very good remuneration and lives a good life precisely thanks to this situation. I don’t know if the exact relationships used by Steve Keen are correct or not in an accounting sense since I’m not familiar with his work, but at least it is helpful that he highlights the role of money / debt creation, as it is useful that Michael Pettis focuses on savings distortions and trade imbalances and their impact on balance sheets, since these certainly modifies profoundly the dynamics of the economic system if not its accounting relationships and is one of the critical but poorly understood questions we are now facing.

      • ^P.G. WROTE: “I think the writers fail to see how what I would name “Minsky’s condition for growth in spending” (below, I use Minsky’s terms)
        “current spending plans” being greater than “current received income”
        can be translated as
        “current spending plans” being greater than previous (realized) spending (as spending=income)”
        ———————————————–

        Minsky said the same thing as Michael is saying. Please read the following VERY CAREFULLY:

        1) According to your quote, Minsky said: Current spending PLANS > Current received income
        2) Minsky did NOT say: Current spending > Current received income
        3) The word ‘PLAN’ refers to an agenda for future action (“ex ante”).
        4) This implies that Current spending PLANS = Spending in NEXT PERIOD
        5) Therefore, Minsky said: Spending in NEXT PERIOD > Current received income
        6) Therefore, Minsky said: Future spending > current income
        7) Therefore, Minsky said: Future income > current income
        8) Therefore, Minsky said: The money-supply tends to grow with the nominal economy
        9) Therefore, Minsky said: Nominal GDP = Money-supply X Velocity of Money
        10) Therefore, Minsky said: I agree with Herr Krugmann

        Note that in this exciting new game of “what Minsky said”, point (5) is EXACTLY what Michael said (quote): “I think what Keen might actually be saying is that if investment in the NEXT PERIOD is greater than savings in the CURRENT PERIOD – if it is boosted, so the argument goes, by the ability of the banking system to fund investment by CREATING DEBT “out of thin air” – this does not violate the identity, and it is not only possible, but even likely. (If by any chance Steve keen should read this, perhaps he might respond.)” <<ENDQUOTE

        All in all, stripped of the pointless twisting & turning of 'ex-ante', 'ex-post', t-1, t, t+1, and all the other convoluted patterns of tap-dancing, what Minsky means is merely that (i) the money-supply tends to grow along with the economy and that (ii) it is the banks that create (most of) this new money. Everybody knows this; this is standard knowledge. For god's sake, even Steve Keen's arch-enemy, the evil Herr Doktor Krugmann, agrees with this.
        https://research.stlouisfed.org/fred2/graph/?g=2lgg

        The problem is not with what Minsky said; the problem lies in an interpretation of what he said that is so bizarre that it bears not even an iota of resemblance to reality. The interpretation is so grotesquely distorted that it appears almost hallucinogenic in a mescalinian sense. The scale of the hallucination is so vast that this new "Minsky-model" leads aggregate demand in the US to exceed US GDP by about the size of the whole economy of Japan (4.7 TRILLION$) in 2008, as you can see in the table entitled "Change in debt and aggregate demand" here:
        http://goo.gl/ZO5Aky

        Finally, note what Krugman says (quote): "My basic reaction to discussions about What Minsky Really Meant — and, similarly, to discussions about What Keynes Really Meant — is, I Don’t Care. I mean, intellectual history is a fine endeavor. But for working economists the reason to read old books is for insight, not authority; if something Keynes or Minsky said helps crystallize an idea in your mind — and there’s a lot of that in both mens’ writing — that’s really good, but if where you take the idea is very different from what the great man said somewhere else in his book, so what? This is economics, not Talmudic scholarship." <<ENDQUOTE
        http://goo.gl/Yv0jnr

        What Krugman is saying is something FUNDAMENTAL. If Minsky (or Keynes or Marx) said something that, upon further examination, does not match up with reality, then it is better to discard what Minsky (or Keynes or Marx) said and to grasp the reality, rather than to discard the reality and cling to what Minsky (or Keynes or Marx) said. This is what Krugman means when he points out that economics is not "Talmudic scholarship"– there are no prophets to whom divine revelations were made.

        • “…. The interpretation is so grotesquely distorted that it appears almost hallucinogenic in a mescalinian sense. The scale of the hallucination is so vast that this new “Minsky-model” leads aggregate demand in the US to exceed US GDP by about the size of the whole economy of Japan (4.7 TRILLION$) in 2008, as you can see in the table entitled “Change in debt and aggregate demand” here: ”
          http://goo.gl/ZO5Aky

          Keen , in the paragraph that follows the table you cite :

          “…..since I con­sider that aggre­gate demand is spent on both goods & ser­vices (which are counted in GDP) and the net sum expended pur­chas­ing exist­ing assets (which is not counted in GDP), then there is no dou­ble count­ing. A stan­dard text­book aggre­gate demand fig­ure is the sum spent buy­ing goods and ser­vices (for the expen­di­ture def­i­n­i­tion), which omits of course the sum spent buy­ing exist­ing assets as well. That would be all well and good if we lived in a world with­out asset sale—which of course we don’t. ”

          So , while it’s unfortunate that Keen confused the issue by including asset values within his “aggregate demand” definition , contrary to the standard convention , I see nothing to suggest that he’s been hitting the magic mushrooms.

          • ^^Marko WROTE: “So , while it’s unfortunate that Keen confused the issue by including asset values within his “aggregate demand” definition , contrary to the standard convention , I see nothing to suggest that he’s been hitting the magic mushrooms.”
            ————————————————

            Yes, I saw that “I am a rebel, I work only by MY definitions” part; it reminded me immediately of Frank Sinatra singing “I did it MY way”. The reason I just ignored that re-definition issue is because it makes no difference. The table *STILL* leads to ABSURD conclusions that clash with reality and defy common sense. To see why, if you have the patience, you can examine (and critique) this somewhat long equation-juggling demonstration that I have put up on the google documents drive:
            https://goo.gl/fXCT8b

        • V.K: I don’t disagree in any way. I only wanted to point out that no one should suggest anything that smells of “Income->Spending” *causation*. That’s why I said that we can as well state

          “Spending in NEXT PERIOD > Current spending”

          as we can state that

          “Spending in NEXT PERIOD > Current received income”

          Depending on what we are discussing, it is current or future *spending* what matters, and it has nothing directly to do with past or current income (no more than it has with past or current spending), respectively. Neither is the difference between current spending and past spending the “change in debt”. As you say (I’ve read your comments on Google drive, thanks!) — and if we want to think in terms of the Quantity Theory — increased spending can be as much or more about increased “velocity” as it is about increased “stock”.

          I assume we are more or less in full agreement here?

    • Now, I’m not an economist (at least not by formal education), so I would greatly appreciate if someone could reconciliate what I just said with what Mr Pettis says in this post we are discussing 🙂 Are we in agreement or are we in disagreement? (I will try to answer my question by reading the post again when I have more time.)

    • ^mjm123 WROTE: “I want to emphasize the point that Keen’s equation is not wrong…..”

      ^mjm123 ALSO WROTE: “So while Keen is correct in asserting that changes in debt allow for current spending to exceed past income….”
      ————————————————

      Your clarification is certainly helpful, but I think you may have misunderstood a few points. This comment is a bit long, so I have put it up on the google document drive. You can read it here:
      https://goo.gl/p8if0x

      • Vinezi,
        You take exception to me saying that Keen’s equation is not wrong but it is just explaining something different than the accounting identity Pettis describes. You say,
        “Keen’s equation *IS* wrong. It is wrong because it simply associates change in income/spending with the creation of money (debt) and neglects the velocity of circulation…Therefore, even if there is NO increase in money-stock (debt-stock), there can STILL be an increase in spending & income via an increase in the velocity of circulation of the existing money-stock (debt-stock).”

        If you read Keen’s paper:
        http://www.elgaronline.com/view/journals/roke/2-3/roke.2014.03.01.xml
        you will see that he fully understands that changes in the velocity of money will impact changes in income (or expenditure). He expresses this many times throughout his paper. He specifically says, ” aggregate demand and income in a given period is the sum of aggregate demand and income at the beginning of that period, plus the change in debt over that fraction of a year, multiplied by the velocity of money. Y(1) = Y(0) + v(1) * ΔD(1)”

        What is confusing about Keen’s paper is that by the end of the paper he drops the velocity of money from his equation. In his paper it is easy to miss why he does this but he is basically saying that when the velocity of money is constant, current income = past income + Δ debt. I hate to speak for Keen but given his absence I will tell you why I believe he does this. I believe he is trying to express that changes in expenditure due to changes in velocity of money is fundamentally different than changes in debt.
        Keen states, “Absent new debt, expenditure is financed by incomes generated by the turnover of the existing stock of money, and the flow of expenditure can expand and contract as behavior changes, while the volume of money in existence remains constant, if the rate of turnover of money changes. However, when an agent finances some expenditure by debt, there is a simultaneous injection of additional money via debt-financed expenditure into the turnover of the pre-existing stock of money and the expenditure it finances.”

      • ^^^
        Above I try to explain why Keen drops the velocity of money from his equation but let me try and explain why I believe the term Current Income = Past Income + Δ Debt can be correct even though it omits the velocity of money.
        As physicists understand, valuable insights can be gleaned by breaking things down to their most fundamental values.
        Because the dynamic economy is not analog, it can be quantized…and the most discrete quantity that the evolving economy can be broken down to is the change after every single transaction that occurs.
        Because the velocity of money only exists when we are measuring all of the transactions that take place over a SPECIFIED TIME the equation for velocity of money becomes undefined (i.e. it has no effect) at this single transaction scale. The velocity of money only becomes definable if you add a time scale (i.e. if you are asking how income in one year is different than another year). But time in this sense is just an arbitrary variable that, for lack of a better phrase, changes the question. If you ask how did income and spending change after each transaction (i.e. without adding a time variable) then Current Income = Past Income + Δ Debt. Where ‘Current’ and ‘Past’ stand for post and pre transaction income, respectively.
        It should be noted that the velocity of money is not a fundamental value (in the sense that it CAN be broken down further into its parts), it is just a residual value that makes the equation true.
        I’m swamped right now, as its the middle of earnings season, but I hope that my comments make sense and weren’t too confusing. If I get some time I want to expand on this because I left out what I believe are some very important related insights. In the mean time maybe some of you can add your own insights based on this logic.

        • ^mjm123 WROTE: “As physicists understand, valuable insights can be gleaned by breaking things down to their most fundamental values…..dynamic economy…..not analog…..quantized…..discrete quantity…..single transaction that occurs…..velocity of money…..becomes undefined…..at this single transaction scale….. only…..definable …..time scale …..but TIME, IN THIS SENSE, is just an ARBITRARY VARIABLE that, for lack of a better phrase, CHANGES THE QUESTION. …..income and spending change…..without adding a time variable…..noted…..velocity of money…..fundamental value…..in the sense …..broken down further…..just a residual value…..”
          ————————————————–

          I think I see what you are saying. You are suggesting that Steve Keen’s model may not be operating in the realm of conventional economics because it is designed to account for quantum effects. Specifically, you are pointing out that the discrete (non-continuous) nature of economic transactions (i.e. buying/selling in quanta) acts as an productivity barrier and that the economy itself exhibits quantum-tunneling effects as it moves through (instead of climbing) that barrier in a way that can only be modeled with the use of quantum-probability functions.

          You may be right. Given that Keyes pretentiously selected an Einsteinian-sounding title for his magnum opus in order to make it sound more scientific & sophisticated that it actually was, it was only a matter of time before other economists, being equally pretentious, started picking terms from quantum physics to give their work an equal aura of scientific authority. This was only to be expected because we know that the roof of the house of post-modern economics would simply collapse without support from the ornate pillars of pretention.

          Along this line of thought, note that Heisenberg’s Uncertainty Principle tells us that it is impossible to determine the POSITION of Steve Keen on any issue without SIMULTANEOUSLY changing his MOMENTUM on that issue. I strongly suspect this is why his definitions keep constantly changing (‘quantum tunneling’) and why nobody seems to be able to determine with any certainty as to exactly what he is trying to say at any given moment (‘particle-wave duality’).

          We had previously discussed this issue of the application of Einsteinian Relativity (General Theory) & Heisenbergian Uncertainty (Special Theory) to post-modern economics in one of Michael’s earlier articles. You can see that old semantics deliberation here:
          http://goo.gl/uNJtzi

          ————————————————–
          ^^mjm123 ALSO WROTE: “What is confusing about Keen’s paper is….”
          ————————————————–

          The confusion of which you correctly speak is being created deliberately. When people are doing things that are demonstrably flawed, their only way of covering it up is by jumping all over the place and loudly screaming insults at Krugman in order to distract attention from their own deficiencies. This sort of behavior is often observed in pan troglodytes that have been held captive under duress. It is said that such pan troglodyte behavior usually climaxes with the flinging of feces, which might, under certain circumstances, hit the fan. I would recommend that you exercise caution whenever you find yourself in close proximity to people exhibiting this sort of behavior.

          Take the example of Michael: Have you ever seen Michael insult or taunt any of his fellow academics? Of course not, and you know that this will never happen. This is not because Michael is a better person than anybody else; rather, it is because Michael has no NEED to jeer at his colleagues since his own work is SOUND. It is precisely because Michael’s research stands up for itself on its own merits that Michael has no need to ridicule his colleagues in a vulgar & demeaning fashion such as this:
          http://goo.gl/EKrrzw

          It is only when their own work is flawed— such as when they say X, but later they say that they really didn’t mean that X to be the same as the X that everyone else means when everyone else says X— that such people turn to jeering, insulting, demeaning and pulling-down their colleagues.

          Note what Krugman says in the article linked-below: “Update: OK, I’m done with this conversation. I’ve had enough back and forth, including off-the-record stuff, to confirm for myself that there’s no THERE there. And there are more important battles to fight.”
          http://goo.gl/IHGuaG

          I agree with Krugman and will follow his example. This is my LAST post on the matter; I am now DONE with this topic of Steve Keen and his revolutionary new theories. Proverbs 26:4-5
          http://goo.gl/HPqJHw

        • Just a note: be careful about using Heisenberg’s Uncertainty Principle. Heisenberg’s Uncertainty Principle doesn’t only tell us that we can’t know position and momentum simultaneously, but it also tells us the degree to which we know one vs the other is normally distributed.

          In economics, however, such concepts do not hold. We do not know that there’s a normal distribution involved in knowing such things. In fact, I’m willing to bet almost all of these things are fat-tailed.

          Simply put: Heisenberg’s Uncertainty Principle assumes much more certainty than what we’d first think about.

        • Also, aggregate demand is not income and never is. A company’s income statement is separated from its cash flow. Similarly, aggregate demand is about an economy’s cash flow, not its income.

  29. Thank you for pushing us to think rigorously.

    The long-running arguments on “Savings = Investment” should be possible to settle in a clear manner once and for all.

    Indeed, aggregate accounts are only the consolidation of the accounts of all individual agents (firms, households, state, commercial banks, central bank) and, for all agents, profit & loss accounts, balance sheets and cashflow statements link, match and balance. So, it is definitely possible to get to the bottom of this, subject to the accounting rules followed and the assumptions made about the appropriate consolidating entity (the biases in national accounts construction which you referred to in a previous article).

    The ferociously logical Keynes must have done this exercise to rigorously establish Savings = Investment (apparently not, according to Ralph Hawtrey). Keen must have done it to establish that Savings + Change in Debt = Investment (if that’s the correct understanding of Keen, I’m not familiar with his work). The economists who designed national accounts must have done it. By construction, there must have been a definitive response to this question a long time ago already. In fact, this exercise of building the aggregate accounting framework seems the obvious starting point from where all would-be macro-economists would begin. It is the foundations of macroeconomy.

    In the meantime, I haven’t done the full exercise myself (I’m not an economist and don’t have so many sleepless nights to devote to this and also it is not often a useful use of time to reinvent the wheel) but i tentatively think that the Variation in Net Assets, ie. the Change in Net Worth (Equity) system-wide is the link to reconcile Keynes and Keen.

    Let’s try:

    All production is either sold or stocked, which we write:
    (1) Production = Sales + Variation of Inventory

    All sales transactions are either for consumption or investment purposes. For instance, the sales of a fast food company are for consumption purposes while the sales of a machinery company are for investment purposes. So we can write:
    (2) Production = Consumption + Investment + Variation of Inventory

    Which can also be written as:
    (3) Production = Consumption + Change in Fixed Assets + Change in Current Assets (neglecting change in receivables, ie. assuming that all sales and purchases are paid cash). This can also be written Production = Consumption + Change in Total Assets

    Since Total Assets = Debt + Equity (Net Assets or Net Worth), we can write:
    (4) Production = Consumption + Change in Debt + Change in Net Worth
    So, if what Keen says is simply that Production is a function of Change in Debt (again, I’m not familiar with his work), it would seem not only correct as per (4) but also totally compatible with Savings = Investment (Variation of Inventory being part of Investment)

    We can also write (4) as:
    (5) Production – Consumption = Change in Debt + Change in Net Worth, which is the same as Investment = Change in Net Worth + Change in Debt
    So, if Keen actually says Investment = Savings + Change in Debt, could it be that what he calls Savings is Change in Net Worth? In which case, the apparent misunderstanding might be due to different definitions for the same word “Savings” from Keynes and Keen. Again, we need to find where the ferociously logical Keynes has defined the terms he used because “Savings” and “Investment” are vague enough that they could easily mean different things to different people. May be those who have read Keynes can point us to the relevant document. Same for Keen, of course.

    At this point, based on (4), it seems to me that if savings arise out of income (Savings = Income – Consumption) and are redeployed into income (Savings = Investment) via the debt or equity financing of those who have excess of investment ideas over savings by those who have excess of savings over investment ideas and if global debt has increased much faster than global production and income over the last 35 years (from ~ 100% to ~ 320%) in the closed system that is the global economy, then it must mean that either global consumption share of global production has decreased and / or that global net worth has decreased relative to global production. In other words, system solvency has decreased. Which is where we meet Minsky again.

    The end of the article which describes the impact of ThinAir on the rest of the economy in the two scenario of full utilization and slack is very interesting as it illustrate the richness with which the economic system might operate even within the rigid boundaries of the accounting identities. Thank you for that.

    • ^DvD WROTE: “The ferociously logical Keynes must have done this exercise to rigorously establish Savings = Investment (apparently not, according to Ralph Hawtrey). Keen must have done it to establish that Savings + Change in Debt = Investment (if that’s the correct understanding of Keen, I’m not familiar with his work). The economists who designed national accounts must have done it. By construction, there must have been a definitive response to this question a long time ago already. In fact, this exercise of building the aggregate accounting framework seems the obvious starting point from where all would-be macro-economists would begin. It is the foundations of macroeconomy.”
      ————————————————

      You are right in general, but in this specific case there is a **KEY** point you have not considered…..

      This comment may be a bit long, so I have put it up on the google documents drive. Interested parties can read it here:
      https://goo.gl/SYppW4

    • ^DvD WROTE:
      1) Production = Sales + Variation of Inventory
      2) Production = Consumption + Investment + Variation of Inventory
      3) Production = Consumption + Change in Fixed Assets + Change in Current Assets ….
      4) Production = Consumption + Change in Debt + Change in Net Worth
      5) Production – Consumption = Change in Debt + Change in Net Worth, which is the same as Investment = Change in Net Worth + Change in Debt
      ————————————————

      You have made some good points. To save on space on Michael’s blog, I have put up my observations on your relations (1)-(5) on googles’ document drive here:
      https://goo.gl/khbNZq

      Let me know your counter thoughts.

      • Vinezi, I fully agree that we must correct what DvD writes in (4) and (5).

        Having said that, I would like you to explain why Debt would be linked to Production at all? Isn’t Debt about Trade/Distribution? You write: “This is what people mean when the say ‘net debt is always zero for a closed economy'”. You have so far ignored me arguing (no worries, I understand you have much on your plate) for pretty much the opposite: Net debt is almost never zero for a closed economy. (The exception is a situation where no agent is indebted to another agent in the economy, which is not conceivable other than in an imaginary “barter-on-the-spot economy”.)

        To suggest that “debts net to zero” reveals a mistaken understanding of what DEBT is. Debt is a relationship which can be described from two opposite angles. I have chosen to call it *debit* when seen from the ‘debtor’s’ point-of-view, and *credit* from the ‘creditor’s’ point-of-view. Makes sense? But this doesn’t mean that debit=”debt” and credit=”anti-debt”, so that they cancel out. To suggest that DEBT nets to zero because CREDIT=DEBIT would be the same as to suggest that TRANSACTIONS net to zero because SALES=PURCHASES.

        Let me know if you disagree.

        • P.G. WROTE: “You have so far ignored me……”
          ———————————————————————————-

          Patience, patience, patience. Nobody is ignoring you. It is just that you are moving so fast that people cannot possibly keep up with you. I have just responded to your point about net-debt being for a closed economy in my recent comment (higher-up on this page):
          http://goo.gl/5mbypL

      • Vinezi, Peter,

        Thank you for your comments.

        The equations above are valid for the business sector in aggregate, assuming in first approximation that all production in the economy is carried out by the business sector (i.e. companies) and assuming that all intermediate inter-company sales and purchases are netted out so that we’re talking about final production and final sales.

        So, yes, it is valid for a sub-part of the economy only.

        To derive the correct accounting relationships for the entire economy including the other sectors (households, state, commercial banks, central bank), I have more work to do, which I will try to do because I’d like to get to the bottom of this but I can’t commit that I will actually do it and even less that I will do it shortly because of time constraints.

        Vinezi, perhaps what you simply mean is that we can assume that all business assets, ie. the entire capital base consisting of business debt plus business equity, is ultimately owned by households and that it is therefore part of Households Net Worth? If so, yes, we could easily do that but it will still be business debt and business equity, not all equity. Also, we would not have captured the entire asset and capital base of the aggregate economy. We would be missing State assets (eg. schools, infrastructure, etc). Of course, we could also say that these are partially or totally funded by debt and that households also own the entire State debt as the ultimate consolidating entity of the economy and that State debt is therefore also part of Household Net Worth. Yes, we could do that but it would still be State debt. We would also be missing residential real estate assets (assuming non-residential real estate assets are already captured in business or State assets) and these will also be part of Household Net Worth but there will almost always be Household Debt against all these flats and houses. That would still be debt. And what about consumer debt for which there is no asset coverage? Yes, of course, it’s part of the Net Worth of the individuals who ultimately own the finance companies providing consumer credit but it doesn’t mean that it’s not debt for some people and, while it is indeed net worth for some other people, netting it out has no practical meaning. I have to agree with Peter here: you can’t consolidate the household sector like you can consolidate the business sector. Well, you can as a matter of accounting procedure, but it has no real life meaning, at least not in a society with individual economic and political freedom. A fully integrated mega-corporation along all the various value chains across the entire has a practical meaning (the only thing preventing it is competition and efficiency considerations) and the eliminations in the consolidation process of the business sector really concern P&L not balance sheet (firms sell to each other, they don’t lend to each other apart from short term commercial payment terms).

        Perhaps what we are saying is that all these non-nettable debts are several layers of claims on ultimately the same aggregate asset base of the global economy, which would still mean that it is an elimination of equity on consolidation since debts have first priority in the current legal system. I have to think further about this.

        In the meantime, to conclude, as you seem to be doing Vinezi, that aggregate debt cancels out to 0 throughout the economy and that the entire RHS of the aggregate balance sheet consists of equity only seems incorrect to me. I have to side with Peter on this, pending further work.

