Banknote Short Follow Up

I have again been ambushed by distractions — Christmas shopping and consulting (to pay for the Christmas shopping). I just have a few short addenda to my earlier post on how banknotes are central bank liabilities.

Banknotes are Matured Bearer Bonds

Accounting is supposed to reflect economic reality, not what statutes might say. Otherwise, statutes could just define central bank balance sheet entries to be whatever sounds good. One hallmark of economic reality is to look through the superficial features of an instrument, and see what they are economically equivalent to.

Yes, Banknotes Are A Central Bank Liability

David Bholat recently wrote “How to Modernise Central Bank Balance Sheets: No Notes.” It is partly in response to this article. The idea is that banknotes (“dollar bills”/”pound notes” etc. issued by the government should not be classified as a liability, rather as some form of capital or possibly taken off the balance sheet. I have run into variants of this idea in the past (the stronger version being that all forms of the monetary base are not liabilities), and the root idea is that “monetary issue is good for the economy, so how can it be a liability?” Such a redefinition or removal of banknotes is either misleading or wrong.

Alex Douglas On Arches And Money

Alex Douglas just published a post on arches and money which I quite liked. It is an easy read, and I will just offer my spin on one of his points. It also leaks into a discussion of engineering, which I will digress into at the end of this post.

He draws on an excellent book — J.E. Gordon’s The New Science of Strong Materials: or, Why You Don’t Fall Through the Floor. (I have sentimental attachment to this book since I won a copy of it and “Structures: Or Why Things Don’t Fall Down” from a provincial high school physics contest. Both books gave me a good introduction to the non-electrical parts of engineering — possibly more than my undergrad electrical engineering degree, since Canadian accreditation bodies do not allow much space for non-EE content in undergraduate programmes.) In the book, an arch is termed an “apparent impossibility.”

Primer: The Cantillon Effect

The Cantillon Effect is the label applied to a process described in Richard Cantillon’s , «Essai sur la nature du commerce en général», published in 1755. (One English translation of the title is “An Essay on Economic Theory.”) The basic premise is that an initial inflow of money will raise prices as the original recipients of the money spend it, which will then raise other prices as the “new money” enters others’ hands.

Money Multiplier Mudslinging

https://twitter.com/IrvingSwisher/status/1657812041812303876?s=20

There was a small kerfuffle on Twitter created by Olivier Blanchard regarding the money multiplier in the next version of his textbook.

Skanda Amarnath gave a reaction which matches my view, but I just want to add a couple of extra comments.

Government Bonds As Money

I ran into the periphery of an argument about the question “Are government bonds money?” on Twitter. I have seen variants of this question in “internet MMT” discussions for some time. I think this question confirms my view that we need to abolish “money” from economic theory.

I am keeping this article as brief as possible. For more information, a lot of this ground is covered in my recent MMT book.

Academic MMT View — No

This first thing to note is that from what I have seen of academic MMT discussions, “money” and “bonds” are distinct. One thing that I see is that “money” shows up in two ways in most MMT writing.

1. The most common is that “money” is a stand in for “government money” — which is the monetary base. This corresponds exactly to the way money and bonds show up as M and B in both heterodox and mainstream models that do not have a banking system. (This leads to the straw man attack that “MMT ignores that most ‘money’ is created by banks!”)

2. If we want to look at “broad money,” bank money is seen as “pyramided” on top of the monetary base. (Which answers the previous straw man attack.)

Old Heterodox Banking Debates

Banking and money is an area of ancient debates between post-Keynesians (and their fore-runners) and mainstream economists. Many of these showed up in my earlier book Abolish Money (From Economics)!, with the theme more focussed on money. Although I believe I need to touch on this topic, I want to keep it short. Partly because it appeared in another book, and partly because I am less and less convinced that these debates are that useful for discussing banking.

Note: Once again, this is a draft of a manuscript section from my banking book. It will be in a chapter on modelling banking.

Crypto And The Real Economy

The following tweet by Jon Sindreu set off a debate on Twitter, which I got tangentially involved in. This is a subject that I touched on some time ago (I believe), but I think I can succinctly cover my views now.

An issue I feel is underdiscussed : DeFi has all the flaws of traditional finance, yes, but on top of this it basically finances other crypto projects, not houses or factories anywhere. It is as if traditional banks only financed other banks (essentially ONE big credit risk). https://t.co/sq0QwpJxVj

— Jon Sindreu (@jonsindreu) June 22, 2022

The Great Borrower/Lender Mismatch(es)

The structure of financial markets is influenced by imbalances between how lenders would like to lend, and borrowers would like to borrow. The economist community often refers to “maturity transformation,” but this formulation is too vague to be useful. Instead, we need to look at a few axes of disagreement.

The structure of banks to a certain extent bridge these mismatches, which explains why they are the centre of financial markets. However, non-bank financial instruments can be structured to bridge the gap. It is therefore that there is a continual blurring between bank and non-bank finance as they attempt to move into each other's turf. It is also unsurprising that the so-called “crypto community” has ended up re-inventing the structures of traditional finance, since even internet money faces the same economic forces.

Why We Cannot Measure Money Velocity Directly

Note: this is an unedited draft of a section from my inflation book manuscript. I wanted to avoid theoretical wrangling within my book, so I am not entirely happy about adding it. That said, money velocity shows up so often in the context of inflation that I feel that we need to cover factual statements about its determination.

