Why they can’t (2022)

Book Review from the August 2022 issue of the Socialist Standard

Can’t We Just Print More Money? By Rupal Patel and Jack Meaning. Cornerston Press for the Bank of England. 2022. £14.99.

This is a very readable exposition of economics as taught in schools and universities and should help students pass their exams. However, the authors are likely to regret having used the terms ‘miracle process’ (p. 191) and ‘out of nothing’ (p.171) in relation to banks. This will be pounced on by currency cranks and used to claim the authority of the Bank of England for their mistaken theories.

Even as described by the authors, there is nothing magical about how banks operate. If you define a bank loan as money (as they do), then when a bank makes a loan it will be, by definition, ‘creating money’. But it doesn’t follow that they are doing this ‘out of thin air’ (p. 192). Only the government or its central bank can do that as ‘fiat money’.

When a bank makes a loan it typically opens a bank account in the name of the borrower and credits it with an amount equal to the loan. Before it is spent the money doesn’t have to be covered. But as soon as the borrower begins to spend it the bank will need to have or get money to transfer to the bank account of the person or business the borrower bought from.

Every day, money is flowing into and out of a bank, in as new depositors, payments to existing customers like wages, repayment of loans, etc and out as cash withdrawals, customers paying bills through direct debits or buying things with their debit card and borrowers spending their loan, etc. At the end of the day (literally) what banks owe each is ‘cleared’. If after this a bank finds its payments out exceed its payments in it has to cover this either by borrowing from the money market or running down its reserves at the Bank of England. So, loans when spent do have to be covered in the end one way or another.

When a bank makes a loan it is not creating anything out of thin air. It is transferring money that might not be spent otherwise to others who will spend it. This will have an economic effect by circulating money more but it is not creating money from nothing. Banks are intermediaries whose primary income is derived from borrowing at one or no rate of interest and re-lending it at a higher rate. After paying the costs of running their business (wages, buildings, computer systems) what is left is their profit.

The authors contradict themselves on this point. In chapter 7 they criticise as outdated the view that ‘banks take in deposits from a pool of savings that people want to put away and then they find ways to distribute those savings around the economy. They are simply intermediaries’ (pp 169-70). In the next chapter they say that banks ‘match borrowers to savers. Banks act as middlemen between people who want to save money and people who want money to spend’ (p. 188). They got it right the second time, especially when they add: ‘Banks’ most crucial role is funnelling money to where it can be most productive – and so stimulating the economy, while also making a profit for themselves’ (p.190). But they spoil this by adding ‘they cause more money to circulate in the system’ whereas the correct formulation is that ‘they cause money to circulate more in the system’.

Anyway, why can’t ‘we’ just print more money? The authors’ reply is more or less right.

‘Banks want to be able to make a profit, and that places a limit on how much money they create [how much they lend]’ (p.170).

Banks are in competition with each other both to attract new deposits and to make loans. As a result, as another Bank of England publication explains:

‘…if a bank continued to attract new borrowers and increase lending by reducing mortgage rates, and sought to attract new deposits by increasing the rates it was paying on its customers’ deposits, it might soon find it unprofitable to keep expanding its lending. Competition for loans and deposits, and the desire to make a profit, therefore limit money creation by banks’ (‘Money Creation in the modern economy’).

As to fiat money: 

‘If central banks were to continue to print more and more without limit, the result would be too much inflation, with prices rising uncomfortably fast and eroding the value of the newly printed money at too fast a rate’ (p. 257).

Adam Buick

Cooking the Books: Who invented money? (2021)

The Cooking the Books column from the May 2021 issue of the Socialist Standard

Whenever goods are systematically exchanged and so become ‘commodities’, one commodity evolves as what Marx called the ‘universal equivalent’ that can be exchanged for any other commodity. So nobody invented money; it came into being spontaneously. At first this money-commodity was gold or silver measured by weight. The next stage in the evolution of money was coinage, where a state stamped an amount of metal to authenticate its weight. In the European tradition this is attributed to King Croesus of Lydia, an area now in western Turkey, in the sixth century BC.

Historical research now suggests that coins may have been invented in China and at a much earlier date, as pointed out by the Mises Institute in an email note of 15 March:

 ‘China was one of the first countries to develop a metallic money that was valued and exchanged by weight. Evidence suggests that this monetary regime originated during the Shang Dynasty (1766–1122 BC) or the Zhou Dynasty (1122–221 BC). China was also one of the first countries to use precious metals as money and may have invented coined money.’