        There is another equally if not more serious objection. It boils down to current design of the banking system. To say, as you seem to be doing, that someone’s debt is someone else’s asset may be true from an accounting point of view in the sense that for for each loan on the LHS of the banking system balance sheet there is indeed a deposit on the RHS (and a slim layer of equity) and this deposit is someone’s liquid asset (cash & cash equivalents). It is true accounting wise but not in reality. That’s because, while the debt actually exists for those who have borrowed from the banks and have to divert part of their income to service this debt, the banking system doesn’t have nearly near the corresponding amount of deposits readily available for depositors on the other side of its balance sheet. The banking system only has a (small) fraction of this amount as reserve readily at the disposal of depositors. The rest – the major portion of this deposit asset – doesn’t exist. It is a DEBT – a promise to pay – of the banking system vis a vis depositors. Said differently, the banking system is intrinsically illiquid hence technically insolvent. By design. The millions of pages of banking regulation don’t change that congenital weakness and have actually shown their complete irrelevance in 2008. Please note that, while there may have been a good reason to set up the banking system in this particular (fragile) way under the gold standard to save on precious metals, there is not the smallest reason why the banking system should still be set up like that under a fiat money system. This is the weakest foundation you can think of for the economic system. It is a fragile design. We need an anti-fragile design. To say of an economic system resting on a foundation of debt (a promise to pay) that there is only equity on the RHS of its balance sheet is a misplaced illusion in my view.

        As an aside, all these discussions would be greatly facilitated – but not necessarily satisfactorily solved – if countries reported their Gross Domestic Balance Sheet (GDBS) in addition to their Gross Domestic Product (GDP). Perhaps Peter would have an example of a complete set of accounts for a closed economic system with all the sectors P&Ls, balance sheets and cashflow statements linked together? And once we have that complete set of accounts by country, it would be quite another job still to have it globally. You would think the IMF, which has no purpose since 1971 (its charter stipulates that it’s role is to keep cross balance of payments close to equilibrium in a system of fixed but adjustable exchange rates), would have at least used the time to make some progress in that regards instead of merely confirming experimentally Parkinsons’s law.

        Thank you the discussion.

        • ^DvD Wrote: “In the meantime, to conclude, as you seem to be doing Vinezi, that aggregate debt cancels out to 0 throughout the economy and that the entire RHS of the aggregate balance sheet consists of equity only seems incorrect to me. I have to side with Peter on this, pending further work.”
          ————————————————————————

          I was speaking of the aggregate balance sheet of a closed economy as a whole. I was not speaking of the aggregate balance sheet of the US economy, which is not a closed economy. On the aggregate balance sheet of the US economy:
          A) LHS (book values)
          (i) Foreign Debt-claims held by Residents
          (ii) Foreign-Equity held by Residents
          (iii) Total Capital Stock of the US
          B) RHS (book values)
          (i) US Debt-claims held by Foreigners
          (ii) US-Equity held by Foreigners
          (iii) Net worth of the United States

          (1) Note that (A(i) + A(ii)) – (B(i) + B(ii)) is called the Net International Investment Position (NIIP) and is tracked by the USG
          http://goo.gl/199ueE
          (2) The total US Capital Stock in A(iii) is always tracked and published by the USG
          https://research.stlouisfed.org/fred2/graph/?g=2peE
          (3) So we can calculate the net-worth (book value) of the US as (Capital Stock + NIIP)
          (4) For the US/UK, NIIP is negative; for Germany/Japan/China NIIP is positive.

          I could be wrong. Let me know if you finds any conceptual flaws.

        • DvD, thanks! I need some time to get into your comment — it seems there is much I can learn from doing it.

          Meanwhile, perhaps you have an idea on how Vinezi and I could reconcile our views here: http://blog.mpettis.com/2015/10/how-to-spend-thin-airs-endogenous-money/#comment-147792 ?

        • DvD wrote: “To say…. that someone’s debt is someone else’s asset may be true from an accounting point of view”
          ———————————————————————————-

          Now I might know what is causing all this trouble. We have a language problem here! (a Wittgenstein moment…)

          Everyone, Herr Krugmann included, says that “one person’s debt is another person’s asset”. But this is only true if we take “debt” to mean “(financial) liability”. If we do that, which is totally fine, then we still have to come up with a name for the said relationship between the two persons, a relationship which is referred to with “financial liability” and “debt” when seen from one side, and with “financial asset” when seen from the other side. What should that name be? (Example: We have the name “transaction” to describe the whole which is formed by “purchases” on one hand, and “sales” on the other.)

          I would personally suggest that we solve this problem by stating that “Debt is one person’s financial liability and another person’s financial asset”, and therefore one person’s debt is *not* another person’s financial asset.

          How does this sound?

          Note that there is an important point hiddden in “Debt is one person’s financial liability and another person’s financial asset”: there are two different persons. If we trace everything back to natural persons / households (like DvD, in my opinion correctly, suggests), then this shows how there is no (net) debt in Vinezi’s “Division A and Division B” example. If we have one company holding a claim on another company, but both companies are 100% “equity owned” by exactly the same group of agents (natural/juridical persons) in exactly the same proportions, then there is no (net) debt.

          Vinezi and DvD: You both have a lot of expertise I lack. I’m not into statistics. I’m not into mainstream economics. It is best to consider me a philosopher. Thus, I really appreciate the chance to discuss these things with you, and should you ever feel we could work together, don’t hesitate to contact me. Oh, and DvD: What you say about the banking system and “deposits” might be slightly confused thinking. (Been there, done that.) You might want to check my blog post about the “Bookkeeping View”, and the couple of posts I’ve written after that. It’s a view that has been formed during the last 18 months. It took a lot of confused thinking around “deposits” — almost 24/7.

        • ^DvD WROTE: “As an aside, all these discussions would be greatly facilitated – but not necessarily satisfactorily solved – if countries reported their Gross Domestic Balance Sheet (GDBS) in addition to their Gross Domestic Product (GDP)…”
          ————————————————–

          But they do publish their Gross Domestic Balance Sheets (GDBS).

          (1) All countries publish their NIIP (book value)
          https://en.wikipedia.org/wiki/Net_international_investment_position
          (2) All countries publish their Capital Stock (book value) estimates
          (3) Net-worth (book value) on Balance Sheet of a particular country = Its Capital Stock + Its NIIP
          (4) Summed over the world (closed economy), Global Net-worth = Global Capital Stock, because NIIP summed across all countries MUST equal zero for the world as a whole.

          Were you looking for something else? Have I misunderstood you?

    • ^DvD WROTE: “….it seems to me that:
      (I) –IF– savings arise out of income (Savings = Income – Consumption) and are redeployed into income (Savings = Investment) via the debt or equity financing of those who have excess of investment ideas over savings by those who have excess of savings over investment ideas
      (II) –ANDIF– global debt has increased much faster than global production and income over the last 35 years (from ~ 100% to ~ 320%) in the closed system that is the global economy,
      (III) –THEN– it MUST mean that either global consumption share of global production has decreased –AND/OR– that global net worth has decreased relative to global production. In other words, system solvency has decreased. Which is where we meet Minsky again.”
      ————————————————

      Interesting points, you make. However, when you say X MUST have increased –OR– Y MUST have decreased, why didn’t you just look at the data to see if which of the two actually happened? This is an interesting issue that reveals a few points of importance.

      To save space on Michael’s blog, I have put up a few observations on googles document drive and you can see it here:
      https://goo.gl/lWGJL5

      Let me know your counter-views.

  30. You are obviously a very polite person. I am less so so I will be blunt: Steve Keen’s model is awful. He has no idea of the most fundamental accounting entities but tries to use them in his work.
    I don’t doubt that Keen is intelligent but his model is the work of a dull 15 year trying to look smart. He also wont debate his work which I find to be a very suspect quality.

    • Dani Rodrik has a new book out “Economic Rules” and here is his discussion

      • Actually above is not completely on Rodrik’s book, but very useful for understanding the trajectory of Int Development, in many ways, Rodrik is quite good on these matters
        (which means we share the same intuitions), but his book discussion is here, which is surprisingly useful, and the discussions provides a more balanced birdseye view of Math and Models in Economics, which conversationally walks across the theories of theory more generally, i found it amusing

        Economics Rules: the rights and wrongs of the dismal science

      • You all about dat Rodrik tho.

        • My interest is Development.
          Michael’s perspective has enriched my wide-ranging study; in addition to commentators.

          Rodrik’s intuitions and my own, are very similar insofar as to the international system, the trajectory of global development and similar.

          Those two video’s are very useful if one is interested in a longer term system view.
          His Globalization Paradox is worth a review.

          He is quite good, frankly.

        • Below is one reason that I believe that China’s impact has been detrimental to the global development trajectory, and that concerns in East Asia over dependency are over-stated (and why Rodrik is worth reviewing, while he may not share my perspective, I believe he supports it).

          http://www.eastasiaforum.org/2015/10/07/the-structural-regression-of-malaysian-manufacturing/

          All developing countries are impacted of the hand of the Chinese State in driving the economy of China.
          ASEAN signed a Free Trade agreement with China, not of China’s rise, but because they feared loosing manufacturing that fed inputs into the supply chains of MNC’s where China has still tried to do everything it could to make occur. China not merely building ghost cities or excessive infrastructure, but using the power of the state, to create industrial clusters, endeavors to displace external suppliers of inputs via policies to support domestic producers, to promote “indigenous innovation”, climb the value chain, and so forth. This is no mere organic process but one driven by the state who can direct resources to industries, provide monopolies to chosen champions and which provides heft unabled to be matched by other peer developers regarding financial and trade promotion incentives, export rebates, low-cost loans and similar policies.

          East Asian trade links into China are largely in raw materials or intermediate goods.
          Commodities, even higher value added refinement of raw materials, rarely provide significant employment or advance in the technological capabilities in these developing nations.
          Intermediate good production usually end in assembly facilities in China that may have been in Malaysia, or Indonesia, or Thailand previously, thus deindustrialization as in the discussion above (Thai transmissions in Japanese factories for cars sold in China)

          This premature industrialization discussed by Rodrik, limits the potential of the world to develop; from India to Africa. This process of centralization upon China, supported by domestic and international constituencies, delimits the potential of global trade to encourage a broad based global development; much as the excess storing of FX reserves, growing inequality between workers and capital, and the trade diversionary policies of those who benefit from participating in a “freer” global market, consistent of institutions to promote free trade.

          This will end, as Rodrik notes, in premature deindustrialization and protectionism, while we see protectionism rise, as Michael has noted.

          There is now a strong disconnect between the assumptions of previous era’s for promoting free trade, against the background of this state intervention that delimits global development, as the political assumptions, of the likes of Larry Diamond, prove false of accommodation and understanding of China’s path, in respect to the grave miscalculation of it’s impact on the global economy which has been gravely “distortionary”.

          The calculation on China has always been that its demand could further global growth, and people seek support of this wherever they can, even as domestic consumption remains such a low proportion of domestic GDP; where is should be assumed that China cannot continue to lay as much cement as the US did in the 20th century, every 2 years to fulfill the fantasies of lessor “knowledged” pundits globally.

          • Yo Csteven,

            This is a book I’m ~40% of the way through, and it’s dirty. I think it’s something you’d be interested in. It’s basically how geopolitical constraints, control of lines of supply, and control of trade routes/networks affected economic development, the development of financial systems, and the problems of empire over the past 1000 years.
            http://www.amazon.com/Power-Plenty-Millennium-Princeton-Economic/dp/0691143277/ref=sr_1_1?ie=UTF8&qid=1447355150&sr=8-1&keywords=power+and+plenty

            To put frankly: this book is straight up DIRTY!!!

          • Having read the first bit of The Globalization Paradox, I think Rodrik gives too much leeway and has too many sympathies towards nation-states and national self-determination. In many parts of the world, the organization of peoples into nation-states just doesn’t make sense, especially among tribal peoples. I don’t think national self-determination should triumph worldwide economic/financial objectives. I’m sorry, but if Indonesia or Brazil wants to massive deforestation, that must be stopped. I don’t care what the people of those countries think about it, it’s just a terrible idea where the costs are borne by the world at large.

            With that being said, Rodrik also says that markets have never existed outside of a large state rule, which isn’t quite correct. In the Indian Ocean trade network before the Portuguese went around Africa, there was basically a complete separation between market and state. So what operated the system? Tradition of course. There’s much to the Austrian School view that’s correct. What really changed things was the connection of the East and West by sea. The duties and fees in place were for revenue purposes only in the heyday of the Indian Ocean trade network. The courts would operate separately and the rule of the day was, quite literally, free trade. This is discussed in Power and Plenty.

            Of course, the monsoon winds were a huge integrative factor in the trade network. Also note how all of those societies all have lunar calendars as opposed to the Julian (or Gregorian) calendars of the Christian world.

            On another note, have you read any of Raghuram Rajan’s work? It’s very similar to the kinds of things we discuss on here and what’s discussed by Rodrik. His track record is one of the best in the world on these issues too.

  31. The bridge analogy is interesting.

    It was Vinezi Karim who highlighted some time ago on this forum the similarities between the alternating boom and bust phases of the economy and financial markets and an oscillator under amplifying force in physics. He showed us a chart of the amplified oscillator pattern and it was indeed striking how the charts of the S&P500 or the MSCI All-Country World look exactly identical to this pattern.

    Since then, I have this image of the global economy being a sort of badly designed Tacoma Narrows Bridge oscillating back and forth between ever stronger booms and ever deeper busts, with the amplifying and destabilizing force being rising debt load.

    The same policymakers who have designed this faulty system are desperately trying to avoid the fatal break and to stabilize the system by blowing the monetary creation wind ever stronger to counteract the ever stronger monetary contraction wind that is itself the result of the unsustainable monetary creation wind they blew in the preceding cycle. And so on so forth. Of course, this is totally vain on the part of policymakers because all other agents recognize that the bridge is poorly performing and unstable from a too large debt load and therefore increase their cash balances out of precaution, thereby feeding the monetary contraction. And so on so forth. While financial markets have been conditioned in the “don’t fight the central bank” imperative, the entire real economy is, collectively, “fighting the central banks”, as shown by the declining velocity of money almost everywhere. If the structural design of the bridge is not corrected (and there is no sign that it is nor that there is any genuine intention to do so or any genuine “courage to act”), it is easy to predict who of the few hundreds of policymakers or of the few billions of real economic agents will ultimately win that battle. Of course, policymakers can go on for quite some time to the very end of their logic (and all the signs are that they will), which is to continuously absorb the permanent excess of supply over demand in exchange for newly issued money so as to permanently avoid a decline in the general price level, so that central banks will eventually, after several decades of that mechanism, end up owning the entire asset base of the economy, also known as collectivization. That’s what the expression “central bank asset purchases” mean, in so many words. I haven’t read Adair Turner’s book but it seems to me that the price to pay for producing “permanent increases in nominal demand” via permanent “government fiat money creation” in a situation of permanent excess supply is the permanent transfer of assets into central banks hands, ie. in government hands. Collectivization, I think, is the essence of permanent quantitative easing in this situation of permanent excess supply. Why is this a problem? Because history has shown that this entails a small risk to economic and political freedom. In that sense, Between Debt and the Devil is a perfectly appropriate title, though may be not in the sense intended by Adair Turner. Of course, if policymakers would only care to resolve the large and persistent international trade and monetary imbalances that result in global excess supply (instead of secretly negotiating free trade agreements right in the middle of raging currency wars between the very currencies in which such trade will be settled), we would not be forced to be in this rather unpleasant situation, between debt and the devil.

    In conclusion, there is no reason to despair about the free economic system. It is not intrinsically faulty. There are only reasons to despair about policymakers whose design model for the economy requires that 2 + 3 = 7 and who therefore put in place inadequate institutions that lead to grave distortions. Getting rid of them is a necessary, though insufficient, condition for peacefully resolving the large and persistent international trade and monetary imbalances that are at the core of the slowing real economic growth trend and rising debt load. This is why political volatility will rise as well as economic and financial volatility.

    • DVD
      Agree, perhaps far more easily aid than done, where a disruption will force the hand, which is what I have thought for more than a decade, implying the system is far more flexible than imagined, to point.

      Have you read the Mehrling book Michael and others discuss, it is listed by Princeton for free download, here:
      http://press.princeton.edu/class_use/courses/mehrling/

      On that matter, Michael, have you thought of a MOOC yet?

      • I’ve been advocating for Prof. Pettis to post lectures (or MOOCs or whatever else that’s similar) for a good minute.

        BTW, Mehrling’s book is excellent. I’m almost done (I’ve got the last chapter and the conclusion left, which will take basically no time and I’ll probably finish it by tomorrow). Mehrling’s Coursera class is pretty sick, although there certainly are things in the book that I felt like he didn’t cover in the class.

        He’s a really bright guy that not only have a high degree of respect for, but someone who I feel it would be foolish for anyone to not take seriously. He’s absolutely, downright brilliant. He’s one of the very best we have and his understanding of the American monetary and financial system is definitely one of the very best. I honestly think he may be THE #1 guy on American finance today (that I know of).

        • I third the MOOC/lectures request. Without it, I may be too tempted to sneak into one of his classes/seminars on my upcoming Beijing trip.

          • Thanks, Deek, I have thought about doing something like that but the difficulty of broadcasting potentially sensitive views in China and, more importantly, the extent to which all this advanced communications technology can throw me into confusion has so far prevented anything from happening. At some point however I do plan to jump on to the MOOC train.

          • Michael, if do decide to MOOC, let me know and I can introduce some local motion graphics people who can help if you need to do some charts and things on video

      • Thank you. No, haven’t read Mehrling. Will try to find the time.

        Just finished Jacques Rueff “Balance of payments: proposals for the resolution of the most pressing world economic problem of our time”. This was published in 1965.

        The problem was “solved” by Nixon 6 years later in a way that … has made it the most pressing world economic problem of the past 35 years …, which Bernanke & co has had the courage to solve post 2008 in a way that … makes it the even more most pressing world economic problem of today.

        Plus ça change…

    • ^DvD WROTE: “Of course, policymakers can go on for quite some time to the very end of their logic (and all the signs are that they will), which is to continuously absorb the permanent excess of supply over demand in exchange for newly issued money so as to permanently avoid a decline in the general price level, so that central banks will eventually, after several decades of that mechanism, end up owning the entire asset base of the economy, also known as collectivization. That’s what the expression “central bank asset purchases” mean, in so many words. I haven’t read Adair Turner’s book but it seems to me that the price to pay for producing “permanent increases in nominal demand” via permanent “government fiat money creation” in a situation of permanent excess supply is the permanent transfer of assets into central banks hands, ie. in government hands. Collectivization, I think, is the essence of permanent quantitative easing in this situation of permanent excess supply. Why is this a problem? Because history has shown that this entails a small risk to economic and political freedom.”
      ———————————————————

      (1) When Adair Turner speaks of creating “permanent increases in nominal demand via permanent government fiat money creation”, he is saying that the government must issues NEW bonds and that the central bank must print NEW money (liability to central bank on RHS of its balance-sheet) to purchase (or swap with) these NEW bonds and hold them as NEW assets on the LHS of its balance-sheet. In other words, what the Right Honorable Lord Turner wants is merely text-book “money printing” finance of a permanent government deficit. Now we know why Turner carries the title of ‘LORD’, even though what he is suggesting is neither Right nor Honorable.

      (2) There is no “collectivization” involved in the sense of the central bank purchasing private assets. The central bank will ONLY be purchasing government bonds. As the central bank prints more NEW money, the government will print more NEW bonds; as the government prints more NEW bonds, the central bank will print more NEW money. This is merely a tango between the Devil and the Deep Blue Sea.

      (3) Therefore, the “essence of permanent quantitative easing in this situation of permanent excess supply” is NOT “collectivization”, in the sense of state-ownership of private assets, but simply an ever-rising government debt-load.
      https://research.stlouisfed.org/fred2/series/DEBTTLJPA188A
      https://research.stlouisfed.org/fred2/series/GGGDTAJPA188N

      NOTES: (a) The central bank cannot purchase your house (i.e. private asset) using printed money, UNLESS the government explicitly gives it special permission to do so.
      (b) Even if the government gives it that permission under extra-ordinary circumstances and it prints money to purchase your house, in reality all this means is that the government is guaranteeing (‘co-signer’) the value of your house on the LHS of the central bank’s balance sheet. Therefore, this is simply government debt (contingent) by other means (‘off-book’).
      (c) The correct, transparent and upfront way of doing this private-asset purchase operation is as follows: The government prints NEW bonds (i.e. records an increase in its debt) and hands them over to the central bank. The central bank prints NEW money and hands it to the government in exchange for the NEW bonds. The government then hands that freshly-printed money to you and takes the title to your house.
      (d) Note carefully that (b) & (c) are actually the same in essence; it is just that (b) is indirectly implicit (smoke & mirrors), whereas (c) is directly explicit (clear & transparent).

      Do you disagree? Let me know of your counter-thoughts.

      • V.K. wrote: “(1) When Adair Turner speaks of creating “permanent increases in nominal demand via permanent government fiat money creation””
        ——————————————————————————

        What is a “permanent increase in nominal demand”? I can guess what Turner means by it, but I don’t find it in my own model of the economy. To me it seems he thinks in terms of the Quantity Theory and assumes constant “velocity”. And not only that, but he assumes that the “money stock” will be permanently increased by his beloved “overt monetary finance”, so that the “money stock” doesn’t diminish in the future. Am I right?

        Thus, what he really means must be that there is a permanent increase in “base money”. But this is not the same as “nominal demand”. If a bank “creates money” when I buy something “using credit”, there is some connection between “nominal demand” (my buying) and “new money”. But to suggest that this growth in nominal demand wasn’t permament because the “new money” will later be destroyed is plainly wrong. When the “new money” later will be destroyed, it happens because someone buys (creating nominal demand, again) something from me, so that I am able to ask the bank to destroy the “money”.

        This confusion might also have to do with how Turner views “purchasing power”, which he conflates with “money”. Again, this is a way of thinking I had to abandon some time ago.

        It might be that I’m confused, but even if it’s that, I blame the poor language we all are forced to use if we want to discuss this at all. (In other words, I don’t feel confused when it comes to what is going on in the real economy.) In this regard, I warmly welcome Vinezi’s efforts to bring clarity into these matters! Thank you.

      • What I mean is that if excess supply is covered by issuance of new government bonds (because private debt capacity is saturated, i.e. there is no appetite to borrow and / or to lend) while the central bank creates new means of payment to make room for this new public debt issuance, then clearly the central bank is amassing financial assets that are contingent claims on real assets.

        If excess supply is temporary, then at some point the (dated) financial assets owned by the central bank will redeem and there would be no change in the ownership of real assets.

        If, however, excess supply becomes permanent and is permanently covered by new public debt issuance with the central bank permanently creating new means of payment, then what happens?

        One thing that could happen is that the inflation of new means of payment trigger inflation in the price of goods and services so as to erode or even wipe out the value of public debt in real terms. Economically, this is a transfer of value from the rest of the economy to the government.

        But if the inflation of new means of payment does not trigger inflation in the price of goods and services but in asset markets, then what might happen?

        One thing that could happen is that government debt securities carry negative interest rates. This is a transfer of value from the rest of the economy to the government.

        Another thing that could happen is that taxes are raised to generate the resources for the government to service its rising debt load. This is a transfer of value from the rest of the economy to the government.

