You’re forgetting the creation of money through commercial banking.
The principle of outstanding loans represents another form of money in the economy. The balance of outstanding loans versus the rate of the principal being diminished is another box.
And what’s missing even in that is that the interest charge is a demand for a concentration of money that stands outside the zero some of the principal extended, and then eventually extinguished through loan payments.
Overall, there’s much to obsession about boxes at this level rather than where money flows. My main objection to most macro economics as they treat money as a perfect gas instantly filling the box called the economy rather than it being a fluid that flows down basins of financial wealth concentration. These flows have everything to do with the actual circumstance of the economy in the same way that the distribution of water vapor over the planet earth has a great deal to do with the disposition of the people living on this planet
Thanks. I have written commercial banking increasing/decreasing the money supply - in another article for sure. Of course commercial banks don't add any 'net' money into the economy - on the Central Bank does that. I'm not sure what this paragraph means "And what’s missing even in that is that the interest charge is a demand for a concentration of money that stands outside the zero some of the principal extended, and then eventually extinguished through loan payments." Interest earned by the banks on their loans is money taken out of the private sector - unless they release it as dividends.
Yes, it is drawn from the private sector. But I make a few observations in order to cover that interest charge, it demands an increase in the effective money supply.
It is helpful to use some distinguishing terms here. Fiat money is what the currency sovereign furnishes, which exists in aggregate minus national taxes paid, and bank money, which expands bank account balances, but is transient because discharging the debt delete the principal from the aggregate account balances.
But I dislike the discussion by Economist saying that the asset (loan) only records the principle, and never reflects the debt charge.
The debt charge has to come from the extant money supply. Absent any expansion of the money supply as with deficit spending, the only other source of ledger balances is an expansion of loan obligations, and only of the principal amount. This is of course, dynamically unstable because as soon as the banking sector takes its foot off the credit gas pedal the money supply begins to shrink leading to austerity propagating in the economy.
--
And I would like to pause for a moment and mention that there is a very distinct difference between taxation, interest and inflation, each which can be viewed as reducing purchasing power in some fashion.
Interest and inflation both wither purchasing power. Both require an expansion of the money supply (fiat+bank money), while taxation because it's shrinking the money supply, actually increases the purchasing power of the remaining money in the economy because it's reduced the money supply.
--
But the pick up the thread of thinking here I feel that the neat set of boxes here don't reflect that interest (usury in its archaic sense) is an outflow that has to be matched by an inflow (fiat + bank money).
Work by Fix, Nitzan and Bichler document the process of inflation, which at some stage needs to be added to a more detailed flow diagram of a nation's monetary system. Inflation and interest have similar effects. They both demand an increase in the money supply. Unlike fiat whose provision can be culled by tax.
“that interest charge, it demands an increase in the effective money supply.”
“The debt charge has to come from the extant money supply. Absent any expansion of the money supply as with deficit spending, the only other source of ledger balances is an expansion of loan obligations, and only of the principal amount”
This is a common misunderstanding of thinking money is a linear model Y = Mx + B
However, money is a dynamic model:
M*V = Q*P
M= (Q*P)/V
Changes in the money supply are caused by -Q, -P OR an increase in V.
As V of often around 2 this means the money circulates multiple times in the economy, so there us enough money for the interest, but the interest must be created in the real economy by activating the Division of Labor DoL, teams developing specialized skills to increase productivity are the only way to ‘create’ capital, everything else is capital redistribution..there us enough money to pay the interest as long as it comes out of the growth of the real economy.
This leads us to the #1 problem today, not enough productive debt growing the economy, and too much unproductive debt which serves to drive up asset prices unsustainably. Inflation has been great for homeowners, who use their house as an ATM, but prices are too high relative to wages so we have created homelessness, where we house our cars in our garages but park people on the street.
I am accounting for commerce in my statement; I'm not thinking in terms of stock but flows. You need to understand I have a degree in applied math "dropped out of physics" for it, and I am an engineer. I am more than familiar with complex dynamic systems.
The problem with standard economic equations is they do not comprehend and do not account for distribution.
When you account or start considering where the shortage of money occurs in the economy, then you begin to understand the problem. If too many people encounter a shortage of money because it is bunged up somewhere else in the economy, you see restrictions in commerce, causing inflation and austerity. Inflation will come from those who can raise prices, austerity will come from those who cannot.
