Money is a creature of the State

I’ve had a number of friends that have been encouraging me to write a blog for at least a few years now. This is my attempt at a blog.

For the last five years I’ve been informally studying Modern Monetary Theory. I became captivated by the elegance and internal consistency of the body of work. The captivation went so far that I named a fighting fish (the one pictured on the main blog page) after a well known MMT academic. I did so because the fish happened to sit under one of Randall Wray’s books on my bookshelf. Irrelevant to the topic at hand but Randy (the fish) spends his life in the Darwin Festival office.

I looked after Randy the fish over the Christmas/New Year and he reminded me of one of the first papers I read while learning MMT. “The Credit Money and State Money Approaches” by L.Randall Wray.

Orthodox economist will tell a simplistic story about barter and ‘money’ evolving out of that.

A credit approach to money stems from the work of an economist Alfred-Mitchell Innes where he emphasises credit and debt are the same thing but from a different view point. David Graeber’s book, Debt:The First 5000 years is recommended if you wanted to delve into detail about credit and debt relations throughout history and I might write more about on what debt is at a latter date. Simply put think of it as ‘Someone else’s debt is someone else’s asset.’

The State Theory of Money comes from the work of Georg Friedrich Knapp where he states “Validity by proclamation is not bound to any material” That is a states currency gains its value from the liability enforced in that same unit of account.

Wray in the conclusion of his paper writes there is an integration between the creditary and state money approaches. I’ll discuss the state money approach first.

…the state chooses the unit of account in which the various money things will be denominated. In all modern economies, it does this when it chooses the unit in which taxes will be denominated and names what is accepted in tax payments. Imposition of the tax liability is what makes these money things desirable in the first place. And those things will then become the money-thing at the top of the “money pyramid” used for ultimate clearing.

L. Randall Wray, The Credit Money and State Money Approaches, Center for Full Employment and Price Stability, University of Missouri-Kansas City.

An easy way to think about that is to first distinguish between a Currency Issuer and a Currency User.

Say you want chores completed around your house and you offer your business cards in exchange for household chores. Why would your children desire your business cards?

The MMT money story states the tax liability comes first, followed up by government spending, so the people can meet the liability imposed and taxation comes after the fact the currency issuer has spent.

In the business card example sighted above, you would impose a tax of say 30 cards a month and without payment at the end of each month there would be consequences. It’s the coercive power of the state that drives the value for the currency.

Soon the kids are doing chores, earning their cards (that only you issue) and they develop a market and trade cards with each other getting their siblings to do chores when they’d rather not. You tell the kids that if they want to snack between meals and have desert there is charge, denominated in business cards.

There is a limit to the kids spending because eventually they have to earn more to pay their taxes and be able to eat desert and snack between meals.

Think of the snacks and desert as a fee imposed to gain access to things you may want to limit. Breakfast, Lunch and Dinner involve no exchange of cards and are akin to a public service – they can always be provided by you, provided you have the food to cook!

Going back to Wray’s conclusion and discussing the creditary money approach.

The private credit system leverages state money, which in turn is supported by the state’s ability to impose social obligations mostly in the form of taxes. 

L. Randall Wray, The Credit Money and State Money Approaches, Center for Full Employment and Price Stability, University of Missouri-Kansas City.

You may have heard loans create deposits. The Bank of England in this paper says;

‘Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created

That is the bank creating itself an asset which becomes the borrowers liability.

There are several different ‘money things’ we refer to as money:

1. Physical notes and coins
2. Reserves – like you have an account with the bank, your bank has an account with the central bank. They use this account to settle payments with each other.
3. Bonds – What we refer to as Government debt. Banks exchange their reserves to purchase these and they earn interest and the face value paid upon maturity, similar to what you would do with a term deposit account
4. Demand deposits – what you see when you check your online bank account.

And I’ll write more about these in the future.

Federal Government spending adds to reserves and then is placed in a demand deposit. Banks create demand deposits and need to ensure their reserves are in surplus at the end of each day. It is the central bank’s job to ensure there are sufficient reserves for financial institutes to pay each other otherwise the payments system would grind to a halt. Banks are reliant on the consolidated government (treasury and the central bank) to add to those reserves.

What we call ‘money‘ is a social construct. Each of the numbered points above are created using different ‘mechanisms’. What matters is whether we have the real resources (labour, skills, raw materials) to provide for our society. There are only political constraints that stop a currency issuer from deploying real resources for a public purpose.

I recently attended the Sustainable Prosperity Conference in Adelaide. It was great to meet people I’ve linked in with through social media and meeting several of the keynote speakers whose work I have been reading. This lecture was put on by the university of Adelaide for the Harcourt Lecture an annual talk featuring a prominent economist. This year it was Stephanie Kelton and is an excellent introduction to modern monetary theory and understanding economics.

© Jengis 2020

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