        Look what’s happening in Japan. Having started down this path 15 years before others, the BoJ now owns assets worth about 80% of nominal GDP (that’s on top of assets owned by other entities of the Japanese State). Extrapolating the exponential pace at which the BoJ monetizes vs. the flattish trend observed so far in nominal GDP, it will take less than another 15 years for it to own the entire capital base of Japan. That’s what I mean when I say “policymakers can go on for quite some time to the very end of their logic”.

        Said differently, the guarantors of the system are not providing the guarantee for free but, one way or anther, against the collateral that is system assets.

        • DvD, could you clarify a couple of things:

          You write: “If, however, excess supply becomes permanent and is permanently covered by new public debt issuance with the central bank permanently creating new means of payment, then what happens?”

          Do you assume that total supply is given, so that this increased public demand doesn’t create its own supply but only absorbs excess supply? Excess Supply = Total Supply – Private Demand – “Tax-Funded” Public Demand —- assuming full employment? Or, if we assume non-full employment, then Excess Supply = *Potential* Total Supply – Private Demand – “Tax-Funded” Public Demand? Or should we factor in some “normal” level of Public Deficit? ——- I have my problems with this view, but I assume this is how most economists view things?

          You write: “This is a transfer of value from the rest of the economy to the government.”

          I know you know that there are problems connected with the “government vs. rest of the economy” dichotomy. Could I re-write your sentence like this: “”This is a transfer of value from certain creditors to certain debtors”? It must be natural persons who, in the end, gain and lose value?

          From your earlier comment on global debt and its effects on the future, I gather that you and I view debt much in the same way. Knowing that your conclusions probably don’t need to change dramatically as a consequence, could you consider abandoning thinking of “money” as a “means of payment”? It might sound radical, but I have personally found it very beneficial when it comes to understanding debt. See my answer to Vinezi here: http://blog.mpettis.com/2015/10/how-to-spend-thin-airs-endogenous-money/#comment-149650

          Related to this, I don’t understand what the CB creating “new means of payment” has to do with public spending. Those credit balances at the CB, when they are created by the CB buying government bonds, are themselves (indirect) public debt. And, as I try to explain, we should not view them as “means of payment”, no more than we view government bonds as “means of payment”. As you see, this is about the unsolved argument about what is “money” and what is not — my answer: nothing is, if “money” is supposed to be a “means of payment”. This is a central tenet of the Bookkeeping View I have adopted. In case you wonder: I have no trouble explaining inflation using the language I’ve adopted, so I’m not asking for a giant leap; many think that I’m not really saying anything new, most of the time.

          • Peter,

            On the issue of permanent excess supply, this is what I mean:

            If supply is higher than demand globally and policymakers have determined that it is not a good idea to let price drop to equalize supply and demand, then global debt has to rise to equalize demand with supply. Let’s say that private debt capacity is essentially saturated because this situation of excess supply has been going on for quite some time. Therefore, it is global government debt that rises. Let’s also say that, to avoid upward pressure on interest rates, this increased government debt is funded by newly created money. You recognize of course the situation in which we currently find ourselves. Let’s now say the new purchasing power thus created is distributed among less fortunate households under the form of various benefits in developed countries where a welfare state system exists. Let’s say these developed countries households spend this extra income on goods manufactured in developing countries since those are cheaper at the prevailing exchange rates than equivalent goods manufactured domestically. Say developing countries companies, seeing this extra demand for their products coming from developed countries, conclude that they have to increase capacity to accommodate this rising demand, such investment appearing all the more profitable that it can be funded cheaply since interest rates are suppressed by new monetary creation. Thus, global supply will grow. Of course, the expanding companies in developing countries will hire more people directly and indirectly to make the additional equipment they have ordered and to staff their expanded facilities and so salary income, hence demand, will also grow. But if we say that the sales price in developed countries of the new supply of goods made in developing countries is a fraction of the price of equivalent goods produced in developed countries but that this fraction is higher than the fraction represented by the salary level in developing countries versus the cost of living in developed countries, then we see that global supply has grown by more than global demand in value terms. So supply is again higher than demand globally. Another iteration is therefore necessary to balance the system. And so on so forth, so that this unbalanced regime becomes effectively permanent.

            On the issue of the transfer of value from the rest of the economy to the government that such unbalanced regime necessarily implies:

            Yes, of course, this is just a particular case of a more general transfer of value from certain creditors to certain debtors. But since we are placing ourselves here in the scenario where the debtor of last resort is the government because private debt capacity is assumed to be saturated and that only the government has the ability to create new money because we are assuming no appetite to lend from commercial banks, then we can say that it is in this specific case a transfer of value from the rest of the economy to the government.

            On the issue of “money” being “means of payment”:

            It is simply more concrete, hence easier, for me to think of money as “means of payment”. As I understand it, it is compatible with your debit / credit book keeping view.

            On the issue of what new central bank money creation has to do with public spending:

            – Public spending could be financed by taxation in absence of any new money creation, in which case it will simply substitute spending that may have been done by other agents.
            – Public spending could be financed by government debt issuance in absence of any new money creation, in which case it will mobilize savings of other agents, either domestic and / or foreign if non-domestic investors (including foreign central banks) subscribe to the issue.
            – Public spending could be financed by money creation by commercial banks, either domestic and / or foreign, if such banks would simply open an account in the name of the government and credit this account with an amount of loan granted to the government.
            – Public spending could be financed by money creation by the domestic central bank directly.
            – Public spending could in fact be financed by any combination of the above. It is just that, in our example, we have assumed that the first three sources are exhausted because the first one would not increase aggregate spending in the domestic economy, the second one would put upward pressure on interest rates and the third one would put banks ratios under too much pressure.

        • DvD, I have touched this subject in an earlier blog post: http://clumsystatements.blogspot.com/2015/10/helicopter-money-as-i-see-it.html

          I conclude regarding Turner’s “overt monetary finance”:

          “First, we cannot say that OMF can be used to “finance” certain productive investments by the government. Any attempt at “ear-marking” would be just an exercise in illusion. OMF will be an inseparable part of the overall government budget, and will thus “finance” in equal proportion all the consumption and investment that may arise from government spending — also the wasteful activities. We are all imperfect, and the government doesn’t make an exception here. Further, we should expect that any easily identifiable productive investments are already made by the government. In any case, our ability to undertake them should have nothing directly to do with OMF.

          Secondly, and more importantly, it makes very little sense to say that OMF can finance anything at all. The whole point with OMF is that part of government spending will never be financed in any meaningful sense of the word. That a person of a very high intellectual capability can claim that OMF (yes, the F stands for ‘Finance’) can be used to finance government spending shows mainly how horrible is the state of our economic vocabulary. “Overt Monetary Fooling/Faking/Failure” would, to me, sound more descriptive. Unfortunately, sloppy language often corresponds with sloppy thinking, and even Mr Turner doesn’t seem to be able to fully escape this trap.”

          I don’t want to push my view on you, but it would be nice to hear if you have an idea of what I’m talking about. You and I seem to draw similar conclusions from all this, despite the fact that we view the monetary/financial system in a different way (which is no surprise, as I believe I have come up with a fairly novel way to view it).

    • ^DvD WROTE: “….increase their cash balances out of precaution, thereby feeding the monetary contraction.”
      ————————————————

      “….increase their cash balances out of precaution, thereby feeding the VELOCITY contraction.”

      Going into cash, or holding more cash, or hoarding liquidity, or hoarding debt-claims, leads to a decrease in the VELOCITY of circulation. This means that the intensity of activity on the RHS of consolidated balance-sheet of the entire banking system (or frequency with which entities come into and go from the RHS of said balance-sheet) is reduced. This fall in intensity of activity is represented by a shrinking of the *WIDTH* of the consolidated balance-sheet of the entire banking system.
      https://research.stlouisfed.org/fred2/graph/?g=240Y

      ‘Monetary contraction’, on the other hand, implies a shrinking of the *LENGTH* of the consolidated balance-sheet of the entire banking system. This is achieved via a reduction in the total amount of debt or money and is associated with the paying back of debt (‘deleveraging’) and not with the hoarding of debt-claims.
      https://research.stlouisfed.org/fred2/graph/?g=2ixq

      Have I misunderstood you? Let me know your thoughts.

  32. Question to the readers:

    It looks like liquidity is now flowing into residential RE in 1st tier City. It has been exploding upwards, including rents. This will probably cause another feedback loop, money will be sucked out of the stock market and other areas and cause farther increase in residential RE in 1st tier cities.

    My question is, what can cause the liquidity to get sucked out of this market? Would it be correct to say that this is similar to how the market reacted both in Japan and the U.S. just before the “cut off date”?

    Thanks!

  33. The MMT folks are “off the deep end”.
    https://en.wikipedia.org/wiki/Modern_monetary_theory

    – The MMT nutcases confuse “solvency” with “liquidity”. A government/central bank can help out with liquidity problems but can’t help out when there’s a “Solvency” problem.
    – Each (monetary) action has consequences. Monetizing debt, creating more debt or (literally) printing money DO have REAL consequences. It simply creates one or more types of inflation and weakens the currency.
    If a central bank is monetizing government debt then the central bank still has to pay interest and principal (when the government loan matures) and that has to come out of tax revenues. Literally “printing money” (banknotes) leads to Hyper-Inflation (think: Weimar Germany).
    – And it’s the Households & Workers that have to bear the brunt of a currency weakening. A good example is Weimar Germany. Before the german central bank stopped (literally) printing bank notes in november of 1923, there were riots & (general) strikes in Germany.

    No, the debt surge wasn’t mischaracterized as “The Great Moderation”. The “Great Moderation” was the result of “Moderate Wage Growth” & falling interest rates from 1980 onwards. If there hadn’t been falling interest rates then we would already have seen the “Great Deflation” in the 1980s. Those falling interest rates facilitated the debt surge since the early 1980s.

    – In the early 1920s the US demanded that Europe should repay its war debts but the US didn’t want to allow Europe to export to the US. It was the same story as with France & Germany in the same early 1920s.

    – How detrimental “creating money out of thin air” is, can be seen in Australia. China went on a credit binge after 2008. It helped to keep commodity prices high and australian mining investments high. But those increased australian investments has led to over-investment. And that over-investment now has started to haunt Australia in the form of FALLING commodity prices. And NOW those falling commodity prices is (one of) the reason(s) that the australian real estate bubble is in the first stage of deflating. One of the red hot real estate markets in Australia (Sydney) is now seeing the first signs of FALLING real estate prices.
    – In the australian coal mining town of Moranbah (Queensland) home prices already have seen a sharp drop. One house that was worth AUD 800,000, in 2011 was only worth 200,000 in late 2014. This drop in home prices followed the drop in price for australian coal. Ouch. This is how the (supposedly) “good deflation” WILL turn into “Bad deflation” (=credit contraction).

    • – I must improve my previous reply. I should have written:

      “One house that was worth AUD 800,000 (in 2011), went down to AUD 200,000 in late 2014.”

    • There were riots and strikes in Germany right after World War I too.

      Australia is going down the deep end. There’s trouble in sight for places like Australia and Canada, which I wrote about >1 year ago. This is basically what I said would happen.
      http://suvysthoughts.blogspot.com/2014/09/economicsfinancial-consequences-of.html

      “The reason I bring up countries like Australia and Canada is because of the global mining boom that’s been happening. In my economic and geopolitical posts on China, I speak about how China has effectively been driving the market for commodities–particularly industrial commodities like iron ore, tin, copper, and a whole host of other metals. These raw materials are being exported from countries like Brazil, Russia, South Africa, Australia, and Canada. As China becomes forced to rebalance its economy and growth rates start to fall (as they already have), the worldwide demand for industrial commodities will fall. Iron ore prices already peaked at around $190/dry metric ton and iron ore is currently trading at around $100/dry metric ton.

      This brings us to the next question: what are the consequences of falling commodity prices on these particular countries? As the prices of commodities falls, the demand to hold currencies of countries who export commodities will fall. In other words, we’re likely to see the currencies of these countries (Brazil, Russia, Australia, Canada, etc.) fall in terms of foreign exchange (FX). Not only are the currencies of these countries likely to fall, but these countries are also likely to experience decreases in production stemming from a world with falling aggregate demand and falling production. So the countries in question (Australia, Russia, Canada, Brazil, and South Africa) will see input cost inflation stemming from their falling currencies while simultaneously seeing falling output and rising unemployment.

      Keep in mind that many of these countries (ex. Australia, Canada) have large asset bubbles stemming from capital inflows and their currency strength over the past decade or so. These countries will have to deal with falling production and falling currencies while their asset bubbles would be bursting. On the plus side; however, Australia and Canada will experience inflation that could help prevent the real debt burden (debt/NGDP ratio) from ballooning.”

      • – Falling/Rising currencies are also a function of interest rate differences between countries. Rates in the US & Europe are low while rates in e.g. Australia & Brazil are (much) higher. In good times investors are willing to buy higher yielding fixed income paper. And that was ONE reason why e.g. from 2009 onwards (especially) the USD went lower against a whole range of currencies.
        – One also has to keep in mind that falling commodity prices (priced in USD around the globe) automatically lead to a rising USD. When one is “long” commodities then one is automatically “short” the USD.
        – In 2009 & 2010 Australia & Canada have stimulated their economies by subsidizing mortgages more. That was an additional reason for those real estate bubbles to form & continue.
        – Nope. Australia & Canada WILL experience DEFLATION. As a result of falling commodity prices A LOT OF investments have been canceled. Resulting in rising unemployment. less spending, less demand and more defaults. And that WILL lead to a Credit Deflation in the (very) near (not distant) future. Rising price inflation (e.g. gasoline) actually will increase the deflationary forces. What do you mean Inflation ?
        – Oil priced in AUD & CAD actually has gone down in 2014. What do you mean inflation ? And that’s precisely one more reason why the canadian “oilpatch” is suffering so much.
        – Nope. In Australia & Canada commodity prices have fallen more than interest rates ==> rising REAL interest rates. I have read stories of workers who were laid off and earned wages of $ 100,000, $ 200,000 and more. When such a worker loses his/her job then it doesn’t help that gasoline prices have fallen. He/She simply can’t afford it anymore.
        – Falling commodity prices are actually bad for the US financial system as a whole. It means that, assuming import volumes remain flat, that the CA deficit shrinks and with it the “Exorbitant Privilege/Burden” shrinks. Just imagine what would happen to the CA deficit when also import volumes shrink (like in the 2nd half of 2008).

        Remember the title of one of Mr. Pettis’ books (“Global Rebalancing”) ???

        In that regard, falling commodity prices are ONE (vastly overlooked, IMO) component that will bring about that “Rebalancing”, both abroad and here at home.

      • I don’t think currencies are entirely built on interest rate differentials. In the case of Australia and Brazil, they’re both heavy commodity exporters in a time when commodity prices are being crushed. It’s no surprise they’re facing stagflationary effects.

        Australia and Canada are not experiencing deflation and probably won’t. Deflation comes from rising production relative to consumption. When you have heavy commodity exporters, production falls which places downward pressure on the currency, which increases input costs.

        “Australia & Canada WILL experience DEFLATION. As a result of falling commodity prices A LOT OF investments have been canceled.”

        Okay, so you’re seeing falling production while consumption isn’t falling as much and while the currency is falling. A falling currency increases input costs while falling production certainly increases inflationary effects (assuming inflation is measured by CPI). Let me ask you this: have YOU read The Great Rebalancing? And more importantly, have you read The Volatility Machine?

        “Falling commodity prices are actually bad for the US financial system as a whole.”

        They’re bad for the US FINANCIAL MARKETS, but not for the financial system and certainly not for the real economy. They’re actually quite good for households. I go shopping here and get gas as well. My bills have dropped quite a bit.

        Keep in mind that a current account deficit necessarily means the country is a net debtor. If the current account deficit declines, it becomes easier for the country to deleverage because it’s becoming less of a debtor (and thus more of a creditor).

      • – In the 1920s there was also (supposedly) “good” deflation. I.e. production (capacity) rose faster than demand. But that rising production was on the back of rising debt levels. And that rising production led eventually to overcapacity/-production & falling prices. And that debt bubble deflated in the 1930s. (Did I use the words “Woodrow Wilson” here ??)
        Same story for australian iron ore, canadian & US (shale) oil production today.
        – No. A falling currency does not necessarily lead to higher input costs. A US exporter to say Australia has a choice: Increase prices (think; rising USD/AUD) and lose market share or leave prices (in AUD) flat and retain market share but also lower profits. If I were an exporter then I would choose to leave prices flat and retain market share in Australia.
        – Even if\when e.g. australian & canadian consumers would experience price inflation (as a result of a falling currency) then it will make servicing debts much more difficult and that means more (credit) deflation.
        – Just look what happened to Brazil: falling currency (rising price inflation) & rising rates (rising cost for credit). Two reason why brazilian companies & consumers have a much harder time servicing their debtloads. In other words, Brazil sees 2 inflationary forces that actually increases the (Credit-) DEFLATION.
        – Yes, I did read “The Great Rebalancing” & “The Volatility Machine”. (Excellent books btw). Those books only confirmed what I wrote above about the relationship between falling commodity prices & the shrinking CA deficit and being detrimental for the US financial system. But households & financial markets are part of that “Financial system”, remember ?
        – The situation is actually much worse than one thinks. Because the combination of falling commodity prices (think CA deficit) and a US budget deficit that’s rising (again) is actually EXTREMELY detrimental for the US. (source: “SuperImperialism”, Michael Hudson.)
        – Deleveraging = (Credit) Deflation. So, if the CA deficit shrinks the US will deleverage and experience deflation.
        – And, as said before, in deflation REAL interest rates rise/go through the roof.

        • “And that rising production led eventually to overcapacity/-production & falling prices. And that debt bubble deflated in the 1930s.”

          The 1930’s were an aberration in American history. The norm was usually a consumption fueled boom through the entire 19th century. In a consumption driven economy (this DOES NOT apply after World War I), deflation doesn’t result in debt deflation and a collapse in capacity. In fact, after the recessionary periods in the 19th century, even the “severe” ones, consumption always went up. Often times, the consumption increase was quite remarkable. Throughout the entire 19th century, excluding the Civil War, the US experienced significant, and usually sustained, deflation.

          The deflation in the 20’s was resultant from a poor monetary policy where the worldwide policymakers tried to return to pre-war parity for gold convertibility. It led to a speculative boom where the US became the world’s creditor, probably the largest in the history of the world at the time.

          Also note that before the creation of the Federal Reserve, interest rates and the money supply would usually shift within the agricultural cycles. The policy by the Federal Reserve basically stabilized interest rates instead of having volatility in interest rates. So a large reason for the excess capacity was that the stability in interest rates led to large-scale borrowing by small farmers without bankruptcies occurring in a seasonal manner due to the fixing of interest rates. This was combined with an explicit policy (pushed by Woodrow Wilson) to provide additional subsidized credit to farmers, particularly small farmers. All of this led to a massive investment boom and excess production by the US, including in agriculture.

          “No. A falling currency does not necessarily lead to higher input costs.”

          Okay, let me rephrase this: assuming prices of input costs stay fixed, a falling currency pushes up input costs. With that being said, Australia is primarily a commodity exporter, so I’m guessing that they use their commodity exports to purchase some sort of industrial or service goods from abroad since the Australian current account is basically zero or close to it. Due to China’s massive overproduction of industrial goods, the demand for commodities, and the price for commodities has gone up through the roof while the prices of industrial goods stay relatively flat because China’s overproducing en masse. This has started to shift, so non-commodity goods/services will, probably relatively soon, begin an upward trajectory sooner rather than later. So Australia’s input costs will not fall while their commodity exports and their currency will.

          How is a shrinking current account deficit bad for the US? A current account deficit implies that your banking system is being a net debtor to the rest of the world. A reversal of the world’s current account balances is necessary for the entire world to deleverage.

          The current account deficit has FALLEN in the US BTW. In 2006, the CAD was 6-7% of GDP, it was 2.4% of GDP in 2014. The estimates for 2015 are below what it was in 2014.

          Also, I wouldn’t cite Michael Hudson’s Super Imperialism if I were you. The guy uses imperialism and is too dumb to even define the word. I read the introduction and the first few chapters and Hudson’s “facts” are straight up wrong dude. He cites Leninism Imperialism as the first use of the theory, but that theory belongs to Charles Arthur Conant. Then, he says that the Civil War was about a democracy supported by the Union populace fighting the evil elites of the South when he’s too stupid to realize that the Union populace (and obviously the Southern populace) was against the war.

          Then, Hudson makes the common mistake of thinking the American Civil War was only about slavery, which isn’t quite right. The primary trade routes for the entire Midwest to ship their goods was the Greater Mississippi trade network and tariffs were a HUGE deal as well. If the war was only about slavery, it would’ve been settled peacefully (like it was everywhere else at the time sans Haiti). Now, if we’re talking about wars over trade networks in the 19th century, that basically explains almost every war in the 19th century.

          “And, as said before, in deflation REAL interest rates rise/go through the roof.”

          They can, but it just depends. If you see a decline in inflation with a rise in real growth where NGDP growth stays constant while nominal interest rates decline due to a fall in inflation, real interest rates may stagnate.

          I’d also argue interest rates relative to inflation are really a stupid, and relatively useless, measurement for several reasons. First off, it assumes we can accurately measure inflation, which we really can’t since the inflation/deflation cycles are really driven by expansions and contractions of money by the banking system. Secondly, and more importantly, interest rates matter relative to NATIONAL INCOME GROWTH more than inflation. Why? Because it’s your growth in income that ultimately warrants your ability to pay off your debts.

      • In reply to this reply:
        http://blog.mpettis.com/2015/10/how-to-spend-thin-airs-endogenous-money/#comment-148562:

        – Falling prices is not equal to (Credit) Deflation. Falling prices are the result of too much production/supply relative (!) to demand.
        – There was (the supposedly) “Good Deflation” in the 1920s. But this “Good Deflation” or the “Great Moderation” (think: Steve Keen) turned into “Bad Deflation” in the 1930s. The same “Great Moderation” happened from 1981 up to 2007 and e.g. before the crash of 1873.

        – In the 1920s, before 1873 and from 1981 up to 2007, there was also Credit Inflation/Rising (Corporate & Household) debt relative to GDP. And that’s why that (supposedly) “Good Inflation”/”Great Moderation” turned into “Bad” Credit Deflation after 1929, 1873 and 2007.

        Remember the words (of Mark Twain ?) : “History doesn’t repeat itself, but it rhymes”. ?

        – The US government ran budget surplusses in the 1920s. That actually was a force that REDUCED total debt to GDP ratio somewhat. Very Keynesian !!

        – Never heard of the crash of 1873 ? And was followed by “Bad” (Credit) Deflation. So, the deflation of the 1930s was NOT an “aberration”.
        http://jared.realizingresonance.com/2011/07/08/the-american-railroads-and-the-panic-of-1873
        http://www.pbs.org/wgbh/americanexperience/features/general-article/grant-panic/

        – No. Monetary/fiscal policy only makes the credit cycles worse. It’s NOT the main cause of credit inflation/deflation. Rising & falling prices are.
        – No. The FED is NOT responsible for stabilizing rates. In spite of all the garbage the media is spouting. E.g. In the crash of 1873 short term rates went down very close to zero even WITHOUT the FED. (The FED was founded in 1913, remember ?).
        – “Okay, let me rephrase this: assuming prices of input costs stay ………… ”
        Lots of nonsense !!!!