The primary problem of commercially generated money is banks will withdraw the creation of more outstanding debt, more credit money, just when the economy actually needs more of it. This is an addition to the overhead the systemic loading of the system for more money supply. The constructions are amplified. This is why you need government expenditure, especially in times of economic uncertainty. Keynes absolutely right here.
--
The other problem with those standard equations you are using: they do not account for commercial money creation. Banks create money when they lend because the double entry accounting shows an asset of the total value of the loan, which means the principal plus the total interest charge and the borrower's bank account is credited with the principal, but they carry with them the loan obligation. (see Keen, BoE, Graziani etc)
They also do not cover is the dynamic contribution of government spending, the direct creation of money with no debt obligation along with addition the commercial creation of money which both contribute to aggregate demand (this is Keen's contribution)
--
But this is the fundamental problem of a privatized money creation system because there's an obligation to repay the created money, destroying it. It creates systemic flows that are subject to constriction.
The fundamental problem with mainstream economic equations are the equations that you use. They are insufficient to account for the system itself.
I will agree, however, that there is little productive debt. When wealth disparity reaches a sufficient differential, those with the wealth stop actually spending any of their own money. Stan they use their net worth as collateral to take on commercial debt, which is to say that the banks create money through the lending process which they used to finance their own expenses, but also go out and buy up other parts of the economy..
We are all familiar with that process where private equity hedge funds, and even standard business management, think Boeing, force the rest of the economy to pay off that financing through, ignored maintenance, no capital investment, layoffs and inflation.
Until wealth disparity is brought back to earth, the wealthiest will continue to cannibalize the economy. This critical effort will require taxing wealth, as well as aggressive, aggressive, antitrust. It is in almost impossible to tax net worth outside of real estate taxes. Capital gains taxes are almost useless because the very wealthiest and the largest corporations have the resources to hide in shelter their assets from taxation, and whatever assets are actually subject to taxation enjoys a lower tax rate. See capital gains
“banks will withdraw the creation of more outstanding debt, more credit money, just when the economy actually needs more of it.”
This is called a ‘Minsky moment’ where the collapse of bank credit $ cause a financial collapse and will collapse in the real economy. As a mathematician who understands modern banking king, you can probably see this better than most..
“I am an engineer.” I find engineers often have a tough time thinking that banks do not print enough money for both principal and interest, because they do not realize only the financial economy is a zero sum game, not the real economy, which starts at 100% and grows to 102.5%, etc. I was trying to point out the velocity of money V is how these two are reconciled simply.
More complicated is what you start to refer to, the real economy is always expanding or contracting by sector and geography, so contraction in one industry stands besides expansion in another, and by adding them we do not get a clear picture.
What really matters for inflation of goods and services is Purchase money in an ecosystem, and for assets Investment money in an ecosystem. Profits eventually flow into Investmdnt Mindy, but investment money mostly does not come bs k as Purchase money, so we are pooling tremendous investment money from deficit spending in bonds, stocks and real state, which drives asset prices up and makes homes unaffordable. No bueno for we the people.
Yes, we need more deficit spending when the economy is not at full employment, but we need higher taxes to drain out excess $ from the economy to stop inflation, or else the Fed is going to increase interest rates to cut growth, making people lose their jobs, their companies and their homes simply because we don’t tax more, which is totally immoral. And, it has led to $30T in negative U.S. Gov equity that we have to repay…
I think you have some wires crossed in this:
“They also do not cover is the dynamic contribution of government spending, the direct creation of money with no debt obligation”
The U.S. Gov does not issue the U.S. Dollar my friend, in 2024 the U.S. Gov issued $0.
I laid out what happens when the Gov sells bonds above in this thread, so ONLY when the Fed buys can you say no debt obligation, and even that is incorrect because we do pay it back, it’s just that the Fed returns their profits after investor distribution to UST.. JU
I really want to discuss Godley Tables, but like many of the topics you introduced, they deserve their own article. Maybe you can do breakouts next.
As you have pointed out, Gov Deficit Spending (Negative Gov Equity or Gov red ink) leads to private sector black ink. Setting aside the trade deficit for the moment, there is more important minutiae to understand in this, because regardless of whether the Gov sells the bonds prior (my view) or after (your view) the source of funds for the Gov bond sales is a critical element!
If we track the money supply prior to the bond being sold to after, there are some amazing insights, and I’ll even use consolidated Balance Sheet like MMT uses.