Also:

  ‘While ideas about the development of money were expressed as early as the seventh century BC, the most prevalent view of money’s origin is attributable to a politician of the sixth century BC. Shan Qi (b. 585 BC) contended that money was invented by one of the ancient philosopher-kings to measure the value of goods. However, several Chinese writers later disputed this story and argued that money originated as a market phenomenon. Sima Qian (104~91 BC) [sic: actually 145~86 BC], Luo Mi (1165~1173 AD) and Ye Shi (1150~223 AD)[sic: actually 1223] basically argued that money grew out of the trading of commodities and could not have emerged in the absence of commodity exchange. Money was only later adopted by kings as an aid in ruling their countries’ (bit.ly/3dc24Sm).

This same debate took place in Europe, with some arguing that coins were introduced by states to enable taxes to be paid in that form and others that they evolved out of commodity exchange. The debate is still ongoing with the proponents of so-called ‘Modern Monetary Theory’ and David Graeber in his book Debt arguing for the former, a position known in the literature as ‘Chartalism’. The other view is defended by Marxists and the Austrian school of economics as represented by the Mises Institute – strange bedfellows as Ludwig von Mises was an arch-enemy of socialism as well as of state capitalism (which he tended to confuse with socialism).

The case for the state being the inventor not just of coins but of money as a ‘universal equivalent’ is given some plausibility by the fact that today the currency – money as a means of exchange – is entirely the creation of the state, ‘fiat’ money as it is known. Gold and silver coins have long ceased to be used as a means of exchange; this is now made up of paper notes and metal discs issued by the state and which have no value in themselves. They are just tokens or counters that can be used to buy things.

However, the commodity-exchange origin of money is still there. Commodity production and exchange is basic to capitalism and the ratios in which they exchange for each other are still related to their labour content. The state issuing more money tokens than needed to carry out these exchanges does not increase the amount of values in existence or to be exchanged. What it changes is the unit in which the price of goods is expressed, reducing it and so raising the number of them to express prices, i.e., increasing prices all round. Which is why the ‘chartalists’ of MMT would come unstuck if ever their policy was to be implemented.

Muddled Money Theory (2021)

Book Review from the March 2021 issue of the Socialist Standard

The deficit myth: modern monetary theory and how to build a better economy. Stephanie Kelton, John Murray Publishers, 2020

You may have read or heard about Modern Monetary Theory (MMT), which has become popular in some left-wing circles as a means for justifying government spending programmes. In essence, it affirms that any state that can issue its own inconvertible (fiat) currency, cannot go bankrupt (so long as it only borrows in its own currency).

This leads to a model of the state in which it is not reliant on taxation nor borrowing to spend. Taxes, for MMT, are merely a means for driving demand for the state-issued currency, and any money paid in tax is effectively destroyed. All state spending is simply the issuing of newly created money. The national debt is simply a different form of money that attracts interest in the normal money the state issues. The national debt, in this model, is merely a means to regulate interest rates.

The only limit to state spending, for MMT, is the availability of resources in the real economy. These limits only become evident through the appearance of inflation: prices would begin to rise as demand from government spending outstripped supply. The method that Kelton promotes to regulate this spending is a government jobs guarantee scheme, so that full employment is maintained at all times. If private sector employment drops, the government jobs scheme kicks in to offer employment, at a minimum rate. As the economy recovers, people leave the job scheme, attracted by private sector wages.

This is, then, unlike the Keynsian prescription, in that MMT encourages government spending at any stage of the business cycle, rather than cutting spending during the upswing and borrowing during the recession.

The core premise of MMT is banally true: the state can always issue more money in its own currency. There is a question of just how much scope there is for increasing state spending before inflation kicks in, and Kelton certainly seems to write a lot of cheques against that spending capacity: healthcare, university education, pensions, etc.

She seems to imply that the current models, wherein the state is assumed to be funded through taxation and borrowing, are simply an error, rather than representing the ideological form of the interests of the owners of money and capital.

Before 1971 other currencies had a fixed rate of exchange with the dollar and the dollar was convertible into gold at the fixed rate of $35 an ounce. This provided an indirect link between a currency and gold. The currencies themselves, however, were not convertible into gold and states could issue as much as they wanted. To the extent that they over-issued them this led to inflation and in the end to a formal devaluation of their exchange rate with the dollar.

When this ‘gold exchange standard’ was abandoned by the US in 1971 the commodity origin of currencies was completely disguised, giving rise to the illusion on which MMT is based that money is entirely a creation of a state. Since then currencies have floated up and down against each other in accordance with the demand for them, for instance to pay for imports. An increase in their supply was still liable, if excessive, to cause inflation. The result wasn’t a formal devaluation, simply a downwards float vis-à-vis other currencies.