        If some non-commodity goods and/or services are becoming too expensive as a result of a falling currency then that production/those services also can/will move back to e.g. Australia, the US or Mexico (e.g. for export to the US). That’s part of the “Great Rebalancing” as well.
        The main point you’re overlooking is that Australia (like e.g. the US & Europe) is up to its eyeballs in debt. And that’s why “Down Under” is very unlikely to experience Inflation of some sort. (Credit) Deflation is the name of the game in the next few years.
        – Hudson: I have very little knowledge regarding US politics in the 19th century. I therefore can’t comment on that topic. One also shouldn’t listen to his left-leaning political talk/ideas. But his economic/financial views (e.g. his book Superimperialism) are, precisely because of his “left leaning”, much much more realistic than all the right wing/corporate talking points.
        – A shrinking CA deficit means that the US is subsidized (think: e.g. military expenses abroad) less by foreigners. Very bad, especially when now the US budget deficit starts to grow again. But only people who are well versed in balance of payment issues (like Michael Hudson) are able to grasp these themes.
        Scattered around the book “SuperImperialism” are a number pieces that combined gave me that insight.
        – Your reply confirms that the US will see more (Credit) Deflation and that a shrinking CA deficit is bad for the US.
        “A current account deficit implies that your banking system is being a net debtor to the rest of the world.”.
        And a shrinking CA deficit makes it more difficult to repay those debts. Credit Deflation !!

        • “The FED is NOT responsible for stabilizing rates. In spite of all the garbage the media is spouting. E.g. In the crash of 1873 short term rates went down very close to zero even WITHOUT the FED. (The FED was founded in 1913, remember ?).”

          Interest rates can’t be stable without a central bank, especially if you’re still on a gold standard because the gold supply determines the interest rates, which varies with the agricultural cycles. I like the theories you come up with, but here’s the facts (which don’t support the theory):
          http://www.ritholtz.com/blog/2011/12/interest-rates-1831-2011/

          “Never heard of the crash of 1873 ? And was followed by “Bad” (Credit) Deflation.”

          The “crash” of 1873 was a “crash” driven by a consumption driven economy running current account deficits, not by an economy with excess capacity.

          “And a shrinking CA deficit makes it more difficult to repay those debts. Credit Deflation !!”

          A shrinking CAD, BY DEFINITION, means that you’re a net creditor on the margin. If you’re going from a debtor to a creditor, you’re must deleverage, by definition. THE ACCOUNTS MUST BALANCE!

          “The US government ran budget surplusses in the 1920s. That actually was a force that REDUCED total debt to GDP ratio somewhat.”

          The money supply was fixed to the gold reserves inside the country, so if you run budget deficits, your banking system loses bank reserves. You can’t compare things to today like that because it’s a different monetary system.

        • Here’s some more basic facts from 1869-1879:
          1. There was an 3%/year INCREASE in the money national product
          2. There was a 6.8%/year INCREASE in the REAL national product
          3. There was a 4.5%/year INCREASE in real product per capita
          4. From the end of the Civil War to 1879, prices FELL by 3.8%/year

          Here’s data the for the Wholesale Price Index, the Consumer Price Index , and wages in 1869, 1879, and 1889 (all of these are indexed with 100 being years 1910-14):
          WPI–1869: 151 1879: 90 1889: 81
          CPI–1869:138 1879: 97 1889: 93
          Wages for Urban Labor–1869: 77 1879: 61 1889: 72
          Wages for Farm Labor–1869: 96 1879: 61 1889:78
          Combined Wages–1869: 87 1879: 61 1889: 75

          So while wages fell in the 70’s by ~20%, CPI fell by ~40%. In the 80’s, CPI fell by ~5% while real wages wages rose by ~15%. Basically, through the 1880’s and 1890’s, real wages rose by ~20%.

          From 1880 to 1900, long term bond yields kept declining steadily. Here’s Railroad Bonds, Commercial Paper, and Call Money during this time period:
          Railroad Bonds–1878: 6.45% 1879: 5.98% 1889: 4.43%
          Commercial Paper–1870-1879: 6.46% 1880-1889: 5.14%
          Call Money–1870-1879: 5.14% 1880-1889: 3.78%

          Here’s GDP and GDP/capita (in $ billions at 1958 prices) for the decade averages during this period:
          GDP–1869-78 average: $23.1 1879-88 average: $42.4 1889-98 average: $49.1
          GDP/capita–1869-78 average: $531 1879-88 average: $774 1889-98 average: $795

          Here’s capital formation during that same period (in $ billions at 1929 prices):
          1872-1876 Average: $2.6
          1877-1881 Average: $3.7
          1882-1886 Average: $4.5
          1887-1891 Average: $5.9

          From 1873-1879, the total supply of bank money ROSE from $1.964 billion to $2.221 billion.

        • Now, let’s take a look at the 1930’s. Look at Figure 4 on this link.
          http://www.chapman.edu/esi/wp/recessions_1929_2007.pdf

          From 1929-1933:
          Consumption fell by ~15%, fixed investment fell by ~70%, housing fell by ~90%, and GDP fell by ~30% while prices fell by ~10-20%.

        • Okay, so you’re comparing the 1870’s to the 1930’s, but that comparison isn’t valid. Here are the facts about the 1870’s.

          From 1869-1879, the money national product INCREASED by 3%/yr.

          Non-farm wages did fall by ~20% from 1869-79, but CPI fell by ~30% while wholesale prices fell by 40%.

          Gross Capital Formation (both public and private) in 1929 prices:
          1872-76 Average: $2.6 billion
          1877-81 Average: $3.7 billion
          1882-86 Average: $4.5 billion

          From 1929-33, investment fell by 90%, non-durable consumption fell 10%, nominal output fell by 50%, and real GDP fell by 30-35%. It took 8 years for output to reach where it was in 1929 and it took over a decade for a sustained recovery to take place

        • The US is the world’s reserve currency, so it doesn’t need foreign financing of its current account deficit. It operates in the other direction with other countries having to accumulate dollars to make payments.

          In the Panic of 1873, there was simply a healthy market correction. As you clearly take a look at the data, you can see that the real economy did quite well. One of the reasons the American economy had what was probably the highest SUSTAINABLE increase in real wealth, living standards, and quality of life during this highly deflationary period was because of the periodic crashes.

          Why are you assuming that eliminating market crashes or financial crises is good? Financial crises are necessary adjustment mechanisms to built up imbalances. In this sense, financial crises are healthy. As we can clearly see, the 1870’s were a great decade for the American financial system.

          “The main point you’re overlooking is that Australia (like e.g. the US & Europe) is up to its eyeballs in debt.”

          You can be “eyeballs in debt” and experience stagflation-like effects. The AUD will fall and it will increase economic inputs. And yes, there can (and will) be a movement of the production of non-commodity goods, but that’s not gonna happen in the midst of a depression on a large scale. If we’re talking about 20 year trends, then sure, but not in the midst of a once in a century depression where the other half not in depression is about to enter it. Once markets clear, you could be correct.

    • BTW, SOME workers and households benefit from currency weakening–namely labor unions and others (like those who collect social security checks) who have their incomes indexed to inflation. Keynes was right. Very high inflation wipes out both the bourgeoisie and the proletariat by completely overturning the existing basis of society.

  34. @Csteven,

    I’ve kinda flipped my opinion on Robert Kaplan. He really is a well-traveled guy who knows a lot of different things about a lot of different stuff, but his understanding of economics/finance (particularly finance) is poor at best. Alas, therein lies his problem. Other than this, he does provide us a good perspective at which to look at and view the world. His understanding of history along with his connections and interactions with elites are very interesting, to say the least.

    • Kaplan is great for a fluid birds eye view; flowing like a river.
      His writing is tight, easy and amusing.
      A common theme runs through his writing.
      But, Zeihan, might just paint a much more rich and diverse picture.

      Kaplan is knowledgeable, and his thesis’ are generally fairly iron-clad, if lacking in ambition…relationships with elites or otherwise, I would place him as a Liberal Cosmopolitan (Liberal in terms of the enlightenment, and Cosmopolitan, rather than a Classical Laissaez Faire Liberal; so likely popular with New York finance; whose perspectives are so 1990’s)

      With that said, for a broad falcon-eye view across a broad swath of territory in terms of a singular, linear “trend”, his are fairly presented and reported (yet, unambitious). And his books are fun and quick page-turners.

      My only criticism, he should mix his pitch up when doing discussions. Zeihan does this quite well.

  35. >> In the first case, assume that we are in an economy in which there is absolutely no slack. Workers are fully employed, inventories are just high enough to allow businesses to operate normally, factories are working at capacity, and infrastructure is fully utilized.

    >> In the second case, assume the other extreme, in which the economy has a tremendous amount of slack – there are plenty of unemployed workers who have all the skills we might need and can get to work at no cost, factories are operating at well below capacity and they can be mobilized at a flick of the switch, and there is enough unutilized infrastructure to satisfy any increase in economic activity.

    This is one of the most insightful things I’ve ever read about economics. Is there a book somewhere where this is worked out in full? It would make a great book.

    This thing resolves the seemingly eternal argument between those like Krugman who seem to endorse deficit spending under any or all or no conditions, with those who seem to argue against it under the same all or no conditions; it’s been the source of so much politicized economics. It seems really profound to me. It says what has always seemed intuitively obvious to me, and I assume to lots of folks who are not attracted to the polar ends of this argument, that everything depends on how productive the investment by the government is. Very interesting stuff, probably very important stuff too.

    >> Buying an existing asset is often called “investing”, but we can safely ignore its impact

    And yet those purchase amounts always find their way into GDP figures, don’t they? This seems to me connected to the “over-financialization” that has happened in the US. Lots of companies have grown up in the past couple decades whose business is basically to raise money on public equity exchanges and to use it to buy assets of varying quality. It feels to me like those companies are hurting the economy by draining money away from the “real” economy. I wonder if this line of argument leads to a way to expose the fundamental hollowness of what they are doing.

    • ^^Luddy WROTE: “Buying an existing asset is often called “investing”, but we can safely ignore its impact”
      And yet those purchase amounts always find their way into GDP figures, don’t they? This seems to me connected to the “over-financialization” that has happened in the US. Lots of companies have grown up in the past couple decades whose business is basically to raise money on public equity exchanges and to use it to buy assets of varying quality. It feels to me like those companies are hurting the economy by draining money away from the “real” economy. I wonder if this line of argument leads to a way to expose the fundamental hollowness of what they are doing.”
      ———————————————————

      It is not the “purchase amounts” paid by buyers that find their way into GDP figures, it is the CAPITAL GAINS/LOSSES made by the sellers that are added/subtracted into the GDP figures. This is because it is assumed that the seller must have added/destroyed VALUE to the underlying assets since they sold their titles for more/less than for what they bought them previously.

      But is this really ‘investment’? If there are no capital gains/losses, then obviously the answer is no, because it is merely a title to past investment/savings (i.e. existing CAPITAL-STOCK) that is being transferred from one person to another.

      But what if there are capital gains/losses? The answer is still ‘no’, because we are now distinguishing between capital-stock (i.e. book value) and WEALTH-STOCK (i.e. market value). Savings & investment accumulate into the capital-stock. Therefore, if capital-stock is unchanged, then no additional savings/investment have been made. Even if rising/falling market-values (i.e. rising wealth-stock) lead to capital gains/losses for the sellers, there is still no addition to capital-stock and so there is no REAL ‘investment’ that has been made.

      If unsustainable debt is used to finance such purchases of titles to existing capital-stock at higher and higher prices, without any real change in the underlying capital-stock itself (i.e. Market-price/Book-price ratio or the Wealth-stock/Capital-Stock ratio keeps rising), then the GDP number will go up (due to capital gains being ADDED), but the real capital-stock (accumulated savings/investment) underlying those assets will remain the same. This will cause the Capital-Stock/GDP RATIO for the economy as a whole to FALL and make it (falsely) appear that the economy is becoming even more efficient (w.r.t. capital-usage) than it really is, when in actuality it may be merely a valuations-bubble.

      If the unsustainability of the debt then manifests itself, then the whole process may be quickly reversed, with crashing market-valuations leading to cascading capital losses which must be then SUBTRACTED from the GDP number. When this happens, in the reverse process, the capital-stock/GDP ratio will RISE once again, thereby (falsely) suggesting that the economy has suddenly become more inefficient (w.r.t. capital-usage), when in reality it is merely the correction of the preceding valuations bubble.

      This up-down trend in the Capital-stock/GDP data can clearly be seen in the 1989, 2000 & 2007 ‘wealth-effect’ bubble & crash periods. Here are some of the graphs that were provided or suggested by Marko that show the relevant trends. People here can VERIFY for themselves if the ideas in the paragraphs above make sense w.r.t. the reality (data):
      (i) Capital-Stock/GDP (i.e. book value or accumulated savings/investment)
      https://research.stlouisfed.org/fred2/graph/?g=1OVr
      (ii) Wealth-Stock/GDP (i.e. market value or market-price of titles to capital stock)
      https://research.stlouisfed.org/fred2/graph/?g=1LTQ
      (iii) Wealth-Stock/Capital-Stock (simply (ii) divided by (i))
      https://research.stlouisfed.org/fred2/graph/?g=2lkU

      Let me know if you either disagree or have any doubts/questions.

      • ERRATUM: It appears that the Bureau of Economic Affairs (BEA) does *NOT* include capital gains or losses in their National Income and Products Accounts (NIPA), from which US GDP is calculated. The BEA reasoning as follows:

        “Capital gains and losses are not included in NIPA measures, because they result from the revaluation and sale of existing assets rather than from current production. In other words, a change in the sale price of an asset does not add or subtract from the goods and services produced in the United States today.”

        Since I can’t argue with the BEA, I will have to admit that I was wrong. I stand corrected.

        • Interesting. Well, if that’s so, then I guess I should have a lot more respect for the GDP figure, because if it factors out all sale and purchase of assets, then what is left is a lot more anchored in the real economy than I thought. For no particular reason, I had the impression that the asset sales and purchases of big investment / financial firms found their way into the GDP, but in fact it should be only interest income and fees that are contributed by those firms.

          • ^Luddy WROTE: “Interesting. Well, if that’s so…”
            —————————————————-

            Consider the Gambling Industry (casinos et cetera):
            1) Gambling is treated as a form of entertainment and hence considered a form of ‘consumption’
            2) The equation is written as Money Lost by some gamblers = Money Won by other gamblers + Operating-Margin of the House/Casino
            3) The gamblers who lose are treated as the “entertained” and their losings are treated as “consumption”.
            4) The gamblers who win (plus the House/Casino) are treated as the “entertainers” and their winnings are booked as income (production of entertainment)
            5) So equation (2) can be written: CONSUMPTION (Entertainment) = INCOME = PRODUCTION = Addition to GDP

            What this tells us is that if the government wants to stimulate growth (i.e. raise the GDP number), then it should consider the active promotion of gambling everywhere and at all times. In fact, the government could even consider passing legislation that makes it compulsory to place slot-machines in every school, such that young people are trained to be productive members of society from a very early age.

          • Yet again, well done sir.

  36. Steve Keen recently posted a new video in which he focusses on the (Post-)Keynesians. Turns out that Keynes was a classical economist who morphed into a “keynesian” economist.

    • Does he also point out the realism and uncertainty taken into account when people like Joan Robinson (and others) thought Mao Zedong and Jawaharlal Nehru were taking up sound economic policies for countries like China and India?

      • This is the 3rd video in a serie in which Keen focusses on a number economic schools. After focussing on /discussing the “Neoclassical” & “Austrian” school in the previous 2 videos, he now focusses on the “Keynesian” school. Nothing more.

        • Yea, his description of the “Austrian” school is complete bullshit and intellectually dishonest. He really should be ashamed at himself. I know Austrians who’d tear this guy apart.

          • – The Austrians have a (much) better grasp on how the economy works than the (Neo-)Classical school but they still are missing a number of (economic) points the keynesians do get.

          • Sure, but the opposite exists as well. There’s a lot of things Austrians understand that “Keynesians” (who usually stand against what Keynes said) don’t get.

    • ^Willy2 WROTE: “Turns out that Keynes was a classical economist who morphed into a “keynesian” economist.”
      ————————————————

      It is counterproductive of speak of “Classical economists” and “Keynesian economists”. It is more meaningful to speak of “Classical economies” (or economies in a Classical state) and “Keynesian economies” (or economies in a Keynesian state). For god’s sake, let economists simply be economists.

      Let’s make an analogy to common household experience:

      Assume that there is essence in the traditional remedy, “starve a fever and feed a cold”. If a patient is feeling under the weather, a doctor will first perform a diagnosis. This diagnosis will determine the specific malady (cold/fever) from which the patient suffers. Once the pathology has been determined, the doctor will prescribe the appropriate remedy (feed/starve). So if a fever is diagnosed, the doctor will recommend reducing calorific intake. Alternatively, if a cold is diagnosed, the SAME doctor will recommend increasing calorific intake.

      There is no such thing as a “Fever doctor”, who will always prescribe a decrease in calorific intake without regard to the diagnosis of the presenting malady. Similarly, there is no such thing as a “Cold doctor”, who will always prescribe an increase in calorific intake without regard to the diagnosis of the presenting malady. A doctor is simply a doctor.

      This is how it should be in economics as well.

      PS: Note CAREFULLY that just as there have always been QUACKS who pose as doctors and sell snake-oil to the gullible public, there will always be QUACKS who will pose as economists and sell bizarre-notions to gullible people.

      • ^The comment above says: “A doctor is simply a doctor.”
        ——————————————————–

        It was noticed in ancient times that the human body is bilaterally symmetrical. Ancient thinkers noticed that if they drew a straight vertical line through the navel of a person, the height of left side was always equal to the height of right side of the body. For centuries this was assumed to be a given property of human bodies.

        Suddenly, there seems to be a raging debate about whether that is really true at all times. A ‘heterodox’ school of Pediatrics is now challenging the conventional wisdom of the ‘orthodox’ school of Pediatrics. The debate seems to specifically centered on what is called the “paradox of pediatric growth”.

        The heterodox pediatricians point out that if the height of a child on its left side is ALWAYS equal to its height on its right side, then the child CANNOT possibly grow.

        This heterodox school of pediatrics claims that the heights of the two sides of children are only equal in the abstraction of equilibrium. In order to explain the growing heights of children, they propose a dynamic model that allows for the disequilibrium that reflects the reality of childhood. They suggesting modifying the neo-classical model of child-growth by adding a function called “endogenous change in height” that is dependent upon, inter alia, good nutrition and proper exercise.

        Here is a picture of their revolutionary new model that resolves the “paradox of pediatric growth” and finally explains how children actually grow in a non-linear and dynamic fashion:
        http://goo.gl/aYiRbG

        UPDATE: At a conference in San Francisco’s Haight-Ashbury district, Dr. Keve Steen, a leading heterodox pediatrician, explained this revolutionary new theory to an audience of mothers who were attending with their children. Media reports indicate that the mothers were so horrified when they saw the diagrams explaining child-growth that they stormed out of the hall, clutching their children and screaming at Dr. Keve Steen, “stay the hell away from our kids, you sick bastard!”.

  37. “there most certainly are limits to fiscal deficits, and that the state’s ability to monetize its debt does not mean that it can borrow indefinitely without, eventually, destroying the economy and undermining the credibility that allows it to borrow in the first place.”

    Credibility from whom? People like Pettis? Pettis doesn’t understand what a model is, inherently flawed. In defining his “accounting identities” to be absolutely true, he reveals himself as failing to understand the basic principles of logic: the problem of infinite regress, for example. Thus I have no credibility in Pettis when he says that deficits or government money creation will undermine its credibility.

    I wonder if Pettis has ever heard of the problem of explosion in classical logic? The Banach-Tarski paradox, for one example, makes explosion real. Thus trying to use logic to disprove possible hypotheses is silly because logic can also be used to prove the exact opposite.

    • You have no credibility “in” Pettis? Almost certainly none “with” Pettis, with or without the thus, Robert, but I suspect this isn’t what you were trying to say. I agree that invoking magical phrases like “the Banach-Tarski paradox” can sound impressive, but the fact that it is called a “paradox” might have suggested that its theoretical possibility seems paradoxical precisely because it never occurs in practice, and leaving aside that it is derived from an unproved axiom, it only applies to conditions that are infinitely divisible, which clearly does not apply to anything discussed in this blog entry. Unfortunately this particular impressive phrase is wholly irrelevant and, again with or without the other thus, seems inappropriate. And does Banach-Tarski really prove that disproving any hypothesis “is silly because logic can also be used to prove the exact opposite”? That isn’t at all what I thought it proved, but at least you are being consistent in your distaste for logic.

    • ^Robert Mitchell WROTE: “Credibility from whom? People like Pettis? Pettis doesn’t understand what a model is…”
      ———————————————————

      What Robert Mitchell is trying to suggest is that Michael is wrong. But that is impossible, because such a thing would violate the accounting identity [MICHAEL = CORRECT]. People seem to keep forgetting that ‘Michael’ and ‘Correct’ are just two different words for the SAME thing. We can use the very “explosion in classical logic” of which Robert Mitchell speaks to demonstrate this as follows:
      https://goo.gl/Qiyzr8

  38. What stops thin-air-money? US and China appear to not have a limit because of their economic sizes. Issue seems to be pushed off to their trading partners. For India I’m thinking the stopper is the price of fuel. For Egypt and possibly Russia the price of food. Smaller countries civil war. Japan doesn’t appear to have a limit because of their cohesiveness. Is the stopper for the two largest economies a lack of trading partners?

  39. You woke me up for several milliseconds.

    It’s ‘all’ about cashflow. No more or less simple. It always was and ever will be. Make it as complicated as you like but life is always an accounting exercise. Balance that! Take your margin.

  40. QUOTE from original article: “….regardless of whether or not Vinezi is correctly interpreting Steve Keen on the savings and investment identity….”
    ————————————————

    The famous Keen-Minsky equation is:
    Aggregate Demand = Income + Change in Debt

    This may be re-written as:
    Consumption + Investment = Consumption + Savings + Change in Debt

    Therefore, we can conclude that Steve Keen is saying the following:
    Investment = Saving + Change in Debt

    This is implicit in Steve Keen’s work, regardless of how much his disciples on this forum might protest.

    Along this line of thought, we note that in the paper linked (above) by Jo Mitchell, Marc Lavoie writes EXPLICITLY: “Thus Keen’s revolution seems to RELY on the claim that investment is equal to saving plus the creation of money.”

    Marc Lavoie then concludes his commentary paper with the statement, “Keen makes the grandiose claim that his approach leads to a ‘new, monetary macroeconomics’. While statements of this kind may appeal to an internet audience, I doubt they will convince readers of this journal.”

    Readers can compare Lavoie’s conclusion with the following: “Steve Keen begins with a misunderstanding of basic concepts of economics and adds to that a misunderstanding of the basic concepts of calculus; from this double error he goes on to launch a bizarre model, which he then claims will overthrow all the established theories. It will do no such thing.”
    SOURCE: https://goo.gl/JS9I6l

  41. QUOTE from original article: “I think what Keen might actually be saying is that if investment in the NEXT PERIOD is greater than savings in the CURRENT PERIOD – if it is boosted, so the argument goes, by the ability of the banking system to fund investment by CREATING DEBT “out of thin air” – this does not violate the identity, and it is not only possible, but even likely. (If by any chance Steve keen should read this, perhaps he might respond.)”
    ————————————————

    Could this presumption be correct? Could this be what Steve Keen is “actually saying”?