1. If the CB buys those bonds, they issue new reserves to buy them, expanding the supply of reserves. And at this point, there is no effect on deposits, however, as soon as the government spends those reserves the receiving bank credits the Government payees deposit account, creating new deposits and expanding the money supply. AND, as long as the CB Holds those bonds To Maturity HTM, the CB will return profits to the Gov, so no negative equity fir the Gov, BUT, there is an increase in private wealth after the Gov spends those reserves. It looks like the Gov/Cb worked together to print free money, although over time they do take it out of circulation by repayment. But, deficits financed like this result in no negative Gov equity, but an increase in Public equity and public wealth from the new Gov spending and new Deposits the public receives.
MMT = +Reserves (Gov payees bank) + deposits (Gov payee) and no publicly owned bond do no negative equity
= +Bond + R +D
2. Banks buy those bonds and the Gov spends, this results in the bank debiting their reserve account, and when the Gov spends these reserves are returned to the banking sector, but they also credit the Gov payee deposit account, expanding the money supply. Banks do an asset swap so no new equity in the banking sector from buying bonds, BUT, then the Gov spends those reserves. It looks like the bond is the new equity, but it’s really the new reserves, and they create the new deposits, so Gov spending is the source of the new equity, not the bond.
MMT = -R bond sale (swap bond for reserves) + R Gov spending, +D banks credit payee deposit accounts.
= +Bond +D
3. Public buys the bond, -deposits - reserves, +bond, then the gov spends, +Reserves + deposits,
MMT -D -R +Bond +R +D = +Bond.
In cases 2 &3, the Gov red ink results in the public’s black ink, BUT, it’s not the bond that creates new equity, the buyer swapped assets to receive it, so -D + bond public or -R +Bond bank.
The ONLY reason there is an increase in public equity is because the Gov decided to deficit spend, and the public payees receives those new deposits.
If we add in the Trade deficit, the beneficiary of deficit spending can also be foreign countries, as a deficit means we import goods and services and export capital.
In 2024, the U.S. had roughly a $1T trade deficit, so exported $T of capital and equity to other countries. Our economy grew by about the same amount, so the U.S. exported the equivalent of 100% of new economic growth. Staying away from the politics and just looking at the Economics, that’s why the U.S. Treasury Secretarry and the President want to adjust the trade deficits through restructuring tariffs. I am not saying they did it the best way possible, just highlighting there is actually economics behind what they are doing…
You’re forgetting the creation of money through commercial banking.
The principle of outstanding loans represents another form of money in the economy. The balance of outstanding loans versus the rate of the principal being diminished is another box.
And what’s missing even in that is that the interest charge is a demand for a concentration of money that stands outside the zero some of the principal extended, and then eventually extinguished through loan payments.
Overall, there’s much to obsession about boxes at this level rather than where money flows. My main objection to most macro economics as they treat money as a perfect gas instantly filling the box called the economy rather than it being a fluid that flows down basins of financial wealth concentration. These flows have everything to do with the actual circumstance of the economy in the same way that the distribution of water vapor over the planet earth has a great deal to do with the disposition of the people living on this planet
Thanks. I have written commercial banking increasing/decreasing the money supply - in another article for sure. Of course commercial banks don't add any 'net' money into the economy - on the Central Bank does that. I'm not sure what this paragraph means "And what’s missing even in that is that the interest charge is a demand for a concentration of money that stands outside the zero some of the principal extended, and then eventually extinguished through loan payments." Interest earned by the banks on their loans is money taken out of the private sector - unless they release it as dividends.
Yes, it is drawn from the private sector. But I make a few observations in order to cover that interest charge, it demands an increase in the effective money supply.
It is helpful to use some distinguishing terms here. Fiat money is what the currency sovereign furnishes, which exists in aggregate minus national taxes paid, and bank money, which expands bank account balances, but is transient because discharging the debt delete the principal from the aggregate account balances.
But I dislike the discussion by Economist saying that the asset (loan) only records the principle, and never reflects the debt charge.
The debt charge has to come from the extant money supply. Absent any expansion of the money supply as with deficit spending, the only other source of ledger balances is an expansion of loan obligations, and only of the principal amount. This is of course, dynamically unstable because as soon as the banking sector takes its foot off the credit gas pedal the money supply begins to shrink leading to austerity propagating in the economy.
--
And I would like to pause for a moment and mention that there is a very distinct difference between taxation, interest and inflation, each which can be viewed as reducing purchasing power in some fashion.
Interest and inflation both wither purchasing power. Both require an expansion of the money supply (fiat+bank money), while taxation because it's shrinking the money supply, actually increases the purchasing power of the remaining money in the economy because it's reduced the money supply.