To an extent, the commodity origin is still relevant because the state monopoly of fiat currency is not absolute. People can abandon pounds or dollars by buying foreign currencies or value-bearing commodities (in a crisis, the price of gold shoots up, as people buy gold to try and protect the value of their assets). Contrary to Kelton’s assertion, the banks do not have to buy the national debt, they have other options, but it has to remain attractive, and the currency has to retain confidence.

Further, her dismissal of ‘crowding out’ theory only goes so far. The usual idea of crowding out is that government borrowing attracts investable capital and pushes up interest rates, making it harder for private sector businesses to find investment and thus damping down overall economic growth. Kelton argues that the state can effectively set its own interest rates for borrowing, and can thus borrow and hold down interest rates at the same time.

To an extent that is true, but only within broad limits governed by general confidence in the security of the government debt. With international money markets, setting the interest rate too low or too high would make the currency a target for speculation, as people would move their assets into or out of the country. Further, leaving interest rates to one side, as the state can only consume resources (as a state) all the resources employed by the state cannot be employed by private capital to produce profits. Whether this transfer really comes from borrowing, taxation or from creating money is moot, the fact remains that from a capitalist’s perspective, state spending is a threat to their profitability. This means less wealth overall is created for the state to commandeer.

The same can be said for a jobs guarantee. It is useful for Kelton to tell us that the US Federal Reserve sees it as part of its role to deliberately sustain a certain level of unemployment in order to control inflation. While she sees this as the result of mistaken theory, we would see it as part of the essential features of capitalism. Capitalism relies on the lash of the threat of poverty and unemployment in order to sustain its profitability for the capitalists, as well as having a buffer of laid-off workers in reserve for the next boom.

A job guarantee scheme would see wages pushed up to the point where they cut into the profits the capitalists make (and this would happen without causing inflation, since the demand would simply be transferring effective demand from one pocket to another). This would likely result in a capital strike occasioning a form of economic crisis. Just as likely, the state might be called in, as it was under the Keynesian nostrums, to regulate wages and use its job guarantee to control wage levels.

To the extent that Kelton talks about looking past money to think about real economic resources and how they can be commanded for the interests of the whole community, she is on the right path. The lever of state-issued money is insufficient. The distortion of money markets would get in the way of that. Likewise, simply seeing the problem as a misunderstanding of theory, rather than actual contesting class interests, is a greater barrier than any theory of how the state is financed.

Pik Smeet

Gold Bores (2014)

Book Review from the June 2014 issue of the Socialist Standard

Gold Wars: The Battle for the Global Economy by Kelly Mitchell (Clarity Press, 2013)

The number of writers that are currently churning out books about ‘debt-enslavement’ and advocating currency-crank ideas seems to be rising faster than the price of the average derivative. One particular group of theorists are the ‘gold bugs’ who advocate gold as a safe-haven investment and tend to argue that only a gold-backed currency and international trading system is likely to stabilise the global market economy. Some hark back to the days when paper currency was ‘as good as gold’ and could be converted into the precious metal at a fixed rate.

Business analyst Kelly Mitchell, author of Gold Wars: The Battle for the Global Economy (Clarity Press, 2013) seems to be part of this group. In fairness, to those who are interested, there is a lot of fascinating (if sometimes technical) detail in his book about the operation of the precious metals markets in gold and silver. Part of Mitchell’s case is that the powers-that-be are frightened that physical gold and silver will emerge as real money again now that the currency in use across the world is fiat (token) money not backed by anything of real value like precious metals. He contends that economies using fiat money are prone to asset price bubbles stimulated by credit expansion from the central banks and wider banking system.

Mitchell repeats some of the myths about the power of the banks to create massive multiples of credit out of nothing that have been resurgent in recent years, and also trots out some of the highly questionable quotes often used to justify these views (see Socialist Standard October 2012 on these). He claims the financial crisis has now laid bare the mountains of debt and worthless paper being pumped out by banks and governments and that in order to stop a flight towards precious metals banks and governments have been manipulating the gold price downwards for years. This is to make it look less attractive and credible as an alternative to paper money and credit.