    Let us take a look at the table entitled “Change in debt and aggregate demand” as provided by Steve Keen on the following page:
    http://goo.gl/ZO5Aky

    Note CAREFULLY that the table shows the relationship as:
    Aggregate Demand (2008) = GDP (2008) + Change in Debt (from 2007 to 2008)

    Note VERY CAREFULLY that the table is *NOT* showing the relationship as:
    Aggregate Demand (2008) = GDP (2007) + Change in Debt (from 2007 to 2008)

    Now does this settle the matter? Or are there any doubts still remaining?

    • Okay, I may have finally broke the code. I think I finally understand the logic of ‘next period’ & ‘current period’ and what Steve Keen meant when he accused Michael of falling into the trap of “period thinking source of errors”. To see what Steve Keen means, consider the following:

      In that linked-table, Steve Keen uses:
      Aggregate Demand (2006) = Income (2006) + Change in Debt (from 2005 to 2006) — (I)

      On the other hand, Michael’s understanding was that Steve Keen *MUST* have actually meant:
      Aggregate Demand (2006) = Income (2005) + Change in Debt (from 2005 to 2006) — (II)

      Otherwise (I) would violate Michael’s accounting identities, because, IF,
      Aggregate Demand = Income at all times, THEN,
      Aggregate Demand (2006) = Income (2006).

      This is because when Michael said “NEXT PERIOD”, he mean next ACCOUNTING period, and when Michael said “CURRENT PERIOD”, he meant the current ACCOUNTING period.

      Steve Keen says Michael is WRONG, because he is falling into the trap of “period thinking source of errors”. Steve Keen is not dealing with ACCOUNTING periods, he is dealing with (theoretically) infinitesimal steps of time. This is why he speaks of “period thinking source of errors”.

      Apparently, Steve Keen is saying this:
      (0) Start on Jan 1, 2006. This is the beginning of the new “accumulative” period.
      (1) Each day (or some small unit of time) there is some income.
      (2) Next day’s spending = previous day’s income PLUS increment in daily debt (Minsky).
      (3) Day-after’s spending = previous day’s income PLUS another increment in daily debt
      (4) And so on for 365 days, until December 31, 2006.
      (5) On December 31, the sum of all the daily quanta of income from Jan 1 to Dec 31 = Income (2006)
      (6) On December 31, the sum of all the daily increments in debt from Jan 1 to Dec 31 = Change in Debt (from Dec 31, 2005 to Dec 31, 2006)
      (7) On December 31, the sum of all the daily spending quanta form Jan 1 to Dec 31 = Spending (2006)

      Therefore, Steve Keen writes:
      Spending (2006) = Income (2006) + Change in Debt (from 2005 to 2006)

      So, yes, Steve Keen *IS* VERY MUCH violating Michael’s identities and is giving a specific reason why he does so. Note that there is NO difference or change in definitions here. The definitions of Aggregate Demand, Income, GDP & Change in Debt et cetera are exactly the same as what Michael’s use.

      I think it should be clear to all blog participants about what Steve Keen means when he says (t), (t-1), (t+1). He does not mean an accounting period, he means any (theoretically) infinitesimal step of time. Therefore, his cryptic remark about “period thinking source of errors” should be now crystal clear to everyone.

      So Steve Keen writes the final “Post-Keynesian” Identities as:
      (a) Spending (2006) = Income (2006) + Change in Debt (from 2005 to 2006)
      (b) Aggregate Demand (2006) = Income (2006) + Change in Debt (from 2005 to 2006)
      (c) Aggregate Demand (2006) = GDP (2006) + Change in Debt (from 2005 to 2006)
      But Michael’s accounting identities (which are the same as the accounting identities of B.E.A. & Keynes) says [EXPENDITURE = INCOME] at all times. Therefore, how can the cumulative expenditure from Jan 1, 2006 to December 31, 2006 *NOT* be equal to the cumulative income from Jan 1, 2006 to December 31, 2006?

      Clearly, we appear to have a logical paradox with (Michael, Keynes & Bureau of Economic Analysis) on one side, VERSUS, (Steve Keen and the Post-Keynesians) on the other side.

      Would any of the regular blog participants want to take a shot at resolving this paradox? DvD? Marko?

      • Vinezi ,

        I’ve been following Keen for a while and I can basically see where he’s coming from , but it’s mostly an intuitive understanding. He mixes and matches commonly accepted terminology , and uses other terms like “asset turnover” without specifying what the heck he really means by using them. I’m not sure he’s totally clear in his own mind about the whole picture.

        Not speaking for him , but rather for my own sense of how things operate , I’ll toss out a couple of thoughts : First , I’m comfortable with the idea that at a given level of gdp , and with zero growth and zero inflation , the U.S. economy could function from year to year with no injections into the money supply ( and here I think it’s worthwhile to think about something like Peter’s “bookkeeping view” definition of money – simply a set of accounts , a tally sheet , whatever. It could be completely electronic , the important thing is the universal understanding of the units ( $ ) and the knowledge that all rights are enforceable by law , backed by courts and cops – or nukes – as needed. )

        So , let’s say we’re currently in that zero-growth steady state economy ( closed , for simplicity ) , and call it $17 trillion in gdp or gdi terms. The money supply , from the accounting standpoint ( leaving assets aside ) has to be $17 trillion. You have to be able to imagine that everyone in the country could decide at once to do business on an honor checking system for one whole year – never depositing , spending or investing actual money , but otherwise conducting business normally , then all going to the banks on the same day to present the checks and demand withdrawal of the whole $17 T. It’s a ridiculous thought experiment , of course , but I think the system of accounts has to be set up so that in theory , at least , the $ 17 T would be there waiting for us on the appointed day.

        That’s the setup for a $17 T zero-growth , closed economy already up and running. We’re assuming that part , just like the economists do. Now , fast forward one more year. Instead of $17 T , we find that it’s grown to $17.5 T ( again , at zero inflation , to keep things simple ). A year ago the accounts only showed $17 T , now there’s an extra $.5 T , and it had to come from somewhere. The only people who can access the accounting system are the banks and the gov’t/central bank. So the extra $.5T had to come via gov’t or private thin-air debt-to-deposits ( i.e. bringing future income forward ) , or via gdp-generated savings with CB-facilitated topping of the bank accounts , or via direct CB injections.

        You can imagine a similar story for the nation’s net worth. That figure , currently ~$ 80 T , has to be embedded safely in the accounts ( just like the $17 T in gdp , above ) , such that , in theory , we could all dump our assets in the banks and walk away with the whole $80 trillion on a given day. The same reasoning applies as in the gdp example above for any net worth increases that occur. Again , that extra money can only get entered into the accounts in those few specific ways.

        In the real world it’s all about continuous flows , of course , not static stocks as I’ve emphasized above , and no doubt one day a single quantum dollar will somehow instantaneously and spookily settle all accounts all the time , but I think it’s important that the stock accounts add up within reason. So , starting long ago with the very first one dollar transaction until today , we’ve got a change of $17 T in gdp and $80 T in net worth that we have to account for in the bookkeeping , or $97 T total ( +/- asset market fluctuation effects on NW ).

        Cumulative gdp-generated gross savings amounts to $65 T or so , and total domestic nonfinancial debt is about $ 44 T , for a total of $ 109 T , which seems to me close enough for gov’t work.

        I know some will say : “Wait , you’re double counting those savings , which is what is being lent in that debt figure. ” Some part , maybe , but I think most debt is really thin-air , drawn on the promise of payback from future earnings , and doesn’t impair or displace savings in any way in its creation. The BOE and others have disavowed loanable funds theory in recent years , and I can give you a half-dozen or more quotes from prominent central bankers who use the “borrowing from the future” language. They’re starting to come clean all over the place , but people don’t want to hear it.

        What’s reflected in the market value of a publicly-traded firm ? The present value of a future earnings stream. For established firms , that and a signature on the IOU are all they need to get those thin-air loans. The only thing different about non-traded firms and individuals is that there’s no market , so the bank has to do some due diligence , but the principle is the same.

        • Oh , on the identities stuff. Here’s the actual data on saving vs investment :

          https://research.stlouisfed.org/fred2/graph/?g=2ncF

          All as % of gdp :

          1) Blue : Gross domestic investment

          2) Red : Gross saving

          3) Green : Investment minus Saving

          4) Purple : Net exports ( inverse )

          Until ~ 1975 or so S=I held up pretty well , but since then there’s been some significant divergence , reflected in the close match between ( I minus S ) and the inverse of the current account deficit , which means a corresponding liability to foreign lenders in the capital account.

          • Marko WROTE: “Oh , on the identities stuff. Here’s the actual data on saving vs investment ..”
            ————————————————

            Whenever we see accounting identities violated, it means that we are making a mistake. There is no point wasting our time in asking whether the accounting identities are wrong. Our time would be more productively utilized in finding out where our mistake lies.

            Gross Domestic Product = Gross Domestic Consumption + Gross Domestic Savings
            Gross Domestic Product = Gross Domestic Consumption + Gross Domestic Investment + Trade-Account Balance
            Gross Domestic Savings = Gross Domestic Investment + Trade-Account Balance
            Gross Domestic Savings/GDP = Gross Domestic Investment/GDP + Trade-Account Balance/GDP

            I give you credit that you have at least used Gross DOMESTIC Product in the denominator CONSISTENTLY. In the numerators, however, while you have INVESTMENT correctly stated as Gross Domestic Investment, you have picked the WRONG savings. The terms “Gross Savings” implies Gross NATIONAL savings.

            In other words, while have picked SAVINGS from the NATIONAL accounts book, you have picked the rest of the terms from the DOMESTIC accounts book. This is why your identities are not “balancing”. If you pick everything from the same book, then they will “balance”, because the books must balance.

            In summary, when you replace “Gross Saving” by “Gross Domestic Savings”, your green & purple curves will become identical.

          • Although don’t forget, Vinezi and Marko, that the identity holds only in a closed system (e.g. the global economy). In an open system (e.g. the US economy), if investment exceeds savings all this means is that the US is running a current account deficit.

          • Right , Michael. This BIS paper by Borio et al is a good read on the matter :

            http://www.bis.org/publ/work346.pdf

            ( Borio and Lowe were among the first to warn about the developing credit /debt crisis back in 2004. )

            Some quotes relating to S=I as well as the thin-air issue , from the paper linked above :

            “……Saving, defined as income not consumed, is a national accounts construct that traces the use of real production. It does not represent the availability of financing to fund expenditures. By construction, it simply captures the contribution that expenditures other than consumption
            make to income (output). Put differently, in a closed economy, or for the world as a whole, the only way to save in a given period is to produce something that is not consumed, ie to invest. Because saving and investment are the mirror image of each other, it is misleading to
            say that saving is needed to finance investment. In ex post terms, being simply the outcome of various forms of expenditure, saving does not represent the constraint on how much agents are able to spend ex ante…….
            …….The distinguishing characteristic of our economies is that they are monetary economies, in which credit creation plays a fundamental.role. The financial system can endogenously generate financing means, regardless of the underlying real resources backing them…..”

          • Thanks, Marko. The BIS paper claims that “the financial system can endogenously generate financing means, regardless of the underlying real resources backing them”, but for this to be a useful way of thinking about the role of the financial system, as must we understand what it means to “generate” financing. There are at least two very different processes (or some combination of the two) that will be involved here: one in which the goods and services purchased by the spending that the financial system “endogenously generated” are made available only because consumption or investment spending in another part of the economy was suppressed, and one in which the “endogenously generated” financing created new demand which brought unemployed workers, unused capacity, and resources (energy, raw material, etc.) that were sitting around as unwanted inventory, causing the total production of goods and services in the economy to rise by some amount greater than the original amount of “endogenously generated” financing (divide that by one minus the savings rate). These are two completely different processes.

          • Michael Pettis wrote: “There are at least two very different processes (or some combination of the two) that will be involved here: one in which the goods and services purchased by the spending that the financial system “endogenously generated” are made available only because consumption or investment spending in another part of the economy was suppressed, and one in which the “endogenously generated” financing created new demand which brought unemployed workers, unused capacity, and resources (energy, raw material, etc.) that were sitting around as unwanted inventory, causing the total production of goods and services in the economy to rise by some amount greater than the original amount of “endogenously generated” financing (divide that by one minus the savings rate). These are two completely different processes.”
            ———————————————————————————–

            Mr Pettis, I doubt you have carefully read what I’ve been saying. I don’t blame you for that as I’m new to your blog and must naturally earn, in one way or another, some respect before I can get a full hearing 😉

            Here are two passages from your comment which I would really like to see in a more understandable language (someone familiar with Mr Pettis’s thinking can perhaps try to help if he is busy?):

            “purchased by the spending that the financial system ‘endogenously generated'”

            and

            “the ‘endogenously generated’ financing”

            What do you mean here? How is this spending or financing ‘endogenously generated’?

            I do understand pretty much fully the concept of “endogenous money” (no matter how blurry the concept is revealed to be on further examination), so that doesn’t need to be separately explained to me.

        • ^^Markos WROTE: ” I’m not sure he’s totally clear in his own mind about the whole picture.”
          ——————————————————–

          No, no. He has been working on all this for years on end. I think he must be very clear in his own mind about the whole picture. It is just that this particular ‘whole picture’ he has in his own mind has nothing whatsoever to do with reality.

          It is just like Joanne Rawling having an very clear picture in her own mind about the adventures of Harry Potter.

        • Marko wrote: “So , let’s say we’re currently in that zero-growth steady state economy ( closed , for simplicity ) , and call it $17 trillion in gdp or gdi terms. The money supply , from the accounting standpoint ( leaving assets aside ) has to be $17 trillion. You have to be able to imagine that everyone in the country could decide at once to do business on an honor checking system for one whole year – never depositing , spending or investing actual money , but otherwise conducting business normally , then all going to the banks on the same day to present the checks and demand withdrawal of the whole $17 T.”
          ——————————————————————————————–

          Marko, I do appreciate your effort here, but you must be erroneously conflating “Income/Spending” with “money”. GDP is not connected to “money supply”. GDP could be $16T and the “money supply” could be, well, almost anything. “Money supply” is a partial measure of Debt (there exists, of course, a lot of Debt that is not reflected in the “money supply”), and has nothing to do with GDP as such.

          “Money supply” could easily shrink while GDP grows, and vice versa. So it is plainly wrong to describe an economy with a constant “money supply” as a “zero-growth economy”. It sounds to me that you see “money” where there is only a nominal value expressed in a common unit of account ($). Have I misunderstood you?

          Please see my reply to Vinezi’s “Post-Keynesian” below. Do you see what I mean?

          • I’ll just post some graphs that show empirically what makes sense to me from a “mass balance” perspective – that delta gdp + delta net worth sums to savings plus debt closely enough to make me think that this explanation – simple as it is – is correct , or very nearly so.

            There’s no Fred series for cumulated gross savings , so I did a curve-matching exercise to generate a Fred proxy for the spreadsheet data I had made for the cumulative series. The curve matches the data well except for the early years , and the final total is right on.

            In these graphs I’m using the Haig-Simons concept of income to describe the economy , i.e. , each agents’ total income over a given period is represented by the sum of their consumption and their change in net worth. All agents combined in this way represents the total economy. Savings plus debt plus monetary base is the monetary foundation. The period of interest in this case is essentially the beginning of time as T-1 , and 2014 as T. Net worth is shown in the top panel (green curve ) , and is a reproduction of the new flow of funds B.1 table , which purports to show ” national net wealth” , i.e. , “real” wealth, with financial assets and liabilities netted out. To that is added consumption ( as gdp minus gross saving ). The bottom panel ( blue curve ) is saving + debt + mb. You can ignore the terms in the saving proxy – they’re just components I manipulated to generate the saving curve to match the data:

            https://research.stlouisfed.org/fred2/graph/?g=2qbp

            As of 2014 there is a gap of ~ $21 Trillion between the monetary and the “real” economy , and it’s pretty clear that the gaps develop after the three main crises – the S&L crisis of the late 80s-early 90s , the dotcom bust , and subprime. Even so , the ratio of money to the total economy is .81 in 2014 , and close to 1.0 throughout much of the curve. ( Keep in mind that Zucman says there are ~ $5 trillion in U.S. financial liabilities that don’t have matching assets , which are no doubt squirreled away offshore.)

            An interesting counterfactual is to imagine what things might look like if we had maintained the same 1.35-1.4 ratio of nonfinancial debt / gdp that maintained pre-1980 , so in this graph I substituted 1.4xgdp for the debt component :

            https://research.stlouisfed.org/fred2/graph/?g=2qbK

            This reduces the monetary gap from ~ 21 T to ~ 2.5 T. It’s also hard to see how the housing bubble could have blown up in this scenario. It’s just a hypothetical , of course , as many things would have changed.

            This shows y-o-y % changes as a share of gdp. In this case I was able to use the Fred gross saving data. The monetary curve is in red here :

            https://research.stlouisfed.org/fred2/graph/?g=2qbT

            Finally , since Keen’s work is of interest here , this shows the monetary “impulse” , corresponding to Keen’s credit impulse ( or “accelerator” ) :

            https://research.stlouisfed.org/fred2/graph/?g=2qc6

            I don’t really expect to convince anyone that this is how the world works , I’m just putting it up here for comments , and for the record.

          • Marko, I hate to say this, but I cannot follow your thinking here.

            What I’m looking for is some kind of theory which could say us something about causality. To me, that would be *thinking*. If I only see presentations about *correlation*, I have to do all the thinking myself. (I might be quite extreme in this sense: I had hard time understanding what’s the point of university statistics classes. I searched for causality, while others got the point much faster. You can imagine how I was of no help in group work. Only later I realized that I wasn’t supposed to think at all how things really work.)

            Am I right if I say that all you do here is about correlation?

            I, too, believe that there is correlation between Debt growth and GDP growth, and that Debt growth has been an important *cause* for GDP growth especially since the 1980s. I also believe that I have a consistent theory about how the causality works. That theory tells me that this Debt growth is only one way to increase GDP, and that it is not a sustainable way to do it. We have other ways to do it, but those other ways are more difficult, and that seems to be the reason we have chosen Debt growth, especially since the 1980s (Here I agree with, for instance, the BIS). I doubt we would have chosen Debt growth if we had fully understood the mechanism behind all this. (And here we get to the “borrowing from the future” concept.) An additional problem with choosing Debt growth is that after the genie is out of the bottle, it’s very hard to get it back in there: After a while, we start to face periodical situations (eg, S&L, dotcom, GFC) where we have to choose between even more Debt and a Recession/Depression (here I probably side with some “Austrians”, but our difference is in the theory we use to explain this).

            I continue to argue that there is no direct link between GDP and “money supply”, and that these can even move in opposite directions — but this is obviously not the case when we try to create GDP growth by intentionally pushing for Debt growth.

          • Marko wrote: “You have to be able to imagine that everyone in the country could decide at once to do business on an honor checking system for one whole year – never depositing , spending or investing actual money , but otherwise conducting business normally , then all going to the banks on the same day to present the checks and demand withdrawal of the whole $17 T.”
            ———————————————————

            Marko, let me pose a question to you regarding the sentence above:

            What if we choose, instead of 12 months, another arbitrary time period to calculate GDP — how would this change the link between GDP (a flow) and money supply (a stock), if at all? The size of the money supply cannot possibly depend on our arbitrary choice of a time period. Thus, 6-month GDP could be $8T, 12-month GDP $17T and 24-month GDP $33T, while MS would average $17T during all these periods?

            It might very well be that I have misunderstood you.

      • I doubt it can be this simple, but from what you’re saying and based on how I, too, interpret Keen, the problem seems to be this:

        Keen is unable to mentally handle the macroeconomic fact that “Spending and Income” are like “Purchases and Sales” (often literally the same, as sales create income and purchases are spending), or like “Savings and Investment”. They are two sides of the same coin. In other words, Keen doesn’t manage to think like The Great Planner (a good macroeconomist must forget his own mortality.)

        As you say in one of your comments further up: “SAVINGS = INVESTMENT is just as true as SALES = PURCHASES, because the word on the LHS and the word on the RHS are merely describing the same event from two different (opposite) angles.”

      • V.K,

        Look at this paper from Keen et al: http://debunkingeconomics.com/wp-content/uploads/2012/10/TowardsUnificationMonetaryMacroeconomicsMathArgument.pdf

        “Figure 2: Debt-financed expenditure and a discontinuity in income” (p. 14).

        To pick one point in time where there is a simultaneous increase in debt and in spending and to call this a “discontinuity” misses the fact that income as measured by accountants for *any time period* consists in part of debt-financed spending. So the whole starting point in the figure is wrong. You cannot show “Income” as a curve like that, varying from moment to moment, as if before the “discontinuity” there wasn’t any similar discontinuity and yet income varied (as we see in the graph). Current spending just isn’t defined by previous income in the way the authors seem to suggest.

        A solution to our “paradox”:

        Spending is *never* financed by Income. Spending *is* Income. And Spending (or Income, depending on our viewpoint) is financed either by “Personal Savings” (an existing credit balance) or Debt. It is a mistake to think that Income = Personal Savings.

        Problem solved?

        If you happen to be a salary-earner, your Income often leads to an increase in your Personal Savings. We often mix Income with the technical transfer of a credit balance in a bank ledger from our employer to us. This is not the moment Income is usually recorded in accounting; instead, Income is recorded when a sale is made. We should also keep in mind that Income can be used to pay down Debt without it first appearing as “Personal Savings” on our account.

        I have criticized “cash flow thinking” above. I hope the reason why I do it starts to be clear now?

        • P.G. WROTE: “Spending is *never* financed by Income. Spending *is* Income.”
          ———————————————————

          I agree with you completely that SPENDING = INCOME. I understand what you mean perfectly. But you see, the problem here is that the “post-Keynesians” (whatever that means) will respond to your statement as follows:

          1) Spending = Income is just a static identity. Keynes never proved that Spending = Income, he merely stated it.
          2) It tells you nothing at all. If Spending = Income at all times, how can income grow?
          3) It has no information about how income actually grows. It is true just in the abstraction of equilibrium
          4) It does not account for disequilibrium, and the real world is not always in perfect equilibrium
          5) We need a new dynamic model to reflect the natural disequilibrium and constant change in the real world.
          6) We must account for the reality that banks endogenously create new money so as to enable rising expenditure.
          7) The rising debt in the economy is not shown anywhere because the mainstream has ignored debt.
          8) Endogenous creation of new money (rising debt) allows expenditure to exceed income in the short-run.
          9) The income then catches up with the expenditure only later. Therefore, expenditure drives income in disequilibrium.
          10) We must re-write the static identity and convert into a dynamic identity reflect all these things

          Therefore, SPENDING = INCOME + Change in Debt. This is the only way to account for the endogenous creation of money by banks.

          This will be a Glorious Revolution, comrade. The masses of mainstream economists lack consciousness, so this revolution can only be led by a vanguard of the post-Keynesian elite who are acutely aware of the Key to History. Onward with The Heroic Struggle!

          • Vinezi wrote: “I agree with you completely that SPENDING = INCOME. I understand what you mean perfectly.”
            ———————————————————–

            Did you read the rest of my “proof”? It was not only about the fact that this identity must always hold.

            We are discussing macroeconomics, right? Even Keen’s “SPENDING = INCOME + Change in Debt” is supposed to be about the economy as a whole. Am I correct? There’s the problem. These people write macro, but think micro. “SPENDING = INCOME + Change in Debt” might hold (not perfectly, though, as I’ll explain below; see point 8-9) at microeconomic level, but it is nonsense when it comes to the economy as a whole.

