nature of money and debt 2 16-13

The Nature of Money and Debt

John Bradford, Ph.D.

What is MONEY?

• First, we must distinguish between MONEY and MONEY-THINGS, those material objects that represent or symbolize money to us.– Throughout history, many things have been used to represent

money. – Today, most money is virtual or digital money- electronic

entries in bank accounts- not cash.

What is MONEY?

• Second, and more importantly, we must distinguish between WHAT MONEY IS versus HOW MONEY FUNCTIONS (i.e. what it does).

• Some Functions of Money:1. medium of exchange2. store of value3. medium of deferment (Luhmann; Esposito)

Money = Debt, Credit• Money is first and foremost a unit of account

measuring credits and debts defined by a public authority. (Keynes, Innes, Ingham, Knapp, Wray)

• NOTE: A ‘DEBT’ PRESUPPOSES A ‘CREDIT’ AND VICE-VERSA, JUST AS A DEBTOR PRESUPPOSES A CREDITOR, BORROWING PRESUPPOSES LENDING, ETC . They are like two sides of the same coin.

• MONEY REPRESENTS A SOCIAL RELATIONSHIP OF OBLIGATION, i.e. an agreement, contract, or quantified obligation expressed in standard 'unit of account.‘

TOKEN OF DEBT

Money = Debt, CreditRelated Definitions:

– Money is a public monopoly; the ‘currency of taxation’ [Wray; Knapp]

– Money is a unit of social obligations [Ingham; Wray]

– Money is credit [Macleod, Innes] – An Agreement, a contract– Debt; Debt = a quantified obligation– Money = debt claim against society [Simmel, Soddy]– Universally redeemable IOU

TOKEN OF DEBT

‘Taxes Drive Money’Fundamentals

• Money is fundamentally a unit of accounting; a unit of measuring credits and debts.

• This unit is determined by a government that issues currency denominated in this unit (e.g. US Dollars).

• Money is valuable because governments accept only their own currency as a means of payment for taxes (and fees and penalties, etc.)

• Money is accepted as a means of exchange because people need money in order to pay taxes.

Two Views on ‘Money and Taxes’

Conventional View • Taxes finance government spending. Whatever

revenue isn’t collected in taxes must be borrowed by issuing government IOU’s (i.e. bonds).

‘Taxes-Drive-Money’ View(Lerner 1943; Wray 1998)

• Governments do not need the public’s money in order to finance their spending! Instead, the public needs money issued by government in order to pay taxes.

How Money CirculatesHistorical Illustration

Rome issues (spends) coins to Roman soldiers occupying a village. Rome then imposes a tax on the villagers, and the tax can only be paid in Roman coins!

Now, the villagers will provision the Roman soldiers with food, clothing, shelter, etc. in exchange for these coins, so that they can use them to pay taxes to Rome.

ROME

OCCUPIED VILLAGE

Explaining Public Deficits

• Normally, tax revenue will be less than total government spending: TAXES < SPENDING

• Why? Governments cannot collect more money than they have created!

$10

TAXES <= $10

Government Public

Explaining Public Deficits

• Step 1: Zero Money (i.e. no credit-debt relationship between government and public).

• Step 2: Government spends money into existence, in exchange for goods and/or labor, thus crediting bank account reserves.

• Step 3: Government imposes tax liability; citizens are able to pay their tax ‘debt’ with government ‘credit’.’ Taxes debit bank reserves.

$10

TAXES <= $10

Government Public

Is ‘Public’ Debt a Problem?

• A government cannot collect in taxes more money than it makes available: if all ‘debts’ were paid off, there would be no money left in circulation!

TAXES < SPENDING• Deficits are normal, and budget surpluses are

necessarily temporary.• Unlike households, currency-issuing

governments have no budget constraints.

Is ‘Public’ Debt a Problem?Two Views on ‘Austerity’

Conventional View • Persistent deficits should be avoided • Austerity is the inevitable result of

‘too much’ borrowing and spending, and its ‘remedy’!

• NO PAIN, NO GAIN‘Modern Money’ View• Persistent deficits are normal. • Austerity is unnecessary and self-

imposed.• ALL PAIN, NO GAIN! Austerity protests in Greece

Explaining Private Deficits

• Banks ‘make money’ by ‘making money’, (i.e. creating new credit from lending “borrowed” money, aka leveraging.)1. ‘Make money’ = ‘make a

profit’2. ‘Make money = ‘expands

money supply’

$10

$10 + compounding interest!

Private Bank Public

IOU

Explaining Private Deficits

• In the aggregate, private credits and debts cancel each other out: no net money (credit) is created.

• However, because of the application of interest,

• CREDIT (of Bank) > LOAN• DEBT (of Bob) > LOAN

– The original loan amt is called the loan “principal”

$10

$10 + compounding interest!

Private Bank Public

IOU

Explaining Private Deficits

• Question: In the aggregate, where does the extra money come from to pay off the interest???

• Answer:

MORE DEBT!

$10

$10 + compounding interest!