Market manipulation
It is certainly true that there appears to have been short-term market manipulation taking place periodically in the gold and silver markets, and this is where Mitchell clearly has accumulated much knowledge and evidence. Indeed, although Mitchell doesn’t describe it in detail here, the way the gold price for physical bullion is fixed in London each day – long the centre of the world gold market – is itself a gift to the conspiracy theorists. The five leading members of the London Bullion Market Association meet at 10.30am and 3pm each day to ‘fix’ in their words, the international ‘spot’ gold price. Until recent years this used to be done at the offices of NM Rothschild in the City of London (enough, of itself, to get the conspiracy theorists’ pulses racing) though these days it is done by Barclays, HSBC, Deutsche Bank, the Bank of Nova Scotia, and Société Générale. Private tele-conferences between these banks communicate information about demand and supply for physical gold until an average price emerges. When representatives of the five banks concerned are happy with the price, they each lower a miniature Union Jack flag on their desks – when all five flags are down the price is then fixed and relayed to other markets (including those for gold futures, options, etc).

Naturally, it is in this sort of environment that conspiracy theories flourish and there are a fair few in this book concerning precious metals and the power struggles around them. These include a bizarre historical one linking the JFK assassination with an apparent attempt by Kennedy to get the US Treasury to issue currency backed by precious metal (in that particular case, silver). A more plausible contemporary theory is that because there are now mountains of paper derivatives of gold, including Exchange Traded-Funds which are investments intended to mimic fluctuations in the gold price, there may not be appropriate levels of physical gold held by banks to satisfy the potential claims on it. In other words, investment banks have been busy creating financial products to sell derived from gold but which are not really backed by gold. Indeed, Mitchell and others have claimed that it is likely that the same gold is used several times over to ‘back’ derivatives – and that if the owners of these financial products demanded physical gold bullion in return for their paper certificates there would be nowhere near enough gold held in the vaults of the major banks and central banks to satisfy the demand, leading to financial panic.

Fort Knox
Compounding this is the mystery about how much gold banks actually have in their vaults, and about the quality of this gold. In 2009, the Chinese government received a shipment of gold from the US only to find that when the bullion bars were drilled they were partly tungsten, and it is thought that an increasing proportion of gold held in bank vaults is adulterated and of poor quality. Most major governments are very reluctant to have the gold held in their vaults audited for volume and quality – the US government has resisted for years an audit of the 4,600 tons of bullion it claims is held in Fort Knox.

What is for certain – and partly accounts for the title of Mitchell’s book – is that a significant shift has been taking place in recent years in the ownership of gold bullion. China and Russia have been significant buyers and so have some Middle Eastern states. This in turn seems to be part of a concerted attempt to undermine the US dollar and the American political and economic hegemony underpinning it, by establishing alternative trading mechanisms to the US currency. An example is that oil has been priced and traded in dollars for decades (the so-called ‘petro-dollar’), but many states are now showing signs of moving away from this system, including both Russia and China who have recently signed a deal to trade oil in the Chinese Yuan. This is indicative of the US losing its place as the dominant global capitalist power as happened to Britain after the end of the First World War. The dollar is seen as a far weaker currency than it has been in living memory and Mitchell claims that the lack of real gold backing it has been part of the cause.

Interesting though it is, there are nevertheless a number of problems with this book. One is that it is not especially well written and many of the charts and figures included are not properly explained or even reproduced in an intelligible way. The analytical faults, however, are even more serious. Like many in this field, Mitchell is prone to exaggeration and overlooks evidence which contradicts his case. For instance, if suppression of the gold price is part of a concerted attempt by major central banks and private banks to prevent gold emerging as an alternative to fiat currency as a representative of wealth, this is hardly consistent with the 800 percent increase in the price of gold seen in recent years, even if it is down on the highs it achieved in the immediate wake of the financial crisis.

Gold standard
More seriously still, Mitchell holds totally untenable views about monetary and trading systems based on gold (both in terms of national currencies and earlier international trading systems like the Gold Standard). Referring to the US Federal Reserve, he says ‘Since the Fed’s inception, the dollar has declined over 95%, the economy has seen a series of booms, busts, crashes, asset bubbles, and bank runs, that almost never happened under a gold standard, and unemployment has been far greater’ (p.110-111). But apart from the decline in the value of the dollar caused by inflation, none of this is true.

The idea that slumps, asset bubbles and bank runs didn’t happen under the Gold Standard of international trading payments and when currencies like the pound sterling and the dollar were convertible into gold on demand, is frankly ludicrous. They actually happened on a regular basis including the major 1907 financial crisis in the US when JP Morgan organised a bail-out of several major US banks that were about to fail, and of course the 1929 Wall Street crash and subsequent Great Depression. As well as banking crises and equity bubbles and crashes, there were also asset price bubbles in housing, land, commodities and a range of other assets. Asset bubbles, runs on banks and financial panics were commonplace throughout the period, and in all major countries. For example, the UK has experienced 12 banking crises since 1800, with only four of these since it came off the Gold Standard, while in the US the figures are 13 and two respectively (see This Time is Different: Eight Centuries of Financial Folly by Reinhart and Rogoff).