            Please, read carefully my answer to your (imaginary, as I don’t want to judge all P-Ks) “Post-Keynesian”:

            1) “Spending = Income” at macroeconomic level, because one agent’s spending is another agent’s income. There cannot be any proof for this. This is about assigning a meaning to the words “spending” and “income”.

            2) The question “If Spending = Income at all times, how can income grow?” doesn’t make any sense. Income/Spending growth has nothing to do with the identity “Spending = Income”. The identity doesn’t in any way restrict growth of the variable which “Spending” and “Income” describe from two opposite angles. (What is this variable?) Would it make sense to ask: “If both sides of a coin are always the same size, how can there exist a bigger coin than the one in front of us right now?”???

            3) Correct. It has no information about how Income/Spending grows. It is not supposed to have. I have no idea what you mean with “It is true just in the abstraction of equilibrium”. Would you care to explain?

            4) It *does* account for every possible state of the economy, but not for every possible illusion of an economist.

            5) Perhaps. But are we discussing an (accounting) identity or a model?

            6) This is where we really start mixing things that shouldn’t be mixed. Spending (=expenditure?) doesn’t require “money” (which is a name we have given to *some* credit balances in *some* ledgers — mainly bank ledgers — in the economy). We can easily increase Spending/Income without creating “money” (= certain type of credit balances). We can have someone make a purchase (-> increased Spending/Income) either by (i) using an existing credit balance (“personal savings”), or (ii) creating any type of a new credit balance which is not called “money” (say, trade credit). (See also point 8-9)

            7) Here I tend to agree. Debt has been ignored. Is it because some erroneously think that Debt “nets to zero” in a closed economy?

            8-9) This must be a microeconomist talking. From a macro point-of-view this is nonsense. Spending cannot exceed Income, not even in the short run, because one agent’s Spending is always another agent’s Income. NOTE: Neither is this strictly speaking true for an individual agent. All depends on whether we use “accrual accounting” or “cash accounting”. The former is used by all larger businesses and is the basis for national statistics. The latter is how some very small businesses, and households — and apparently many economists, too — choose to view things. For our discussion, the most important difference between “accrual accounting” and “cash accounting” is probably how they recognize revenues (=Income?):

            Says Wikipedia of “Revenue recognition principle” of *accrual accounting*: “revenues are recognized when they are realized or realizable, and are earned (usually when goods are transferred or services rendered), no matter when cash is received.” — I repeat: NO MATTER WHEN CASH IS RECEIVED.

            Says Wikipedia (same article) of revenue recognition in *cash accounting*: “In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.” — I repeat: NO MATTER WHEN GOODS OR SERVICES ARE SOLD.
            (https://en.wikipedia.org/wiki/Revenue_recognition)

            From this it follows that if we are using *accrual accounting*, then even at *microeconomic* level we can — and often do — see that “Spending<Income" and nevertheless there is an increase in Debt (and "money" is created). It is perfectly natural for a business to increase its use of an overdraft with a bank (="money" and Spending created) even if it just has recognized/realized/"received" Income that covers/exceeds the amount of this new Spending. This is because the Income almost always first shows up as an increase in its "Accounts receivable", and only later, if ever, as an increase in its "Cash" or "Cash equivalents".

            10) I didn't know that there can be both static and dynamic *identities*? It might be because I'm not an economist, or because my overall understanding of science is still very much lacking. But to me this sounds like we are trying to build a model from an identity, and we want that *model* to be dynamic? I have a model of the economy "in my head", and I cannot imagine how it ever could be static.

            Do you understand why I criticize what I call "cash flow thinking" (and what I probably should call "cash accounting (thinking)" from now on)?

          • Vinezi, there was one thing I forgot to state explicitly in my previous comment:

            Neither does Spending (or, expenditure) need to have anything with “money” to do. The business in my example above (point 8-9) could very well buy something from another business, and that Spending would almost always first show up as an increase in “Accounts payable” (debit entry) — not as a decrease in “Cash” (debit entry). And if there is any overlap between the “Accounts receivable” and “Accounts payable”, so that a “Company X” is both a supplier and a customer to our business — and thus we can have both “accounts receivable from X” and “accounts payable to X” — these can be netted by mutual consent without any “Cash” account being ever affected by (some of) the Income/Spending that took place between our business and Company X.

            Do you see what I mean? Do you agree?

          • CORRECTION:

            I wrote: “Spending would almost always first show up as an increase in “Accounts payable” (debit entry) — not as a decrease in “Cash” (debit entry).”

            What I should have written was “credit entry”, not “debit entry”. I got confused and made an error (beware of accountants!). I apologize. I’m just so used to adopting a bank’s point-of-view, where a credit entry increases the “depositor’s” “money balance”.

      • ^Marko WROTE: “….whole picture is not clear….”
        ^P.G. WROTE: “….micro guys… talking macro…”
        ————————————————

        Marko and P.G. have both made some good points. I think it might be helpful to draw a few diagrams for the benefit of the pictorial-thinkers on this blog, who might otherwise find themselves drowning in a whirlpool of words. A picture being worth a thousand words:

        (1) Part I is a picture of what Steve Keen has in HIS mind when he speaks of the “neo-classical static model in the abstraction of equilibrium”, which “does not account for the endogenous creation of money by banks”.
        (2) Part II is a picture of what Steve Keen has in mind when he speaks of HIS “new post-Keynesian dynamic model that allows for disequilibrium” and “includes the endogenous creation of money by banks”.
        (3) Finally, Part III is a picture of that rarely-seen animal they call ‘REALITY’.
        https://goo.gl/07NBzk

        • Very good, Vinezi. Very good. I have pictures in my head, but I can’t put them on (e-)paper like you can. Impressive.

          One question about a small detail in your stylized ‘reality’: Is Subpart A supposed to represent (net) debtors and Subpart B (net) creditors? That’s why you have the “endogenous money” running one way only? Nothing wrong there, just asking.

          Correct me if I’m wrong: It seems you picked only banks — and ignored the wider financial markets — to drive home the point that “endogenous money” (which refers to credit balances in bank ledgers only) has nothing directly to do with Expenditure/Income? I don’t see any problem with this. But if we want to widen the picture, we could say that financial markets occupy the Banks box in your diagram. How those financial markets affect the bigger picture is via financing the Expenditure(s). By financing I don’t mean “provide money”. What I mean is that the financial markets “(help to) create/arrange, and re-arrange, one-to-one (eg, bonds) and one-to-many (deposits at banks & non-bank financial institutions) debt relations”.

          The story of how debt — both existing and newly-created — is linked to Expenditure goes like this: In course of the transaction, the buyer’s account (in any common ledger; not just bank ledger; this ledger can be even imaginary, if there is no intermediary, like in the case of “accounts receivable”) is *debited* (adopting the bank’s/intermediary’s point of view, not buyer’s or seller’s; in buyer’s own accounting this could be a credit entry) and the seller’s account is *credited*.

          Before the debit entry is made, If there exists a credit balance on the buyer’s account which covers the purchase price, then the transaction doesn’t create new debt. But if there doesn’t exist a credit balance which would cover the purchase price, then new debt is created.

          Theoretically, we could increase Expenditure with a nearly infinite amount without creating any new debt (debit, and credit/”money” balances) in the economy, assuming that there exists some debt, and thus credit balances, in the economy. All it would take would be for agents to debit their accounts as fast as those accounts get credited by other agents (who debit their accounts). In any case, there is no need to create new debt in order for us to increase Expenditure/Income. We can also increase Expenditure/Income by creating a lot of new debt during the accounting period, but without increasing total debt in the economy (remember: Keen’s point is a macro point and seems to imply that total debt needs to increase?). Some agents can incur more debt while others pay their previous debts. Again, this doesn’t directly constrain Expenditure/Income.

          To create that “need” to create new debt (and often, but not necessarily, also “money” which is a slightly special credit balance) we need to start twisting our minds quite a bit. First, we need to start thinking in terms of the Quantity Theory of Money. Second, having adopted that framework — which we didn’t need to do, but did anyway — we need to assume within that framework that the “velocity of money” (a concept which doesn’t have a counterpart in the real world) is more or less constant.

          That’s it. I hope someone has time to read it carefully, as there are way too many parentheses to deal with. The previous paragraph might explain how Steve Keen thinks? If he really thinks so, then there would be some irony here: A rebel (assuming he considers himself one) gets blinded by the good old Quantity Theory of Money.

        • I wrote: “But if there doesn’t exist a credit balance which would cover the purchase price, then new debt is created.”

          I should clarify this. I have got used to thinking in terms of “overdrafts” instead of “traditional bank loans”. I chose to adopt the “overdraft view” recently because it actually gives a clearer picture of what is going on. I understand if for someone not used to thinking in terms of overdrafts the whole idea is initially somewhat confusing. But I can assure you that it doesn’t change the big picture!

          (This is what David Hume had to say about overdrafts: ‘one of the most ingenious ideas that has been executed in commerce’. The funny thing is that overdrafts caused confusion and even fear in the 18th century Scotland when they first were introduced — almost by a chance, if one should trust Wikipedia; this is how markets generally evolve? –, but with the benefit of hindsight I would say that they are closer to the “real thing”, as they don’t confuse us with any “money” being created on the “borrower’s” account. Food for thought?)

        • Vinezi, I spotted a typo in your picture: On the “black board” you have twice written “simultaneously-occurring even”, instead of “… event”. You might want to amend it, just in case we are making history here (hey, one never knows?).

        • Vinezi wrote (behind the link below, one of the last lines):

          “4) This is a misunderstanding. In Step (1), the process of balance-sheet expansion is called “credit creation”. Person A is said to have been issued a ‘credit’. At this point, Person A is NOT YET in debt, because even though he is on the LHS (debt) of the bank balance sheet, he is ALSO on the RHS (credit) to the same amount. At this point Person A is NOT YET a borrower. In fact, this is why the word “credit” is used instead of “debt” to temporarily describe this process at this point.”
          https://docs.google.com/document/d/1RijdWFWlhwKQFfGFG7M8jiI5ypLoNxckWTvDwog2cHo/pub
          ———————————————————————————-

          The whole description was great, thanks! Can it really be that Keen and the “monetary cranks” don’t realize that *this* is what causes the misunderstanding?

          Anyway, at this point I just want to mention that if you look at your point 4 which I quote above, you can see why I think in terms of *overdrafts*. What happens at point 4 is that the borrower has agreed on a line of credit with the bank. For our purposes here, it is irrelevant whether a credit balance is created on the borrower’s account or not.

          As far as I know, unused overdrafts are not included in M1. But it is inconsistent to *not* include unused overdrafts in M1 if all existing credit balances are included in it. Here Keynes agreed. Says Keynes in A Treatise on Money, Bk 1, Ch 3, 8ii(i.) “Deposits and Overdrafts”: “… it is the total of the cash-deposits and the unused overdraft facilities outstanding which together make up the total of Cash Facilities. Properly speaking, unused overdraft facilities – since they represent a liability of the bank – ought, in the same way as acceptances, to appear on both sides of the account. But at present this is not so, with the result that there exists in unused overdraft facilities a form of Bank-Money of growing importance, of which we have no statistical record whatever, whether as regards the absolute aggregate amount of it or as regards the fluctuations in this amount from time to time.
          Thus the Cash Facilities, which are truly cash for the purposes of the Theory of the Value of Money, by no means correspond to the Bank Deposits which are published.”

        • I would also like to make a broader point here:

          If unused overdrafts should be included in M1, then why not all unused credit card limits? Etc. The broader point is thus: NEVER conflate “money” with PURCHASING POWER. I have a feeling that for instance Adair Turner (no matter how brilliant he is when it comes to understanding debt) is guilty of of this. “Money creation” is not “purchasing power creation”. If someone wants an explanation/”proof”, I’m happy to provide it — just ask. I won’t bother now, as it might be that we are already in full agreement on this one.

        • Vinezi and others: If Mr Pettis allows, I’d like to present below my related comment to Martin Wolf’s FT.com article “Corporate surpluses are contributing to the savings glut” (Nov 17, 2015). It’s all about accounting identities, and it has been greatly inspired by our discussions here.

          ——————————————————————–
          http://www.ft.com/cms/s/0/b2df748e-8a3f-11e5-90de-f44762bf9896.html#ixzz3rrhsCjsh

          Comment by P. Golovatscheff:

          “I think it’s time for some new thinking around this subject. So, if you are one of those who need to consume some mescaline to have their minds open, then I would suggest you do so now.

          Mr Wolf writes: “If investment is weak and profits strong, however, the corporate sector will, weirdly, become a net financer of the economy. The result will be a mixture of fiscal deficits, household financial deficits and current account surpluses (that is, capital account deficits).”, and, later in the article, he adds that “Beyond this, it has to be accepted that, so long as the corporate sector runs a structural financial surplus, macroeconomic balance is likely to require fiscal deficits.”

          Mr Wolf is probably too informed to make the mistake I’m going to accuse him of making, so I’m more than willing to hear his side of the story. Nevertheless, to me the sentences above suggest that he cannot recognize the difference between *an accounting identity* and *a model* that could tell us something about causality between different variables.

          Macroeconomic balance doesn’t require anything in any active sense, like in “We need to run fiscal deficits as long as private sector runs a financial surplus”. An accounting identity is always “in balance”, by definition. A fiscal deficit *causes* (in a closed economy) a private sector surplus as much as a private sector surplus causes a fiscal deficit. Likewise, the *result* of a corporate sector surplus is “a mixture of fiscal deficits, household financial deficits and current account surpluses” as much as the result of fiscal deficits, household financial deficits and current account surpluses is a corporate sector surplus.

          For us to be able to suggest any causality between these variables, we must go much deeper than Mr Wolf, or any other commentator, seem to be able or willing to go. We need to ask questions like these (while keeping in mind that “money” is created endogenously!):

          Is there a reason why the corporate sector must run a surplus? Or could it be that it runs a surplus because it can — that is, because the government and, especially, the households run deficits from their free will?

          Where do the means to buy what the corporations produce come if corporations run surpluses (that is, they, in aggregate, sell for more than they pay out wages, dividends and taxes)? (My answer: From increased household and public debt.)

          How could (aggregate) corporate profits be strong if households and the government didn’t run deficits? (My answer: Profits couldn’t be strong.)

          How could corporations, in aggregate, pay massive sums to their owners and *top employees*, if these weren’t at the same time, at aggregate level, the ones who buy what the corporations sell? (My answer: Corporations can do this mainly because the middle-to-low-income households — the masses who create the majority of demand in our economies — incur more and more debt in order to buy what the corporations sell. The asset side (as opposed to the liability side) of this debt, which includes the “money” created by banks when they “lend” to households, ends up — via high salaries, dividends and retained earnings — in the portfolios of the top “10 %” or top “1 %”.)

          If we assume that the previous answer has a grain of truth in it, should we then conclude that not only does increasing inequality cause higher household debt (as Michael Kumhof and Romain Rancière suggest in their IMF working paper “Inequality, Leverage and Crises”, and as Raghuram Rajan has suggested before them), but that *an increase in household indebtness causes increasing inequality*?

          Some food for thought?

          (All the questions above are about a closed economy, but I can assure you that nothing but the wish to not cause more confusion in the reader than already is caused by my long sentences kept me from including the current account into these considerations.)”
          ———————————-

  42. QUOTE from original article: “”….An important point that is often obscured by the intensely political discussion about savings is that in the second case, in which the demand created by Thin Air creates its own supply, it turns out that the lower the savings rate, the more GDP is created by any additional spending unleashed by Thin Air….”
    ————————————————

    Which ‘savings rate’ are we talking about here? Clearly, if the workers “spend (100-X)% of those wages on their own consumption, and save (X)%”, this is not the national savings rate under examination. Instead, it is probably closer to the general household savings rate or ‘personal savings rate’, which is defined as personal savings/personal income. What would this realistically be in today’s economy?

    Let us look at the more general household (or personl) savings rate in America today:
    https://research.stlouisfed.org/fred2/graph/?g=2btJ

    Given that much of the current 5% saving-rate tends to be concentrated amongst people who are less prone to unemployment during downturns, presumably the savings rate of those workers who get newly employed due to the deficit spending will be EVEN LESS. Even so, let us assume that the the newly employed workers have a personal savings-rate which is the same as the US average of 5% as a ‘best case’ scenario. In other words, let us assume they will consume 95% their income once they are hired due to the deficit spending — this is not at all difficult to imagine in the context of the average/median family in America today that lives almost ‘paycheck to paycheck’.

    We know that the Federal government is currently running a deficit of ~440 billion$, with widespread ‘slack’ present in the US economy with high underemployment and a 750 billion$ potential gap.
    https://research.stlouisfed.org/fred2/graph/?g=2ck7
    https://research.stlouisfed.org/fred2/graph/?g=2ckb

    Again following the original example offered by Michael, we then can calculate the resulting increase in GDP “created by the additional spending unleashed” as follows:

    Increase in GDP = Original-Deficit/Savings-rate = 440 billion$/(0.05) = 8.8 Trillion$, with a rise in consumption of 8.36 Trillion$ and a corresponding rise in savings of 440 Billion$ (equal to the deficit).

    This is clearly impossible. Reductio ad absurdum.

    CONCLUSION: If a perfectly plausible input leads an equation to yield an impossible output, then it follows that the equation must either, (a) be flawed in some sense, or, (b) have some implicit assumption that is being violated.

    QUESTION: So what is the flaw or the hidden assumption that is being violated? If someone can successfully resolve this conundrum, then everybody here would gain a much better understanding of this Keynesian multiplier process.

    • Vinezi wrote: “QUESTION: So what is the flaw or the hidden assumption that is being violated? If someone can successfully resolve this conundrum, then everybody here would gain a much better understanding of this Keynesian multiplier process.”
      ——————————————————————————————————

      This is an interesting question I’m happy to spend some time with. My initial thoughts are:

      What if a large part of these people’s income “disappears” through debt payments? If so, we can say that the consumption the multiplier suggests has taken place already earlier?

      Can we say that it was spesifically the deficit which gave rise to these new jobs? (This is how it’s narrated, but is it a plausible narrative, I ask.) Or had we better view the deficit as part of the overall budget, so that the deficit is connected to all government spending? If the latter, then how does this affect, for instance, the personal savings rate assumptions? What speaks for the latter view is that when any specific government spending takes place, there are no plausible grounds for us to say that “There goes the deficit spending!” or that “There goes the non-deficit spending!”. Deficit/Non-deficit split is fully known only after the last day of the year — that is, after all the government spending has taken place –, when we (incl. businesses) can calculate the final private sector income for the year, which will affect taxes.

      I’m not a political expert, but I would guess that once any “great deficit-spending job-creation plan” is included in the budget, it becomes sacred for certain people and should we be forced to cut the deficit later, it doesn’t mean that these jobs go first? In other words, the jobs plan becomes (partly) a “great tax-funded job-creation plan”.

      Just thinking out loud here. Any feedback appreciated!

      • Did you overlook this question?
        http://goo.gl/J2qIGs

        • Vinezi wrote: “Did you overlook this question?”
          ——————————–

          First, sorry for the silence: I’ve been travelling.

          Actually, I didn’t overlook your question. I just thought it might be better to discuss other matters with you first, so that I get a better idea of how you think, and vice versa. I also wanted to learn more about economics, so that we had a better chance of speaking the same language. I’ll try to think of a simple answer to your question — will get back to you soon!

    • ^Comment above said:”So what is the flaw or the hidden assumption that is being violated?”
      —————————————————-

      I am surprised that none of the regulars here have attempted to tackle this curious conundrum. I think there may be some concern among blog-participants that Michael may get upset if they were to suggest that he has made a mistake. This concern is completely unfounded, because Michael is NEVER wrong. Here is why:
      https://goo.gl/GUzkls

      Would someone like to comment? DvD? Marko? Anyone?

      • There is no mistake nor any conundrum.

        Michael Pettis demonstration is only valid for a closed system, i.e. the global economy considered in its entirety. This demonstration may be correct but has no practical applicability for the reason that there is no such thing as a global government and a global central bank creating ThinAir demand in the form of deficit funded by newly created money. In reality, there are only national governments and national central banks (multinational central bank in the case of the ECB). The case you are referring to, Vinezi, is the national situation of the US. The US economy is not a closed system but an open one, therefore Michael Pettis demonstration does not apply. Again, the demonstration has no applicability to any individual country.

        The way the question presents itself to national governments of deficit countries in real life is this:

        In the scenario where there is slack in the domestic economy and domestic ThinAir injects demand in the form of domestic government deficit funded by newly created domestic money and this incremental demand allows the employment not of workers from ThinAir jurisdiction but of workers from another jurisdiction, then what happens?

        What happens is that the extra demand in ThinAir jurisdiction has indeed created its own supply … but elsewhere, in another jurisdiction. There is no multiplier effect in ThinAir jurisdiction nor self-financing of the incremental demand. On the contrary, people from ThinAir jurisdiction are liable for the newly issued liabilities and the attempt to honor these new liabilities has a depressing impact on ThinAir economy.

        As Keynes most likely knew given his views at Bretton Woods, Keynesian stimulus is only possible in a balanced international trade and monetary system. In the non-cooperative system in which we live since 1971, such policies are detrimental and self-defeating to deficit countries, including in the scenario where there is slack in the economy.

      • QUOTE from original article: “There is also a multiplier at work here. Assume that Thin Air’s spending is for investment, and that it plans to acquire $100 of goods and services for investment purposes. Because it has no need to build capacity or acquire inventory, the full expenditures will go towards paying wages. Let us further assume that the newly hired workers save one-quarter of their income.

        As Thin Air pays wages, the workers will spend 75% of those wages on their own consumption, and they will save 25%. Their own consumption will require the production of additional goods and services, which will require hiring more workers. In order that Thin Air acquire $100 of goods and services, it can easily be shown that the total expenditures of Thin Air and of consuming workers will be the original $100 divided by the 25% savings rate, so that in the end GDP will rise by $400, consisting of $300 additional consumption and $100 additional investment. Because the increase in GDP exceeds the increase in consumption by $100, total savings will have risen by $100.”
        ———————————————–

        Here is the “it can easily be shown” part actually shown easily:

        Let d = deficit spending, let x = national consumption rate and y = resulting increase in GDP caused by deficit spending. We can write the ‘cascading sequence of spending’ as follows—
        y = d + d*x + x*d*x + x*x*d*x +…..
        y = d + d*x + d*x^2 + d*x^3 +…..
        y = d + x (d + d*x + d*x^2 + d*x^3 +…..)
        y = d + x*y
        y – xy = d
        y = d/(1-x) — (I)

        In Michael’s specific example:
        d = 100$
        x = 75% (National consumption rate; implying a national savings rate of 25%)
        Using (I) we get y = 400$

        In other words, the GDP will increase by 400$ for an intial deficit spending of 100$. This is the Keynesian ‘multiplier’.

        Here are a few of the assumptions implicit in this calculation (formula) of the Keynesian Multiplier as y/d = 1/(1-x):
        https://goo.gl/B6LDVq

        • If I have interpreted you correctly, the formula is correct but I sense the conclusion is not.
          The original $100 of investment pays wages to workers to produces $100 of goods. The workers wages enable the purchase of $100 of goods; if not the goods produced by the same workers, goods produced by other workers. If all goods in the system are sold (other workers purchase other goods, including the goods produced by the new workers), then at the end of this production cycle the goods sold is $100 more than the previous production cycle. We now have $100 more in production than before the exogenous investment and that same $100 again pays workers to produce $100 of goods, the same amount as they produced in the previous production cycle.