--
But the pick up the thread of thinking here I feel that the neat set of boxes here don't reflect that interest (usury in its archaic sense) is an outflow that has to be matched by an inflow (fiat + bank money).
Work by Fix, Nitzan and Bichler document the process of inflation, which at some stage needs to be added to a more detailed flow diagram of a nation's monetary system. Inflation and interest have similar effects. They both demand an increase in the money supply. Unlike fiat whose provision can be culled by tax.
“that interest charge, it demands an increase in the effective money supply.”
“The debt charge has to come from the extant money supply. Absent any expansion of the money supply as with deficit spending, the only other source of ledger balances is an expansion of loan obligations, and only of the principal amount”
This is a common misunderstanding of thinking money is a linear model Y = Mx + B
However, money is a dynamic model:
M*V = Q*P
M= (Q*P)/V
Changes in the money supply are caused by -Q, -P OR an increase in V.
As V of often around 2 this means the money circulates multiple times in the economy, so there us enough money for the interest, but the interest must be created in the real economy by activating the Division of Labor DoL, teams developing specialized skills to increase productivity are the only way to ‘create’ capital, everything else is capital redistribution..there us enough money to pay the interest as long as it comes out of the growth of the real economy.
This leads us to the #1 problem today, not enough productive debt growing the economy, and too much unproductive debt which serves to drive up asset prices unsustainably. Inflation has been great for homeowners, who use their house as an ATM, but prices are too high relative to wages so we have created homelessness, where we house our cars in our garages but park people on the street.
I am accounting for commerce in my statement; I'm not thinking in terms of stock but flows. You need to understand I have a degree in applied math "dropped out of physics" for it, and I am an engineer. I am more than familiar with complex dynamic systems.
The problem with standard economic equations is they do not comprehend and do not account for distribution.
When you account or start considering where the shortage of money occurs in the economy, then you begin to understand the problem. If too many people encounter a shortage of money because it is bunged up somewhere else in the economy, you see restrictions in commerce, causing inflation and austerity. Inflation will come from those who can raise prices, austerity will come from those who cannot.
The primary problem of commercially generated money is banks will withdraw the creation of more outstanding debt, more credit money, just when the economy actually needs more of it. This is an addition to the overhead the systemic loading of the system for more money supply. The constructions are amplified. This is why you need government expenditure, especially in times of economic uncertainty. Keynes absolutely right here.
--
The other problem with those standard equations you are using: they do not account for commercial money creation. Banks create money when they lend because the double entry accounting shows an asset of the total value of the loan, which means the principal plus the total interest charge and the borrower's bank account is credited with the principal, but they carry with them the loan obligation. (see Keen, BoE, Graziani etc)
They also do not cover is the dynamic contribution of government spending, the direct creation of money with no debt obligation along with addition the commercial creation of money which both contribute to aggregate demand (this is Keen's contribution)
--
But this is the fundamental problem of a privatized money creation system because there's an obligation to repay the created money, destroying it. It creates systemic flows that are subject to constriction.
The fundamental problem with mainstream economic equations are the equations that you use. They are insufficient to account for the system itself.
I will agree, however, that there is little productive debt. When wealth disparity reaches a sufficient differential, those with the wealth stop actually spending any of their own money. Stan they use their net worth as collateral to take on commercial debt, which is to say that the banks create money through the lending process which they used to finance their own expenses, but also go out and buy up other parts of the economy..
We are all familiar with that process where private equity hedge funds, and even standard business management, think Boeing, force the rest of the economy to pay off that financing through, ignored maintenance, no capital investment, layoffs and inflation.
Until wealth disparity is brought back to earth, the wealthiest will continue to cannibalize the economy. This critical effort will require taxing wealth, as well as aggressive, aggressive, antitrust. It is in almost impossible to tax net worth outside of real estate taxes. Capital gains taxes are almost useless because the very wealthiest and the largest corporations have the resources to hide in shelter their assets from taxation, and whatever assets are actually subject to taxation enjoys a lower tax rate. See capital gains
Am I texting with a Rebel Economist?
“banks will withdraw the creation of more outstanding debt, more credit money, just when the economy actually needs more of it.”
This is called a ‘Minsky moment’ where the collapse of bank credit $ cause a financial collapse and will collapse in the real economy. As a mathematician who understands modern banking king, you can probably see this better than most..
“I am an engineer.” I find engineers often have a tough time thinking that banks do not print enough money for both principal and interest, because they do not realize only the financial economy is a zero sum game, not the real economy, which starts at 100% and grows to 102.5%, etc. I was trying to point out the velocity of money V is how these two are reconciled simply.