Mitchell has failed to understand that the expansion and contraction of the credit system that he is fixated on, and its attendant asset bubbles, is a reflection of the underlying trade cycle of the market economy and is not its cause. This instead is the drive by firms to sell commodities at a profit as if the demand for them is unlimited, leading to over-expansion of the booming sectors of the economy. This overproduction leads to cut-backs, hoarding and lay-offs and the monetary and credit systems are what transmits these effects throughout the economy more widely. An example was the over-expansion of the property sector in relation to paying demand in the US, UK, Spain and other countries which triggered the most recent financial crisis when credit lines and derivatives related to this turned sour. And as Marx pointed out in Capital in relation to the many crises that have taken place when monetary systems were based on gold, convertibility was no solution but just another means for transmitting financial chaos:

  ‘[A]s soon as credit is shaken, and this is a regular and necessary phase in the cycle of modern industry, all real wealth is supposed to be actually and suddenly transformed into money, into gold and silver – a crazy demand, but one that necessarily grows out of the system itself. And the gold and silver that is supposed to satisfy these immense claims amounts in all to a few millions in the vaults of the bank . . . with the development of the credit system, capitalist production constantly strives to overcome this metallic barrier, which is both a material and an imaginary barrier to wealth and its movement, while time and again breaking its head on it’ (Volume 3, p.708).

Indeed, whether the market economy operates with a monetary system tied to gold or not is effectively irrelevant so far as its underlying trade cycle is concerned as this cycle occurs irrespective of the precise monetary conditions, which influence the surface froth and bubble but little else. It therefore follows that tinkering with the monetary system is illusory as a solution to this problem of periodic booms, crises and slumps. In fact, it is partly because the international Gold Standard and also convertibility of notes did not solve these very problems (and in the minds of many economists even exacerbated them) that they were abandoned.

The only change of significance since token money (paper notes, etc) has not been convertible any more into gold at a fixed price has been that this has allowed a massive expansion of the note issue to take place. Over time, gold as a real store of wealth and a product of human labour became the means by which all other commodities and services produced by labour could be measured – in this sense it was ‘real money’. If paper tokens were introduced to circulate on behalf of gold, representing it in fixed quantities, these paper tokens acted as money (as ‘good as gold’) and so were representative of the social wealth embodied in commodities more generally in the economy.

But when convertibility was suspended this allowed paper money to be issued far in excess of the amount of gold that was representative of the wealth being produced by society – and this phenomenon has been the source of the massive currency inflation that has occurred across the world market economy since the 1930s, massively eroding the purchasing power of the dollar, pound and other currencies. It means notes and coins in circulation are no longer tied in any way to levels of production and trade in the economy. In this respect, any move to tie paper money back to gold would in all likelihood halt inflation – but it would do nothing whatsoever to halt the market economy’s periodic crises and slumps, like the recent one, that have caused so much misery across the world. Only the abolition of prices, credit and money itself can do that, enabling social regulation of production and free access to wealth. In such circumstances, gold will no longer be stored in bank vaults (as these will not exist) and can instead be used productively and creatively rather than as an object of financial speculation and power-broking. And that situation will represent a golden opportunity for us all.

Dave Perrin

MMT: New Theory, Old Illusion (2017)

From the February 2017 issue of the Socialist Standard

We look at the latest economic theory to claim that governments can spend their way to full employment.

In 1971 the last formal link between paper currencies and gold came to an end when the US decided to end the convertibility, for foreign governments, of the dollar into gold at $35 an ounce. Before then the currencies of IMF member countries had been tied indirectly to gold by having a fixed rate of exchange with the dollar. This change meant that governments no longer had to take into account maintaining the dollar rate of exchange when making economic decisions.

The link had only been for the purpose of international trade. Internally, all currencies, including the dollar, had been, since at least the beginning of WW2, what the Americans call ‘fiat’ money, from the Latin for ‘let it be done’. Fiat money is government-created money that cannot be converted on demand into a fixed amount of gold or silver, as was the case in most countries up until WW1. The amount that is issued is a government decision, whether taken by the Treasury or the central bank.

The fact that the amount of money in circulation is at the government’s discretion does not automatically lead to inflation, as a rise in the general price level, i.e. of all prices. What it does mean is that, to avoid this, the government has to estimate the amount of currency that the economy needs to pay for goods and services, settle debts, pay taxes, etc, and issue only the amount required for this. Inflation will only result if the government issues more than this. In practice governments everywhere did this to varying degrees; hence the non-stop rise in the general price level in all countries since 1940.