          Doesn’t the formula Y=d/(1-x), which represents the infinite series, demonstrate this characteristic? If x=1, then the contribution of the original investment is always one in each production cycle. This value identifies the failure in believing in a multiplier – are we to believe that use of all the investment means the age of super abundance has arrived – production goes to infinity? No chance and no multiplier, just the sum of all the production cycles reaching infinity after an infinite number of years.
          If x=0.75, then the contribution of the original exogenous investment to total production decreases in each production cycle. and becomes nil after a few production cycles. After an infinite number of production cycles and an infinite number of years, the total contribution of the original investment to the infinite number of investment cycles will accumulate (not multiply) to four times its original value.

          By my analysis, the original investment is never multiplied; it is either used entirely over and over again, or if less, it becomes divided. No more than having energy out be more than energy in (cold fusion), can production out ever be more than original investment in?

          • I expected that refuting the famous Keynes multiplier, which is a significant feature in textbooks and discussions on exogenous investment would provoke a strong response. I have debated this proposition for a long time and still cannot understand how and why it is accepted, which makes me believe I am missing a point and have egg on my face. The analysis does not indicate its validity — multiplier goes to infinity if all investment is immediately reinvested, is refuted by analyzing the infinite series that the equation represents (described above in a previous comment), and does not obey even a simple analysis; the same type of multiplier can occur with endogenous investment

            In the exogenous investment case, if A, B and C are three producers who each produce $10 worth of goods, of which $9 are expenses in wages (purchasing power) and $1 is profit, then each needs $1 more in exogenous investment (added purchasing power) to sell all the goods and make a profit. The multiplier claims to sometimes satisfy this by adding $1 to the economy through a government deficit. The one dollar from an exogenous investment purchases the surplus from producer A and gives him the profit. Producer A then purchases the surplus from Producer B who purchases the surplus from Producer C. It then appears that $1 of investment has been multiplied into $3 of investment. Not the case.

            All $30 of production has been sold but in the next production cycle, Producers A and B, who used the dollar to purchase product from another manufacturer can still only produce $10 worth of goods, with $9 available for wages and a hope to sell the surplus somewhere for a $1 profit.
            Producer C has the added dollar and can produce $11 worth of goods, with $10 available for wages and a hope to sell the surplus somewhere for a $1 profit. Only $31 of goods can be produced, one dollar more than previously. This can be extended to a multitude of producers, only passing the dollar along until either supply is exhausted or price is raised.
            The exogenous investment of one dollar can only increase production (GDP) by one dollar.

            The same type of multiplier can occur with endogenous investment.
            .
            In the endogenous investment case, if the wage earners spend all their wages and one of the dollars is used to purchase the surplus from Producer B rather than purchasing Producer A production, then Producer B has sold its surplus and can now purchase the surplus from Producer C. Producer C then purchases $1 of unsold goods from producer A. The latter has sold only $9 worth of goods, makes no profit, suffers no loss and can remain in business..

            One dollar of endogenous investment has also been multiplied, this time into two extra dollars and $29 of production has been sold; one dollar less than if there were one dollar of exogenous investment. All producers who used the dollar to purchase product from another manufacturer can still only produce $10 worth of goods, with $9 available for wages and a hope to sell the surplus somewhere for a $1 profit. Total production has not increased, and is only $1 less than the amount of the production cycle that received the exogenous investment. Endogenous investment can also be used to multiply the purchase of goods but can only maintain production (GDP).

            I write this because of the excessive attention given to the multiplier, all of which may be false. Can we lay the multiplier to rest, which is a significant rebuke to Keynes, or have I erred and is there more to it? I am willing to stand corrected.

            There is another less obvious point to the above brief discussion – exogenous investment, such as credit and government deficits mainly purchase surplus, either by selling securities to repatriate the money leaving the country in negative balance of payments and/or by providing the economy with funds to directly purchase what limited wages cannot purchase — the surplus and mainly that which enables profit. Note how much faster profit has risen than wages have increased in the last years. From where has this purchasing power come?

  43. This seems very complicated but surely if someone applies for a loan it is because they have a use for it. The bank creates the money and they go out and spend it. I have never applied for a loan in order to deposit the money and let it sit idle.

  44. As usual, an impressive blog post. Everything could be expressed in a more simple way but I guess that, when I keep reading what you write, year after year, I like to be tortured by your tortuous way of conveying your ideas. I am not an economist and I cannot be part of your discussion but I like to know how they think and what they think. Your blog is a good window to watch that kind of things and I guess I am not the only outsider out there who enjoys it.

    saludos desde España

  45. Michael (October 30, 9:02 AM),

    “I suspect that within the next two decades orthodox economics will have been forced to change its attitude towards debt.”

    Yes, if it hasn’t changed it’ll be an astonishing case of wilful ignorance. Or should that be “an even more astonishing case”!

    Maybe for the paradigm to properly shift, sufficient of the old guard really do have to die off.

    Anyway, thanks again.

  46. In the scenario where there is slack in the economy and ThinAir injects demand in the form of government deficit funded by newly created money and this incremental demand allows the employment not of workers from ThinAir jurisdiction but of workers from another jurisdiction, what happens then to the multiplier effect, who is liable for ThinAir newly issued liabilities and what’s the impact on the economy of trying to honor these additional liabilities which have created their own supply … but elsewhere, hence in a non self-financing fashion?

    That, i think, is closer to how the problem is actually presenting itself in the current international trade and monetary system.

  47. Just two comments:

    1) I think the notion that new money creates real demand is embedded in old economic theory that does not work any more (if it ever did).

    Lots of money created these days unfortunately does not flow into the real economy and new investments, but into EXISTING assets, EXISTING financial assets (stocks, bonds, etc.) and EXISTING real assets (houses, land, art, oldtimers, etc.)
    And that does not create economic growth but only inflates asset bubbles.

    2) Money creation by private banks does add to debt because it creates additional deposits which are liabilities to the private banks.
    Money creation by central banks (QE) does not add to debt if the seller of the government securities are the private banks themselves. Then one kind of government debt (government bonds) is just converted into another kind of government debt (bank reserves owed by the central bank to the private banks).

    In the latter case, debt monetization in my view is sensible in a deflationary environment. I think Japan is on the way to do this.

    But neither new deposits nor new central bank debt does neccessarily create any additional demand for NEW real investments, it just increases the size of the financial sector until debt becomes unsustainable.

    • In my humble opinion, this is a significant comment, which deserves attention.
      Government deficits in the last years have mainly financed profits (surplus) and Fed QE has almost entirely contributed to the rise in stock and real estate values.

    • On the first point, yes, money supply is growing much faster than the asset base of the economy, in the US and in most developed countries and in some developing countries more recently. So, yes, newly created money goes to a significant extent towards inflating values of existing assets. Such illegitimate distortions in wealth distribution by continuously socializing the losses and privatizing the profits arising out of money creation are socially destabilizing. They are an exorbitant privilege for the few and an exorbitant burden for the many. Because of their lack of a correct diagnostic, central banks are planting the seeds of the next crisis by trying to solve the previous one. It has been like that for a few decades already, without triggering any questioning of the official doxa.

      • How are you defining the money supply? In the American financial system, THE MONEY SUPPLY IS NOT LIMITED TO THE AMOUNT OF BANK DEPOSITS!!! Actually, the amount of bank deposits (and the size of the commercial banking system) are only ~80-90% of GDP in the US. Money supply growth is probably less now than it’s been in several decades. In the case of one of the broadest measures of money supply growth (M4 as defined in the US), the growth rate has been below NGDP growth since 2008. This has been the most reputable source I’ve found on money supply growth. I’ve found other sources including places like the CATO Institute and they do come up with similar conclusions, but I don’t feel confident citing them.
        http://www.centerforfinancialstability.org/amfm_data.php#thumb

        We can talk about money supply growth and central banks, but I’m pretty sure the money supply that’s been created by the Fed hasn’t done much more than to offset private sector money creation. I’m sure that asset markets have been distorted as a result of central bank policy, but what more can we really do? The problem isn’t central banks, but foreign governments that’re turbocharging growth by creating international distortions in capital flows.

      • Any measure of the money supply that ignores repo markets, T-bills, commercial paper, and money market instruments is, by and large, not very useful when discussing modern financial systems.

      • I realize I should have explained my statements.
        Theoretically, the wages in the system are sufficient to purchase the product but not the surplus, which is the profit. Deficit spending, whether its welfare, building infrastructure or purchasing airplanes, directs purchasing power into the system without creating more product.for market sale. That purchasing power, arising from deficit spending enables purchase of the surplus (profit).
        The Federal Reserve thrust has been to maintain low interest rates, QE being one method, in order to stimulate credit. However, banks have not been lending sufficiently and the Feds purchase of government securities, together with low interest rates, has promoted purchase of higher return assets.
        Certainly, profits have expanded faster then wages and asset values have increased faster than the overall economy.

  48. forgive my off-topic post but there seems to be a prob with the site’s rss feeds

  49. In the comments section, Michael WROTE: “The BIS paper claims that “the financial system can endogenously generate financing means, regardless of the underlying real resources backing them”, but for this to be a useful way of thinking about the role of the financial system, as must we understand what it means to “generate” financing. There are at least two very different processes (or some combination of the two) that will be involved here:

    (I) one in which the goods and services purchased by the spending that the financial system “endogenously generated” are made available only because consumption or investment spending in another part of the economy was suppressed,
    and
    (II) one in which the “endogenously generated” financing created new demand which brought unemployed workers, unused capacity, and resources (energy, raw material, etc.) that were sitting around as unwanted inventory, causing the total production of goods and services in the economy to rise by some amount greater than the original amount of “endogenously generated” financing (divide that by one minus the savings rate).

    These are two completely different processes.”
    ————————————————

    (I) is the naturally-occurring endogenous creation of money/debt when the growing economy is operating at potential (i.e. when inventories/prices are fluctuating about the equilibrium level with technical full-employment, technical full-utilization of capital stock and an optimal level of production (‘goldilocks economy’). In order words, when labor and capital-stock inventories are at their natural equilibrium level and production has been maximized w.r.t. all resources available. Here is a diagram of the economy in this state:
    http://goo.gl/Ekf9sm

    (II) is the additional (i.e. over and above the naturally-occurring) endogenous creation of money/debt by the government (Keynesian deficit) when the economy is operating below full-potential (i.e. when inventories of goods & service are maintained about the equilibrium level by large-scale layoffs, plant idling & production declines). In other words, when labor inventory and capital stock inventories are higher than (or above) their natural equilibrium level and production has been curtailed below the level possible with the full utilization of labor & capital-stock. Here is a diagram of the economy in this state:
    http://goo.gl/mhl7xV

    INTERMEDIATE TRANSITION:
    https://goo.gl/jm2fEB

  50. I take issue with the statement, “There is also a multiplier at work here.”
    The exogenous investment only buys a one time product, which is sold to the investor of the exogenous investment. The wages paid in production of that product can either buy existing consumer products from the existing production cycle, which only raises the prices of the consumer goods, or be used to satisfy investment in new production as part of the later production cycles.

    All that is added to the system is the money from the original investment, which is transferred to the workers. From then on the added production minus the profit equals added wages. No more is added to the system during each production cycle than the original investment. As matter of fact, if a portion of the wages from the original investment is not used, then the added production from the original investment and its contribution to GDP decreases with each production cycle until the production from the original investment disappears. The multiplier is actually a divider – don’t use all the wages from the investment and the original contribution to the GDP will fade to nil.

    The confusion is that investment must be defined as part of a production cycle. Each further production cycle contains the added investment and nothing more. The formula for the total contribution of an investment over an infinite number of production cycles is 1/(1-MPC), where MPC is the multiplying factor. If MPC = 0.8, then in an infinite number of production cycles the total contribution of the investment will be 5 times the original investment. If MPC =1 then in an infinite number of production cycles the total contribution of the investment will be an infinite times the original investment. Believing in the multiplier is equivalent to believing in a perpetual motion machine, extracting unlimited investment from a meager investment.

  51. Seems to me that you’re misidentifying bank generated credit as money, which is consistent with a misunderstanding of our current monetary system. Our legal tender money is defined by law. Neither the Fed or the banks have the legal authority to create money. What they can do create is credit, an obligation to pay money. All credit generated is an obligation to pay legal tender money. If it is an obligation to pay money, it cannot be money. As I’ve said; the only ones who benefit from the conflation of money and credit are the issuers of credit with no money, and economists.

    • “Our legal tender money is defined by law. Neither the Fed or the banks have the legal authority to create money.”

      So apparently everything operates at the end of a gun. All that matters is some law backed by the threat of force. It’s the single thing that makes the world operate. There’s an incorrect (implicit) assumption made in your comment that’s simply being assumed away.

      “All credit generated is an obligation to pay legal tender money. If it is an obligation to pay money, it cannot be money.”

      It can be money if people think it’s money. All that matters is what people think and how they trust the institutions. Finance isn’t about anything real; finance is about trust.

  52. “the credibility that allows it to borrow in the first place”

    ????? This is a confused comment. As the US Govt DOES NOT BORROW. Rather it issues bonds to drain reserves. A big difference. And until this difference is understood an economist or financial writer does not understand what’s going on re Govt spending and “borrowing” money. There really is no excuse now as Warren Mosler’s simple book explains all of this very clearly

    • The US government absolutely borrows. The US, like any other financial institution, must meet its bills.

      “Rather it issues bonds to drain reserves”

      This is closer to how Alexander Hamilton’s system worked in 1790, but this is not how things work today. This is just MMT garbage that makes other assumptions about a financial system that just does not have to be the case.

      Actually, the Treasury issues bonds at auction to meet its financing needs. It doesn’t “issue bonds to drain reserves” because Treasury bonds aren’t reserves. As I said, government bonds CAN BE reserves depending on the financial system in place. If I remember correctly, government bonds were reserves in Hamilton’s system where the more debt the government has, the more credit for the entire economic system, but that’s not what we have to day.

    • Since it’s from Warren Mosler, you’re definitely spewing MMT garbage. Ironically, the kind of system that the MMTers say is “modern” is actually about 200 years in the past, as ironic as that may be. Welcome to the 21st century, you might notice that our financial system has a different flavor than the 19th century financial system.

    • So I just wanna make clear how the assumptions impact the conclusions of what you’re saying (cuz there’s assumptions you’re making that you’re not realizing your making). One of the assumptions in MMT is that the government is the primary institution that creates a payment system and imposes it on everyone else by holding a gun to everyone’s head. This can be true, at times, but this is certainly not true in the United States.

      In reality, the government really uses the payment system provided by the private banking system. So what that means is that the Treasury has an account at the Fed just like every other bank and many other financial institution does. That’s basically as far as the link goes. In reality, everything about the American banking system is private, including the Federal Reserve. The government really doesn’t belong to the people (this is just nonsense coming from leftists trying to rewrite narratives to support their garbage). The federal government is nothing more than an empire with an imperial currency that gets its power off the decentralized payment system of the private sector. The entire existence of some sort of a national payment system is purely geopolitical, not some nonsense about “political economy” (wherein the economic system is set up for political uses).

      In other words, the primary reason for the existence of a unified currency is to take the local elites and flip them to the imperial (federal) government.

      Earlier in my comments on another page, Prof. Pettis suggested that I may want to use the word “empire” a little bit less, but the reason I really insist on using it is because this modernistic nonsense really makes no sense. When you try to think according to modernistic nationalist narratives based on “democracy” or “power to the people” rather than the geopolitical reality and when you focus on the “political economy” aspects instead of how financial systems have to adapt to fit geopolitical constraints whilst using theories (all political economy works off theories), you really develop a lot of misconceptions on the way the world works and why it works that way. The narratives sound nice and are very emotionally pleasing, but that’s really all they are. Those narratives aren’t fundamentally sound or robust.

      We really need to change the entire framework with which we operate and question all of the basic assumptions of the modern world. The entire philosophical construct we use (particularly this construct designed by leftists and the Marxist/nationalist bullshit that’s been pushed over the past 100-150 years) is not only wrong and misguided, but completely dangerous. We need to reverse the negative connotation of empire and instead view it as something necessary instead of viewing the nation-state, and all the horrible violence and intolerance that stems from the nation-state, as an evolutionary process. Nation-states aren’t robust structures because they homogenize their population. Empires are antifragile because they’re able to use divisions amongst their populace as a way to strengthen the imperial system as a whole.

      • There needs to be a correction, it should be:
        In other words, the primary reason for the existence of a unified currency is to take the local elites and flip their allegiance to the imperial (federal) government.

      • There are a number of things wrong with this post . But one point is the comment that the Fed is private. Who appoints the Fed chairman. Who gets the Fed profits beyond a certain level. Who is required to automatically issue reserves to support any US treasury payment.

        “In reality, the government really uses the payment system provided by the private banking system”
        Come on. MMT understands this point very well. But the banks must make the payments using reserves (the banks asset / Fed liability) created out of thin air by the Fed to support this bank credit (our money asset / banks liability).

        Do you understand basic double entry book keeping. And what a financial asset is?

        And most of your post is another topic. Interesting and in my view very misguided re empires. But I’m more concerned about correcting confusion about money, banking and treasury payments. The MMT job guarantee is ridiculous nonsense but otherwise they are spot on regarding this subject.

        • “But the banks must make the payments using reserves (the banks asset / Fed liability) created out of thin air by the Fed to support this bank credit (our money asset / banks liability).”

          It operates in the other direction. Banks issue a loan now, they look for the reserves later.

          Do I understand double-entry bookkeeping? Everyone knows both sides of a balance sheet have to expand and contract simultaneously since no such transaction can create a shift in the net worth.

          A financial asset is a liability on the other side and all banking is swap of IOUs.

          Most of my post isn’t another topic and my view of empires is correct. The most violent aspect of world history and the most intolerance came from nation-states and the rise of nationalism. With that being said, it wasn’t the Treaty of Westphalia that created nation-states like the bullshit most people are taught. It was World War I (look at a map before World War I or even during World War I if you don’t believe me). The advantage about empires is that they operate within existing institutions so you don’t get radical change or massive blow-ups. Once this Marxist/nationalist sentimental bullshit started coming in, massive changes happened via revolution while traditional institutions were overthrown.

          Also, don’t assume all empires to be colonial empires.

        • BTW, in the early 19th century, there wasn’t as much debt

          “But I’m more concerned about correcting confusion about money, banking and treasury payments.”

          Then why not look at balance sheets. For some reason, MMT gives theories but I’ve never seen an MMTer draw a balance sheet. Once you look at a balance sheet everything becomes obvious.

          On another note, do you know how double-entry bookkeeping came to be (it was not always the case and certainly not before 1500)?

          As for the rise of nationalism and debt-based monetary systems, debt based financial systems became much more pronounced due to the rise of nationalism.

          When you have nation-states, they have a problem accepting people of different ethnicities or nationalities because their population is homogenized. So any sort of natural shift in population basically makes nation-states incapable of adapting. This is exactly what’s happening in the European nation-states right now. Empires would usually deal with the issue by expanding their frontiers, making some warlord pay nominal respect the “emperor”, collect taxes, and let everything else be.

          Nation-states end up closing their “borders” and not fixing the underlying issue (maintaining peace) so you essentially have apartheid with political correctness. When you do have people come into your society that aren’t the same nationality, you have no way of assimilating them so you get large groups of people viewed as second class citizens living in ghettos that look different, have different cultures, different ways of life, and they’re not accepted which leads to a permanent underclass with effectively no way out. These people then have higher fertility rates, replicate like crazy, and you end up getting bigotry, intolerance, and violence. Anyone who comes into the country for jobs as an immigrant usually gets either thrown out or treated like shit because they depress wages.

          To talk about the ideology or philosophy of mainland Europe as civilization is a joke. Such thinking is barbarian, not civilized. Mainland Europe is now in terminal decline and there’s really not much hope. I also wonder how many people realize that by the beginning of the 20th century, the three most powerful world powers were the British Empire (not, in the least, limited to Britain), the United States, and Japan. I’m guessing not too many.

        • A large part of the rise in debt-based systems along with “growth miracles” that led to more long-term busts or longer term stagnation and environmental damage in the third world came because of the rise of nationalism. Due to the nature of nation-states, they must prevent anyone who’s not of the nationality to have a say in their political system, which means they have to tightly control who holds deposits in their banking system. Throughout most of Europe, capital is a national asset.

          I’m sorry, but anyone who says that going from Alexander I and Napoleon to Hitler and Stalin is a sign of progress is an idiot. You replaced people who only cared about expanding their empires with people who were essentially complete psychopaths. Anyone who has legitimate sympathies to the French Revolution (*cough* Marx *cough*) is a complete sucker.

          The people who’re most attracted to Marx are usually suckers who’d never committed a violent act in their life that portray victimization as virtuous, legitimately believe that if everyone was like them the world would have no issues, and view themselves as so intelligent that they can implement their ideas forcefully by eliminating all barriers to their power and think that all this is how “progress” occurs. That’s just sucker thinking.

          To this day, I still don’t know why people find Marx or Engels good thinkers. These people were two-faced, hypocritical bigots who contradicted themselves.

    • – Yep, the usual MMT claptrap. And it can be easily rdebunked. E.g. the US govt. spends more than it has on income (taks revenues) and therefore needs to borrow the remainder, either from the public (investors, banks) or from the central bank (then it’s called “Monetization”). When a govt. “borrows” from the central bank then it doesn’t “drain the reserves” of the central bank. The central bank simply creates more credit for the govt.
      – Yes, the govt can literally “print money” but then a country is on its way to Hyper-Inflation.

      • Willy2. You need to drop all you think you understand and start again from the beginning.

        The Govt does not print our money except for some notes and coins. And these are only a token for bank credit. The Fed creates by journal entries the banks and treasuries money not our money (=bank credit). This is all created by banks

        The rest is just more nonsense as well. Especially your comment about hyperinflation.

        • – I fully agree with your reply. But that doesn’t refute the fact that a govt borrows money. When I have say $ 10.000 in a cash deposit and take $ 5.000 to buy a T-bond then I reduce my loan to the bank by $ 5.000 and increase the loan to the US govt by $ 5.000. Then there’s no “draining of reserves”. Only the composition of my “reserves” have changed.

          The “draining of the reserves” only occurs when the govt forces the primary dealers to buy T-bonds.

          – Another blind spot of the MMT crowd is that they think that inflation restricts a govt “draining the reserves”. No, the restriction is Deflation. And Hyper-Inflation is EXTREMELY DEFLATIONARY.
          – A third blind spot of the MMT crowd is that they confuse Solvency with Liquidity.

      • In the case of the Federal Reserve, the central bank doesn’t create more credit directly to the Treasury. In the US, the Fed buying bonds directly from the Treasury at auction is banned.

        I remember Steve Keen saying that American law was created that way from a misunderstanding, but it’s Keen who’s wrong on that. It was designed that way on purpose because then you get some nutcase in power who blackmails Fed chairmen to do their bidding along with other possible conflict of interest between varying aspects of the Executive and takes away power from the Legislative, which Congress isn’t gonna just allow for no reason or without something back.

        • eg Treasury pays Microsoft for whatever. Microsoft banks at ABCD Bnak
          The Fed JE is
          CREDIT Bank account ABCD (treasury liability / bank asset)
          DEBIT Treasury bank account (Fed asset / treasury debt)

          ABCD JE is
          CREDIT Bank account Microsoft (ABCD liability / Microsoft asset)
          DEBIT Treasury bank account (ABCD asset / Fed LIABILITY)

          Microsoft JE
          CREDIT Revenue (or debtors)
          DEBIT Money at bank ABCD

          • That’s actually not a correct explanation. Rather than using these weird MMT terms, why don’t you just draw a balance sheets? Your explanation isn’t only wrong, but it’s a poor way of thinking about it.