More complicated is what you start to refer to, the real economy is always expanding or contracting by sector and geography, so contraction in one industry stands besides expansion in another, and by adding them we do not get a clear picture.
What really matters for inflation of goods and services is Purchase money in an ecosystem, and for assets Investment money in an ecosystem. Profits eventually flow into Investmdnt Mindy, but investment money mostly does not come bs k as Purchase money, so we are pooling tremendous investment money from deficit spending in bonds, stocks and real state, which drives asset prices up and makes homes unaffordable. No bueno for we the people.
Yes, we need more deficit spending when the economy is not at full employment, but we need higher taxes to drain out excess $ from the economy to stop inflation, or else the Fed is going to increase interest rates to cut growth, making people lose their jobs, their companies and their homes simply because we don’t tax more, which is totally immoral. And, it has led to $30T in negative U.S. Gov equity that we have to repay…
I think you have some wires crossed in this:
“They also do not cover is the dynamic contribution of government spending, the direct creation of money with no debt obligation”
The U.S. Gov does not issue the U.S. Dollar my friend, in 2024 the U.S. Gov issued $0.
I laid out what happens when the Gov sells bonds above in this thread, so ONLY when the Fed buys can you say no debt obligation, and even that is incorrect because we do pay it back, it’s just that the Fed returns their profits after investor distribution to UST.. JU
Jim, nice post!, but tooooo loooong my friend!
I really want to discuss Godley Tables, but like many of the topics you introduced, they deserve their own article. Maybe you can do breakouts next.
As you have pointed out, Gov Deficit Spending (Negative Gov Equity or Gov red ink) leads to private sector black ink. Setting aside the trade deficit for the moment, there is more important minutiae to understand in this, because regardless of whether the Gov sells the bonds prior (my view) or after (your view) the source of funds for the Gov bond sales is a critical element!
If we track the money supply prior to the bond being sold to after, there are some amazing insights, and I’ll even use consolidated Balance Sheet like MMT uses.
1. If the CB buys those bonds, they issue new reserves to buy them, expanding the supply of reserves. And at this point, there is no effect on deposits, however, as soon as the government spends those reserves the receiving bank credits the Government payees deposit account, creating new deposits and expanding the money supply. AND, as long as the CB Holds those bonds To Maturity HTM, the CB will return profits to the Gov, so no negative equity fir the Gov, BUT, there is an increase in private wealth after the Gov spends those reserves. It looks like the Gov/Cb worked together to print free money, although over time they do take it out of circulation by repayment. But, deficits financed like this result in no negative Gov equity, but an increase in Public equity and public wealth from the new Gov spending and new Deposits the public receives.
MMT = +Reserves (Gov payees bank) + deposits (Gov payee) and no publicly owned bond do no negative equity
= +Bond + R +D
2. Banks buy those bonds and the Gov spends, this results in the bank debiting their reserve account, and when the Gov spends these reserves are returned to the banking sector, but they also credit the Gov payee deposit account, expanding the money supply. Banks do an asset swap so no new equity in the banking sector from buying bonds, BUT, then the Gov spends those reserves. It looks like the bond is the new equity, but it’s really the new reserves, and they create the new deposits, so Gov spending is the source of the new equity, not the bond.
MMT = -R bond sale (swap bond for reserves) + R Gov spending, +D banks credit payee deposit accounts.
= +Bond +D
3. Public buys the bond, -deposits - reserves, +bond, then the gov spends, +Reserves + deposits,
MMT -D -R +Bond +R +D = +Bond.
In cases 2 &3, the Gov red ink results in the public’s black ink, BUT, it’s not the bond that creates new equity, the buyer swapped assets to receive it, so -D + bond public or -R +Bond bank.
The ONLY reason there is an increase in public equity is because the Gov decided to deficit spend, and the public payees receives those new deposits.
If we add in the Trade deficit, the beneficiary of deficit spending can also be foreign countries, as a deficit means we import goods and services and export capital.
In 2024, the U.S. had roughly a $1T trade deficit, so exported $T of capital and equity to other countries. Our economy grew by about the same amount, so the U.S. exported the equivalent of 100% of new economic growth. Staying away from the politics and just looking at the Economics, that’s why the U.S. Treasury Secretarry and the President want to adjust the trade deficits through restructuring tariffs. I am not saying they did it the best way possible, just highlighting there is actually economics behind what they are doing…