Who needs deficits?

In the 1990s a new school of monetary economics emerged calling itself “Modern Monetary Theory” (MMT). Its exponents claimed that a fiat money that wasn’t tied to a fixed rate of exchange with another currency gave governments much more potential control over the economy. For them 1971 is year zero as it meant that from then on governments could issue as much money as they wanted and need not be constrained by lack of finance; they could spend as much as they want on whatever they choose by simply creating the fiat money to do it.

As one of them, Dale Pierce, put it:

  ‘The essential insight of Modern Monetary Theory (or “MMT”) is that sovereign, currency-issuing countries are only constrained by real limits. They are not constrained, and cannot be constrained, by purely financial limits because, as issuers of their respective fiat-currencies, they can never “run out of money.”’ (LINK)

They challenged the view that governments can spend only what they raise from taxes or borrow. According to them, governments don’t need to have recourse either to taxation or to borrowing; they can simply create the money to spend; the budget deficit (the difference between what a government raises in taxes and what it spends, which is filled by borrowing) is a non-issue.

They go on to argue that, if a budget deficit exists, this is because a government has deliberately chosen not to use the power that they have to create money; unemployment only exists because a government has decided as a matter of policy not to create the money to put the unemployed to work.

As Pierce put it, MMT means that

  ‘no such sovereign government can be forced to tolerate mass unemployment because of the state of its finances – no matter what that state happens to be … A currency-issuing government can purchase anything that is for sale in its own currency, including the labor of every last unemployed person who is still looking for a job. So, a key policy recommendation of Modern Monetary Theory is the idea of a “Job Guarantee”’.

What matters is 

   ‘whether there are enough real resources available to produce goods and services that are equal in value to the government’s job-guarantee spending. If these resources are available – if they are not already being used to produce something else – then the increased demand that results from the payment of job-guarantee wages will not be inflationary, regardless of what they go to produce.’

After reading this article, Richard Murphy, the tax accountant who has appointed himself an unofficial adviser in economics to Corbyn, exclaimed that it had taken him ‘a little while to realise that I am what is now called a Modern Money Theorist.’ There are members in Momentum, Corbyn’s support group in the Labour Party, promoting MMT.

No wonder. Such a theory is bound to be attractive to those who think that capitalism can be reformed to work to everyone’s benefit. But there’s nothing ‘modern’ about it. It’s an old illusion of those who see unemployed workers and idle resources alongside unmet needs and think that the obvious solution is simply for the government to create and spend more money. Various schools of currency crankism have been proposing this since the first capitalist economic downturn in 1825. To be fair, MMT rejects the view that banks can create money out of nothing; they correctly say that only a government can.

Would it work?

It’s an attractive theory, but is it valid? Would it work as envisaged?

It is true that – in theory – a government doesn’t have to resort either to taxation or to borrowing to finance its activities. It could simply print the money and spend it. This is a practice more associated with countries like Zimbabwe, but it could be done in Britain even if, when first implemented, it would provoke a financial crisis and in all probability an economic downturn too.

The way it is supposed to work is that the government introduces money into the economy through the wages and salaries of its employees, state pensions and other benefits, and what it pays its contractors; these then spend it, stimulating the growth in the rest of the economy, out of which the government eventually recoups most of the money via taxes. This is an odd way of describing how the economy works, putting the cart before the horse (government spending before taxation) and making the tail wag the dog (government spending driving the economy rather than factors within the economy itself).

In fact of course it assumes that the real economy – where wealth and value are actually produced – is already operating, so what the government would be doing is buying some of the goods and services produced there. It also assumes that the government has already been financed from taxation or borrowing.

An economy operating normally generates, when new goods are produced, new spending power as wages and profits roughly in tandem with new market value created (new things worth buying). The whole of one more or less adds up to the whole of the other, like a pair of balanced scales. If the government starts injecting extra spending power in the form of new money into the economy which is over and above the total value, the scales will tip, more money will chase goods of a lesser total value, and inflation will result.

The proponents of MMT deny this and when there are resources that are underused and people who are unemployed. They argue, as Pierce above that, in these circumstances, the extra government-created money would go towards using these unused resources and employing the unemployed to create an equivalent amount of new value. But they are ignoring the reason why these resources and people are unused in the first place, which is that the market does not recognise any profitability in employing them. This is the cruel fate of many workers who have struggled to pay for their own training and skills only to find that the market does not want them, even though their skills would be considered useful by any sane person. Capitalist economics is not interested in what is useful, it only cares what is profitable.