Given the importance that many people attach to the velocity of money, I feel that I need to offer a longer discussion of the weakness of the concept. Since it is somewhat of a distraction from the flow of this text, I have put it into this appendix section that can be readily skipped if the reader is blissfully unaware of money velocity.

Money Printing (Sigh)

Note: This is an unedited draft section from my inflation text. To what extent it depends upon observed behaviour, those figures will appear in another section (that needs to be written).

In a lot of financial market commentary – and even in the output of some academics – one might often see discussion of “money printing” in the context of inflation. Although this section explains why the concept is not meaningful, these references do serve a purpose: they are a signal that the reader can stop taking the person invoking “money printing” seriously.

Primer: Quantity Theory Of Money

Note: This is an unedited excerpt from my inflation primer manuscript.

Even if we put aside the atypical argument that an increase in the money supply is how to define inflation, there is a widespread belief that increasing the money supply causes inflation (as normally defined). These beliefs can be traced back to what is termed the Quantity Theory of Money, which has a long history in economic thinking.

Is Money Supply Growth The True Definition Of Inflation?

One of the more unusual diversions in the discussion of inflation is the argument made by Austrian economists that inflation is defined as growth in the money supply. I outline the reasons for my disagreement in this article.

(Note: This is an unedited draft from a manuscript that discusses inflation.)

Why Money Doesn't Matter That Much

Scott Sumner has continued his discussion of Modern Monetary Theory (MMT) and money. To summarise, he has misunderstood a passage from MMT version of an Economics 101 textbook (Macroeconomics by Mitchell, Wray, and Watts, denoted MWW), and mixing it up with other statements that he has seen. I am assuming that his misunderstanding is the result of leaping ahead to advanced topics, which requires a correspondingly more advanced set of MMT references. I just want to clear the confusion up in this article, without necessarily offering definitive views.

Primer: Understanding The Money Multiplier Model

I ran into a question about the Money Multiplier Model, and I realised that explaining it is a lot more complicated than I expected.  The story of the model is how an initial cash deposit at one bank creates a chain of smaller and smaller loans, until the aggregate loan book has grown by a multiple of the initial deposit. The key to understanding the model is that it is based on a defective behavioural assumption. That is, it would apply -- if bankers operated in a way that they do not do in the real world.

It is entirely possible that the reader is taking a course that teaches the model. This can be viewed as the "Devil's Guide" to it.

Never Reason From A Change In Monetary Agggregates

I have been looking at questions on the Economics Stack Exchange, and many of them followed a depressing pattern: where is the inflation that results from the change in monetary aggregates? This is a common concern that has been popping up since the end of the Financial Crisis (even earlier in the context of Japan). The prescription is straightforward: one should never reason from a change in a monetary aggregate. The reason behind this is that monetary instruments are financial assets, and the size of the stock held depends upon the portfolio preferences of the private sector, which should be expected to be unstable.

This helps confirm that the message from Abolish Money (From Economics)! has not caught hold yet in the public imagination.

Banks And MMT: J.W. Mason's Comments

J.W. Mason wrote a review of Stephanie Kelton's The Deficit Myth. For my purposes, I am looking at various critiques of MMT, and he makes some statements about banking that are of interest.

Note: My publication schedule is likely to remain erratic. I added in primers that were previously written, and the word count of my MMT manuscript has hit 29,000 words (and my target was 20,000-25,000 words). I am now mainly editing and cutting text, with only a few sections to be written.

Yes, It's Not $1.5 Trillion Of Spending

There's been some complaining to-and-fro on Twitter about the $1.5 trillion repurchase agreement ("repo") facilities by the Fed. On the chance that any of my readers have run into this, just want to say a few words.

1. It is a loan, not the same thing as new spending.
2. Giving entities loans is commercially advantageous, and so it quite reasonably can be described as a "bailout." The trick is understanding that the magnitude of the bailout is not the same size as the dollar amount of the loan.
3. This action underlines that the central government is the monopoly supplier of government money, and so this shows the firepower that alleged "bond vigilantes" actually face.

The Monetary Monopoly Model

What I refer to as the Monetary Monopoly Model is the simplest possible mathematical model that captures basic concepts from Modern Monetary Theory (MMT). Despite its simplicity, it gives a good feeling of how a sovereign could pin down the value of a brand new currency (relative to existing currencies, or the value of real goods or services). However, the model makes almost no assumptions about private sector behaviour, and such assumptions would be needed to simulate an existing industrial capitalist society. The reason to start with this model is that the discussion of those behavioural assumptions will drown out the MMT-specific parts of the model.

Yes, Banks Create Money Out Of Thin Air

Unfortunately, money has not yet been abolished from economic theory, and we are stuck with pointless debates about banks and money creation. The latest salvo is "Banks do not create money out of thin air" by Pontus Rendahl, and Lukas B. Freund. As the title of this article suggests, Rendahl and Freund are incorrect in their assessment.

I assume that the Rendahl/Freund article is a followup to previous arguments, such as a Thomas Hale article I discussed recently. Since I just addressed the topic, I will keep my comments here as short as possible. (I am responding to the article since it is likely that I will do a book on fractional reserve banking, which will be an overview of incorrect theories that keep popping up. Very similar in style to Abolish Money (From Economics)!)