            When a Treasury needs to issue a bond because it’s short of cash, this is how the balance sheet changes
            Treasury Balance Sheet:
            Change in Assets: +Cash
            Change in Liabilities: +Bond

            Private Sector Net Balance Sheet Shift:
            Assets: +Bond, -Cash

            The Fed is not allowed, by law, to buy Treasuries at auction and can only buy Treasuries in the secondary market. So what this means is that the Fed can’t buy bond where the funds go directly into the Treasury. In other words, when the Fed buys bonds, it looks like the transaction below.
            Fed Balance Sheet:
            Assets: +T-bond
            Liabilities: +Cash

            Net Private Sector Balance Sheet:
            Assets: -T-bond, +Cash

            When the Treasury acquires something from Microsoft or whatever, the Fed doesn’t get involved. Yea, the Treasury has an account at the Federal Reserve, but there’s nothing special about that considering that basically every single bank and many other financial institutions do.

          • So I remember Warren Mosler actually would say something similar to me. Then I learned how to think about things in terms of balance sheets and questioned him on this stuff and he stopped responding.

            MMT’s underlying framework isn’t fully correct because there’s implicit assumptions built into the model. For example, Treasury bonds are not a payment clearing mechanism. T-bills kinda are, but if you consider T-bills a payment clearing mechanism, then you should also consider ABCP a payment clearing mechanism.

            Simply put: MMT is a bunch of hogwash and expresses a view of a monetary system that’s neither modern nor correct.

          • Suvy
            “only buy Treasuries in the secondary market.”
            This is true but
            1 Its a self imposed restriction and
            2 can be easily got around by doing QE. where reserves created by JEs can be used to buy back bonds

            And journal entries are not weird MMT terms. And as money is created and destroyed by JE’s it’s impossible to understand how the treasury payments sytsem works and money is created without understand these “weird” JE’s.

            “the Treasury has an account at the Federal Reserve”

            It’s the key to the whole banking system. its the complete opposite to “nothing special”.

          • “This is true but
            1 Its a self imposed restriction and
            2 can be easily got around by doing QE. where reserves created by JEs can be used to buy back bonds”

            It’s not really a “self imposed restriction” because the banking system wasn’t designed by the system. It was designed by the private sector. Let’s be honest, the United States is run by (and has always been run by) finance capital. It’s not the government that creates the system. It’s the government that’s run by the system.

            “It’s the key to the whole banking system. its the complete opposite to “nothing special”.”

            This is nothing more than an assumption.

          • “can be easily got around by doing QE. where reserves created by JEs can be used to buy back bonds”

            This is an inherent contradition. QE occurs in the secondary market. So how can you go around the secondary market by doing QE?

            RJ,

            MMT has a lot of implicit assumptions built into the model that aren’t really true. They CAN BE true, but they’re currently not true. They were true in the US at the turn of the 18th century, but haven’t been true since Andrew Jackson.

            MMT assumes that it’s the government that creates the payments system and that money is created by government spending. This is rarely a true assumption.

            Most money develops privately. Governments come in and take control for geopolitical purposes (to ward off invaders). This is why it’s shifts in the power structures of the financial system that create shifts in governance systems. For example, the rise of republican institutions primarily stems from private money and capital markets developing as ways to get around kings trying to tightly control financing.

            RJ,

            Rather than reading theories without fully understanding the assumptions, you need to go read financial history. It’d debunk a lot of the nonsense that MMT pushes as true.

            Another thing you need to work on is the process by which you’re coming to your conclusions. In other words, you need to take a step back and fully understand the assumptions and logical leaps you’re taking. Learn to always, always question the assumptions rather than taking them for granted. Also learn how geopolitical constraints must be met by financial systems.

            If it weren’t for geopolitical constraints, the natural system of finance is free banking. Only when you get states developed for war (like European nation-states) do you get tightly controlled banking systems that run entire through governments and are controlled by governments.

            Again, be wary of the assumptions and try to understand how shifts in the assumptions create shifts in the conclusions. Many people who don’t think rigorously find theories (especially social science theories) quite enamoring, but those same people usually don’t understand the conditions under which those theories hold.

            Enforcing something like MMT DOES NOT take us to the future. What it does is effectively push us to the past.

  53. @RJ,

    Learn balance sheets and think in terms of balance sheets. MMT’s framework IS NOT how the world operates (ex. the Treasury actually has to acquire financing before it can spend and can’t just credit to an account under current law). MMT is actually (much) closer to the way the American financial system worked in 1800 than it is today. MMT is a horrible representation of today’s financial system and MMT is essentially a system from ~200-250 years ago. Unfortunately, people don’t read financial history and Mosler’s understanding of financial history is actually quite poor (I’ve asked him about this and every time I bring up balance sheets he doesn’t respond, which is probably due to the fact that the truth goes against his own agenda). To say that government debt doesn’t matter or that government debt represents “the people” and their ownership and cooperation in society is bullshit.

    Governments should be run, and are run, by elites. The US is one of the most elitist political systems ever designed. The government doesn’t represent some collective ownership by the people or anything like that and the American political system certainly wasn’t designed by the masses or for the masses. The system was set up by the elite for their own purposes with liberal institutions to check the elite and throw out ineffective elites.

  54. “To say that government debt doesn’t matter.

    He has not said this. Govt debt is essential to stop the economy collapsing. It is the ONLY way the non Govt sector can NET save

    Debt has two sides. The asset and the liability side. the liability side is needed to back assets like money and bank reserves. It is also needed to create net profits.

    Without debt increases = a depression guaranteed. And monetary sovereign Govt debt is irrelevant to the Govt but critically important to us as an asset. The more Govt debt the wealthier the non Govt sector is.

    • “The asset and the liability side. the liability side is needed to back assets like money and bank reserves. It is also needed to create net profits.”

      This is completely wrong. Banking is just a swap of IOUs. Ultimately, it just comes down to trust. It’s just two sides making a deal.

      Profits are a different story. Profits are shown on an income statement, not on a balance sheet. Profits are revenues minus costs.

      “Without debt increases = a depression guaranteed. And monetary sovereign Govt debt is irrelevant to the Govt but critically important to us as an asset. The more Govt debt the wealthier the non Govt sector is.”

      This is flat out wrong. The US actually never really had a depression until after the creation of the Federal Reserve (anyone who says we had depressions in the 19th century needs to pull up the data because the data easily falsifies such conclusions). The “depression” in the 1830’s, 1870’s, and 1890’s weren’t really depressions. In the 1870’s, nominal GDP increased by 3% with real GDP increasing at a rate of 7% while the US had already established the highest standard of living at the time. Wages did fall 20% in the 1870’s, but prices fell 40%. The 1890’s were a great decade for the real economy as well.

      And a monetary sovereign government CAN BE critically important, but it can also be detrimental. You can’t create real resources out of thin air and all government spending necessarily transfers real resources. The question comes down to how those resources are used.

  55. Suvy. You’re one of many that understand a very small amount and think you know the whole picture. But you clearly do not.

    “Profits are a different story. Profits are shown on an income statement, not on a balance sheet. Profits are revenues minus costs.”

    Yes this is a 16 year olds understanding who is just starting to learn book keeping. But if you could think beyond only one company you would start to (maybe) see the connectiveness of the whole. It’s like if half the world is unemployed and earning no income then the other working half can not sell the products to the no income half. So it spirals downwards and then only 40% are employed etc.

    Likewise with companies. They are all connected and in effect the world is one big connected balance sheet (and the profit BTW is a component of the balance sheet. It’s just the RE movement over a period). So if one company earns revenue another company incurs an expense. Or if one records a debtor another records a creditor.

    So where does TOTAL company world profits come from. Otherwise one companies profit = another companies loss. In part its capitalized expenses = assets. But the big part is increasing debt. For example a Govt loss (debt increase) = a non Govt profit (asset increase)

    Think big (connected whole) rather than small (one country/ one company / one person) and you will start to see what is obvious. But most are lost in their little confused world and can’t see outside this little box.

    • “They are all connected and in effect the world is one big connected balance sheet (and the profit BTW is a component of the balance sheet. It’s just the RE movement over a period).”

      One big connected balance sheet would mean that almost all of the financial entries in a financial system like the US would cancel. In other words, this comment makes no sense.

      “So where does TOTAL company world profits come from. Otherwise one companies profit = another companies loss.”

      This is an AWFUL mistake. Where are real assets? What about REAL inputs in production? You can have a rise in profits and consumption purely coming from falling input costs, falling production costs, and falling consumption costs that actually INCREASE real consumption. You don’t need governments even involved in this.

      From a historical standpoint, a simple counter example to this preposterous claim is simply the 19th century US without a central bank where government deficits were effectively zero.

      “For example a Govt loss (debt increase) = a non Govt profit (asset increase)”

      WRONG! A government debt increase can actually INCREASE private sector debts as well. It just depends on how the government debt increase affects everything else. That saying that’s thrown out by MMTers is such nonsense because it assumes that a debt increase by the government impacts everything else linearly, which they don’t bother to state. For example, with the US being the center of the world’s payment system, a government debt increase means you’re creating a safe, liquid asset for the rest of the world to hold. In other words, a government deficit could simply just increase the current account deficit while either leaving the private sector with no shift in its net balance or even a private sector that increases its deficit as well because the safe, liquid asset created is for both the private sector as well as the FX sector.

    • “But if you could think beyond only one company you would start to (maybe) see the connectiveness of the whole. It’s like if half the world is unemployed and earning no income then the other working half can not sell the products to the no income half. So it spirals downwards and then only 40% are employed etc.”

      If you could only understand all of the implicit assumptions you make in your comments and apply some rigor and discipline in your thought process would you realize the blatant and horribly incorrect errors you’re making in your procedure by which you derive your conclusions. You have a country that has the world’s most capable military, that’s second in nuclear stockpiles, is #1 in preparing for warfare in space, and you’re arguing that the US government borrowing more and using a theory that supports current account deficits (MMT supports current account deficits) is good? That’s a horribly unstable situation.

      “Suvy. You’re one of many that understand a very small amount and think you know the whole picture. But you clearly do not.”

      LOL! You’re aruging that it’s stable for the country’s government that’s got the most militarily powerful in world history to accumulate perisistent deficits to fix an unemployment problem?! Then you’re accusing me of not understanding. You’re utterly foolish.

    • Also, it’s not one big connected balance sheet. It’s independent INTERLOCKING balance sheets. Those are two completely different things. Again, you really need to work on being more rigorous in your thought process. You also may wanna read a financial history book or two (or as many as possible so you don’t spew such garbage).

  56. At one final point. i understood all of this before I knew MMT even existed. But MMT explains it all very well. I don’t agree with their (ridiculous) JG (job guarantee) and have doubts about their QE makes no difference at all claim but their explanations of the way the current banking and treasury operates today is spot on. In part because they understand double entry book keeping. Most economists (appallingly) do not. Some try but still don’t get it.

    • The only way that the way you’re thinking every applies to the actual economic system is really during wartime. All other times, the stuff you’re saying is just total and complete garbage. Stuff like saying that a deficit for the government sector is a surplus for the private sector is absurd because it assumes that the variations and effects are linear.

      Obviously, accounting identities have to hold, but accounting identities can still hold if you see a shift in the FX deficit and assuming that there won’t be a shift in the FX sector when the government issues debt, especially when the country in question is at the center of the world’s payment system, is extremely foolish. It’s just a faulty assumption and nothing more.

  57. Trying to solve current crisis by making new one.

  58. “When banks or governments create demand “out of this air”, either by creating bank loans, or by deficit spending, they are always doing one or some combination of two things, as I will show. In some easily specified cases they are simply transferring demand from one sector of the economy to themselves. In other equally easily specified cases they are creating demand for goods and services by simultaneously creating the production of those goods and services. ”

    You can tell the difference by seeing whether you get inflation. If you *do* get inflation, you are simply transferring demand from one sector to another. If you do *not* get inflation, you are creating new economic activity.

    That’s the operational distinction and I’m not sure why it took you several thousand words to make the distinction. But feel free to use my formulation. 🙂

  59. ” The monetarists operate in a supply-sider’s world of full capacity utilization and zero unemployment, whereas the structuralists operate in a Keynesian world of weak demand, high unemployment and low capacity utilization.”

    Absolutely right. However, in practice we have been in the Keynesian world for the majority of industrial civilization, with very rare exceptions.

    The only clear-cut exceptions I can think of offhand are:
    — World War II, which was a pure monetarist world of full employment and no slack
    — the Oil Crises in the 1970s where the US was at full capacity usage of *oil* (given the production rate determined by OPEC) — even though the economy had lots of other slack capacity (labor etc.) This wasn’t understood properly by either the monetarists or the Keynesians even though a very basic “cofactors of production” model explains what’s going on: unemployment is high because the workers can’t do their jobs without the oil. The solution to this is of course to change technologies to stop requiring oil, a solution neither seen nor understood by monetarists or Keynesians at the time, because it’s a structuralist solution.

    • ….anyway, my point is, given that nearly all of economic history since the Industrial Revolution has been “Keynesian world”, being a monetarist is suspiciously opposed to reality.

      As a result I tend to suspect monetarists of having ulterior motives — and they usually do! Usually they are paid by rich people to support the interests of the rich. The rich are often interested in increasing their *relative* wealth — better to be a rich man in a poor country than a middle-class man in a rich country, and ideas like that. Inducing economic recession in a capitalist economy causes wealth to concentrate in a small elite, and using monetarist policies when there’s high unemployment makes sure that the wealth stays with that elite, so the selfish rich often support such policies. And pay corrupt economists to promote them.

    • “Inducing economic recession in a capitalist economy causes wealth to concentrate in a small elite, and using monetarist policies when there’s high unemployment makes sure that the wealth stays with that elite, so the selfish rich often support such policies. And pay corrupt economists to promote them.”

      Uhhhhh, in the case of the US, the largest corrections of inequality have been recessions and depressions. If you a monetary contraction that rapidly tightens liquidity, you will get significant asset price declines. It’s the wealthy that hold assets and they’re the ones that get hurt.

      I also disagree with the idea that using monetarist policies MUST make sure that wealth stays with the elite. I guess it depends on what you mean by monetarist. If you mean liquidity expansion during economic contractions as monetarist, then it’d depend on other factors. A liquidity expansion by central bank balance sheet expansion means that you’re swapping less liquid assets for cash. In other words, you get a bunch of cash looking desperately for a yield. If you’re a wealthy and developed country, much of that cash and liquidity pumped into the financial system (this would probably be cash in the hands of dealers in asset markets) will flow into higher risk assets that include foreign assets, especially emerging markets. In other words, that liquidity expansion can create capital outflows into other countries that depreciates your currency and makes your goods more competitive abroad. In other words, there are situations where “monetarist policies” can actually help an economic adjustment. The reason I actually didn’t have a problem with QE 2 or QE 3 is because it placed downward pressure on the USD in FX markets, which is beneficial for American exporters and places a downward pressure on the current account deficit.

      To be honest, I’d be very scared about what the current account deficit could’ve been over the past 5-7 years without QE 2 or 3. I think it’d have been much higher. Of course, if you are running large current account deficits, it also means that your financial system is a net creditor on the margin to the FX financial system. How can you deleverage your economy and your financial system if you keep running persistently large current account deficits? If we assume NGDP is growing at 4% and government budget deficits at 3% with private sector debt at 100% of NGDP, a current account deficit of 2% vs a current account deficit of 5% for a period of 5-7 years makes a MASSIVE difference in how quickly your private sector deleverages.

      The idea that massive monetary expansion will always result in a disaster that makes deleveraging and demand worse relies on other assumptions that we must examine more carefully. Now it is true that massive liquidity expansion does increase inequality, which we must certainly be mindful of. However, the impacts of liquidity expansion on the current account balance via FX mechanisms cannot be ignored either.

      If liquidity expansion results in a lower current account deficit that allows for quicker private sector deleveraging, it may even prevent some of the transfer to the elite by allowing the poor, working, and middle classes a swifter deleveraging. Of course, I’m assuming the debts of the poor, working, and middle classes are held by the elite, but that is generally true.

      It’s also important to note that liquidity expansion, as discussed in this and other comments, forces those holding assets into more risky assets. Since the primary holders of assets are the wealthy, it forces the wealthy into a situation where they’re forced to take risks with their resources which is not a bad thing. When the liquidity expansion stops or reverses, it’s the wealthy that get hit the hardest. The worst possible consequences for an economy over a longer term period is an elite that takes no risks with its resources and suffers no consequences for it. At certain times, liquidity expansion can prevent these kinds of outcomes.

      Note: I AM NOT saying that liquidity expansion is good or bad. What I am saying is that while liquidity expansion does increase asset prices, we can’t automatically jump the gun to say liquidity expansion helps a crony elite in the longer term. In fact, you could actually get the opposite consequences in the longer term simply because the wealthy are being forced to take risks and not given a “safe” return on their capital.

    • Economics is not zero-sum. The idea that if the populace at large can only benefit if the elite do not or that a rise in inequality must only benefit the elite at the expense of other classes in society is not a valid assumption and is certainly not a universally true conclusion. Now, it is true UNDER SOME CONDITIONS, but that doesn’t mean it’s universally true.

      If you get new technologies where 10,000 new firms invent something new but only one firm succeeds, the benefits of releasing that new technology will accumulate with that one firm. In other words, the probability distribution underlying the wealth creation process is fat-tailed. If that is the case (and I’d argue that it usually is), winner-take-all effects are a necessary byproduct of that process. What it also means is that the rarer the success, the more winner-take-all that success will be and it will be so in a disproportionate manner. It also means that the most important aspect in the creation of wealth is the NUMBER OF TRIALS, regardless of the number of winners. Assuming that the distributions for wealth creation are fat-tailed, everything I said can (and has been) shown mathematically. Unfortunately, economists are horrible at grasping basic mathematical concepts.

      We all understand that excessive inequality creates financial distortions that must be addressed, but that doesn’t mean all increases in inequality should be prevented. It just means that we need an adjustment at a time period when the growth model that was leading to the rise in inequality must be reversed.

  60. Just discovered your blog… as my interest is money and banking I began with this post… only got thru about 4 pages before my mind wandered, or kept thinking, ‘when ya’ gonna get to the good stuff’.

    So I’ll simplify. Debt, no matter how much, is the problem. So no debt is the solution. Governments must never borrow money! NEVER. And why should it, a government is the only entity that can create and SPEND it’s own money. Banks must NEVER create money out of thin air, banks must only LEND pre-existing money – money from depositors who wish the bank to manage for them their savings. Ya gotta take the money creation machine away from banks because they can charge interest on fake debt – debt created out of thin air, which is the job of the government because the government is the only entity that can create money without interest and debt-free at the same time.

    There.

    Solved the whole debt issue for ya.

    • The only way for there to be “debt free money” is if you use money as some real asset like gold or silver while ending fractional reserve. If governments use money that’s a financial asset, the money involves debt, BY DEFINITION, since the other side of a financial asset is a financial liability. Unless that financial asset is equity, which in the case of money it’s not, that financial asset MUST NECESSARILY be a debt BY DEFINITION.

      The idea of “debt-free money” outside of the case used by a few Austrian economists and others is literally a logical contradiction. Hence, using such arguments implies your assumptions are wrong regardless of what those assumptions are.

      Secondly, governments don’t start out with a money that they spend into circulation. That’s true if you have some isolated autocratic kingdom in the eyes of some crazy king. With republics, however, money usually (almost always) begins as a privately issued entity by various groups of trusted elites like merchants, bankers, industrialists, etc that ends up being used by the government as a way to stabilize its accounts.

      *Sigh* More people need to read financial history, war history, and history in general. When governments get control of the monetary system and start issuing absolutist orders on money, it almost always turns to absolutism in general. There’s no financial checks on the government at all and it usually turns into disaster. Honestly, I can’t think of a single time in history where it wasn’t the case.

      • You first part I agree with. This I don’t

        “Secondly, governments don’t start out with a money that they spend into circulation. ”

        In fact they do in effect. The Govt’s and banks money is central bank reserves. Bank credit is second level money. Notes and coins is just a token for bank credit. So the highest level starting money is CB reserves. Without this (CB reserves) banks are finished. So whoever controls the central bank calls the shots. You could argue that it’s not the US Govt but it clearly is. They receive the profits in excess of a certain level. And the Fed is required to always provide the reserves to support US treasury spending. This goes as an asset to the banks to support the banks credit bank liability (our money asset) . US Govt spending automatically creates new money (bank credit) and new reserves. Bond issue (that can be reversed at any time via QE) simply drain these reserves.

        • “In fact they do in effect. The Govt’s and banks money is central bank reserves. Bank credit is second level money.”

          Well, there’s an implicit assumption you’re not aware of. You’re assuming the hierarchy comes from the top-down, but it DOES NOT. The hierarchy comes from the BOTTOM-UP. The private financial system DOES NOT use the government’s payment system. On the contrary, the government uses the PRIVATE FINANCIAL SYSTEM.

          “So the highest level starting money is CB reserves. Without this (CB reserves) banks are finished.”

          LOL! Again, things don’t operate because you hold a gun to your head. You really need to be wary of your assumptions.

          To quote the great Charles Kindleberger:
          “Governments propose, markets dispose.” It’s governments that are held hostage to the decisions of markets, not the other way around (unless we’re in an autocratic and draconian political system from 13th century Europe, which is obviously not the case.

          The Fed also doesn’t drain bank reserves when it buys assets. It buys assets off the private market because the GOVERNMENT USES A PRIVATE SYSTEM! It’s the financial system and finance capital that created the financial operations of the federal government (and it was explicit). Every central bank of the US has been a PRIVATE bank, not a public bank. There’s a REASON for that. It’s because the payment system is a private system, not a public one.

          • That should be:
            *someone holds a gun to your head

            Everything I’m saying is well-documented in the financial history. The financial system was EXPLICITLY designed for this purpose and method of operation. What you’re saying is simply a lie, and it must be so.

    • “Solved the whole debt issue for ya.”

      Not really. Money is a financial asset. All financial assets are backed by debt. So without debt equals no money (ignore the nonsense about debt free money). And what backs our pension saving. Once again debt, Without debt no pension (or any) savings. And what about collective profits. I trillion US $ of increasing yearly Govt debt (govt loss in effect) exactly equals increased collective savings or increased company profits.

      So without increasing debt the worlds financial system is finished. No debt at all means moving back to a barter system. But carry on living in your impossible debt free world.

      • Technically, money can be debt free, but only so under very specific conditions. The classic example would be if we reduced ALL forms of money to ONLY gold or silver coins being passed around. Of course, such measures would be draconian, impractical, and stupid.

        • Exchanging other physical assets or services for gold or silver is barter.

          So no money can’t be debt free. Full stop. It’s what distinguishes a money system from a barter system. All money comes into existence as an asset backed by debt held by another party. It may not be recorded as debt. But the debt still exists.

          • “Exchanging other physical assets or services for gold or silver is barter.”

            Do you really never bother to question your assumptions or not ever bother to check your definitions? If you define money as gold and silver (as I clearly stated in my comment), you must necessarily be wrong.

            You really need to work on your procedure and on using deductive logic. You make lots of assumptions you don’t realize and you don’t understand how definitions impact the way we construct analytical frameworks. The result ends up being either faulty analytical frameworks or the improper use of analytical frameworks.

  61. Thanks for sharing! Good post!

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