We’ve heard this idea before of course. It’s the classical Keynesian argument, though they envisaged the extra government spending being financed by running a budget deficit and financing it by borrowing rather than by simply printing more money.

When put to the test, in the 1970s when the post-war boom began to peter out, Keynesianism didn’t work. The economy remained stagnant and the result was to add inflation to it, a state of affairs that came to be described as ‘stagflation’. 

A slowdown, a standstill or a downturn in production is not caused by a lack of spending power but by a decline in profitable things for capitalists to spend money on. When this happens, it seems as if there’s not enough spending money, whereas in fact money is being kept in the pockets of the capitalists because they see nothing worth investing in.

The only way out is for profitability to be restored. The government can help this to some extent by cutting taxes on profits but this means that, with less income from taxation, it has to cut rather than increase its spending. Other factors such as the clearance of stocks, bankruptcies, capital depreciation, lowered interest rates, and reduced real wages will be more important. These are what will restore profitability and eventually re-stimulate the economy and move it on to the next-stage of its regular boom/slump cycle.

Keynesianism did not work and there is no reason to suppose that MMT would either. The government pumping more money into the economy would just cause inflation, whatever the stage of the cycle. MMT is in fact in the Keynesian tradition, regarding itself as part of ‘post-Keynesian’ economics and advocating the same policies – counter-cyclical government spending and job creation – , the only difference being in how they think this should be financed.

Capitalism runs on profits

MMT’s fundamental flaw is its assumption that the capitalist economy is geared to meeting paying needs – that, as Warren Mosler, the founder of MMT, has put it, ‘capitalism runs on sales’. Capitalism does of course need sales but profitable ones. It is not simply a system of production for sale, but of production for sale with a view to profit. It runs on profits and is driven by investment for profit, not people’s consumption nor government spending.

This is something governments have to recognise and, on pain of provoking an economic downturn, give priority to profits and conditions for profit-making. It’s why governments have to dance to capitalism’s tune. No government can make capitalism work for the benefit of all. The ending of any link with gold has not given governments any more control over the economy than they had before. Pouring newly-minted money onto one side of the scales is not a magic way to balance the books, no matter what the MMT gurus say, and governments will resort to it at their peril.

Adam Buick

Letter: Banking demystified (2011)

Letter to the Editors from the December 2011 issue of the Socialist Standard

Dear Editors

Governments no longer control their own economies, and neither can they act together to control the world economy. Whatever happens is now decided by global brokers and traders, who engineer situations where they can make money no matter which way the markets move, and that is all they are interested in. Their fiscal power now overwhelms any action that a government might take.

The private banking system also creates our money supply from thin air, by means of fractional reserve lending, so that all our money is created as interest bearing debt. Repaying that debt merely shrinks our money supply, and makes a recession worse.

Every year, private banks earn about £70 billion in interest from their lending of magic money. The National Debt is merely a name for the magic money they have lent to the government.

Another £75 billion of quantitative easing now goes to the banks, in the vain hope that it will pass into the economy, but the banks will simply use it to patch up their balance sheets, and square away their lost bets or adverse market positions. It will probably pay for some bonuses as well.

But the one thing that £75 billion of digital thin air money will surely do is fire up inflation, just as the previous £200 billion did, so that money already in circulation will buy less.

In the world of commodities, a similar position prevails. The price of everyday foodstuffs is dictated by the global speculations of commodity traders, who have also arranged to make money in the rising or falling of markets whose movements they control by the sheer size of their trades. Other essentials, such as oil and raw materials, suffer a similar fate.

In reality, the assets of the world have become no more than gambling chips in a casino, and the price of everything is set by those who play in the casino. If their bets are lost, the Bank of England just prints some money to pay those losses.

For the Bank of England or any other Central Bank, to think that they can affect the economy with their quantitative easing or interest rates is therefore just plain ridiculous, and shows a total ignorance of what is actually going on.

Malcolm Parkin, 

Kinross

Reply:

You are right. Neither governments nor central banks can control the way the (capitalist) economy works. But not for the reason you give. It’s not because this control is exercised by “global brokers and traders”, but because the capitalist economy is uncontrollable and governed by economic laws that impose themselves on governments and all economic decision-makers (including bankers) as if they were laws of nature.

You are wrong when you claim that “the private banking system also creates our money supply from thin air.” If money is defined as including bank loans then, of course by definition, banks “create money” and in the form of “interest-bearing debt” but they wouldn’t be doing so from thin air. The money they lend comes from what has been deposited with them or from what they themselves have borrowed, i.e. already exists and is just being recycled by the banking system. When a loan is repaid, money is not cancelled but becomes available for lending again. The interest paid on it comes in the end from what has been produced in the meantime in the real economy.

Nor is there anything mysterious or suspicious about “fractional reserve lending”. All lending institutions, not just banks but building societies, credit unions and savings clubs too, practise it, by keeping a “fraction” only of their money as a cash “reserve” against withdrawals. If a bank didn’t do this it wouldn’t be a bank but a safe deposit.

But if banks don’t create money who does? In the past, before the present era of managed currencies, money took the form of some commodity having its own value as a product of labour (gold and silver) which was made into coins by governments (which also issued metallic and paper tokens for it). Under this gold standard the amount of money in circulation was more or less self-adjusting in accordance with the requirements of the economy for payments.

This system was suspended during the First World War and finally ended with the Second. This meant that from then on governments have had to decide how much money the economy requires. Not an easy task. Issuing more than would have been required under the gold standard has become the norm, resulting in continuous inflation, so much so that people expect prices to rise from year to year.

This government-created, “fiat” money is issued by state-controlled central banks and could be described as being created, if you want to use the term, “from thin air” by them, in effect by governments. In most countries it is introduced into the economy by the central bank buying government bonds from commercial banks of which “quantitative easing” is one form.

Money dominates our lives and as banks deal in it they appear to have more power than they actually have. But banks are only one part of the capitalist system and not the most important part either. They are secondary to the real economy where wealth is produced in the form of goods and services to be sold for profit.

This is why getting at the banks, by reforming and regulating them, won’t solve the problems the profit system causes for most people. Only the common ownership and democratic control of productive resources can provide the framework for this as it will allow production solely and directly for use instead of for profit. This will make money and banks redundant – Editors

Cooking the Books: More Hot Air About Banks (2017)

The Cooking the Books column from the December 2017 issue of the Socialist Standard

'Shock data shows that most MPs do not know how money is created' Guardian columnist Zoe Williams began her article (29 October). She was publicising the results of a survey of MPs by the banking reform group Positive Money which claimed that it showed that '85% were unaware that new money was created every time a commercial bank extended a loan, while 70% thought that only the government had the power to create new money.'

This reflects not the assumed ignorance of MPs, who actually got it right, but the confused use of the word money. This is now used to describe two different monetary phenomena. First, what in America is called 'fiat money', money issued by administrative decision by the state as notes and coins and electronically. Second, what used to be called 'bank credit', loans banks make to businesses and individuals. This is now called 'bank money', so banks are regarded as 'creating money' every time they make a loan.

This confusion misleads some into thinking that banks can create money in the same way that the state can, by a mere 'stroke of the pen'. Williams herself wrote that 'all money comes from a magic tree, in the sense that money is spirited from thin air'. But not all money (in the contemporary usage of the word) does, only fiat money – and that doesn't create any new wealth, just more claims on wealth. What commercial banks lend is not 'spirited out of thin air'. It is already existing money that they lend on from what they themselves borrow from depositors and the money market.

Bank lending certainly has the economic effect of increasing spending. It is this that gives rise to the illusion that they are 'creating new money'. But what they are doing is making available, to those who want money to spend, the money of those who don't want to spend theirs for the time being. This is not creating new money, only activating existing money. That's precisely the economic role of banks and their usefulness to capitalism.

As the article (which currency cranks are always citing, though not this passage) in the March 2014 Bank of England Quarterly Bulletin puts it:

'Banks receive interest payments on their assets, such as loans, but they also generally have to pay interest on their liabilities, such as savings accounts. A bank’s business model relies on receiving a higher interest rate on the loans (or other assets) than the rate it pays out on its deposits (or other liabilities). (. . . ) The commercial bank uses the difference, or spread, between the expected return on their assets and liabilities to cover its operating costs and to make profits'.

Their business model is not based on spiriting money up from thin air and charging interest for the loan of it. That would be too good to be true. They have to have the money – or at least have to obtain it fairly quickly, as the German central bank, the Bundesbank explains:

'The banks also keep a constant eye on the costs that may incur by granting loans and creating book money. For example, if the customer uses the new credit balance to transfer money to an account at another bank, from the bank's point of view money will be flowing out. The bank then often has to recover this money, for example by taking out a loan from another bank, or by "refinancing" itself with a loan from the central bank. Alternatively, it can persuade savers to invest cash or credit balances at the bank in the form of savings or fixed-term deposits.' (Link)

In other words, in the end (if not immediately) they have to pay for what they pick from the ‘money tree’.