Private Bank Public

IOU

Public Money vs. Private Credit

Public (State) Money Private (Bank) Credit

Currency created by state via “deficit” spending

Private credit created by private firms as loans,

Collected (or ‘destroyed’) through taxation.

Collected (or ‘destroyed’) through repayment of loans.

“Debtors” = tax payers; whoever has to pay taxes.

Debtors = borrowers; whoever is originally given the money

Locus of Debt is flexible Locus of Debt is fixed

Public Money vs. Private Credit

Public (State) Money Private (Bank) Credit

Value is relatively stable, based on governments ability to collect taxes

Value is volatile, based solely on the expected ability of borrowers to repay original loan, plus interest

Facilitates indirect, Generalized Exchange

Facilitates direct, Dyadic Exchange

(potentially) Counteracts inequality

Amplifies inequality

Accounting Fundamentals

• In the aggregate, financial assets always equal financial liabilities.

• In other words, TOTAL DEBTS = TOTAL CREDITS;

TOTAL DEBITS = TOTAL CREDITS; or lastly, TOTAL BORROWING = TOTAL LENDING.

Accounting Fundamentals

• WHY? One person’s debt (liability) is another person’s credit (asset).

$100

IOU$100

“Bob”Banker

ASSETS LIABILITIES

$100 cash $100 DEBTASSETS LIABILITIESBob’s IOUworth $100

$100 cash(loaned to Bob)

Accounting Fundamentals

ASSETS = LIABILITIES• “Net worth” is a ‘residual’ category: NW = FA + RA - FL• TOTAL Net financial wealth = the sum of all financial assets less

the sum of all financial liabilities, which always nets to ZERO. Why? Because total financial assets = total financial liabilities.

• However, nonfinancial or REAL assets (i.e. material wealth) DO NOT SUM TO ZERO- i.e. ARE NOT OFFSET BY ANOTHER’S FINANCIAL LIABILITY.

ASSETS LIABILITIES AND NET WORTH

Financial Assets (FA)Real Assets (RA)

Financial Liabilities (FL)Net Worth (NW)

Accounting Fundamentals

WHY DOES THIS MATTER?• If total financial assets = total financial liabilities,

then the financial liability (DEBT) of government must EQUAL the financial assets (SAVINGS) of the non-governmental private sector!

• Summary: government debt = private savings!

ASSETS LIABILITIES AND NET WORTH

Financial Assets (FA)Real Assets (RA)

Financial Liabilities (FL)Net Worth (NW)

Why Deficits = SavingsConsider three scenarios:• SCENARIO 1: Govt must balance its budget

– Private sector makes a nuke worth $100. Govt spends $100 to purchase the nuke. But to purchase the nuke, govt must collect $100 in taxes! The net result is that the real assets (e.g. the nuke) are just moved from the private sector to the government.

Nuke

Government Private sector

+$100 payment MINUS $100 in taxes!$100 - $100 = ZERO

ASSETS

+Nuke

ASSETS

$0-Nuke

Why Deficits = Savings• SCENARIO 2: Govt deficit spends by creating money

– For example, in this (imaginary) scenario, the Treasury could spend without borrowing money from the Fed or elsewhere, i.e. without selling Treasuries, and without incurring debt.

Government

Govt prints money, gives it to private sector in exchange for nukes. No tax liability is imposed! The result is that the net worth of both parties increases.

ASSETS Liability

+Nuke $100

Private sector

+$100Cash

ASSETS Liability

+$100-Nuke

--

Note: the $100 is a “liability” of the govt in the sense that it is a govt IOU which it must accept back as a means of paying taxes.

Why Deficits = Savings• SCENARIO 3: Govt deficit spends by ‘borrowing’ money

– The Treasury must raise revenue by selling bonds (‘Treasuries’) to the private sector (or to a central bank), which is just an IOU. In this case, exactly the same thing happens as in scenario 2: the net worth of both parties increases. The only difference is that the asset of the private sector is in the form of a bond (IOU for cash) rather than cash.

Government

Govt prints money, gives it to private sector in exchange for nukes. No tax liability is imposed! The result is that the net worth of both parties increases.

ASSETS Liability

+Nuke $100 Bond

Private sector

+$100Bond

ASSETS Liability

+$100 Bond-Nuke

--

Money Creation in the U.S.

US Treasury

Federal Reserve

IOUs (Bonds)

Federal Reserve prints money, from nothing, and pays Treasury.

Money as Debt

Whatever bonds the other banks do not purchase, the Federal Reserve purchases.The Federal Reserve can exercise a power that the Treasury cannot: it can simply print the money from nothing! But it creates this money as public debt, i.e. the government’s liability to the Fed. This is exactly scenario #3 in previous slide!

Money Creation in the U.S.

• In the US, the Federal Reserve prints “Federal Reserve notes” which function as legal tender or fiat money.

• This money essentially represents debt to the Fed, (i.e. the government’s liability).

• US coins, however, are produced by the US Treasury, and do not represent debt to private banks.

Money Creation in the U.S.OPEN QUESTIONS

1. Why does the Treasury have to ‘borrow’ money from the Fed? Would it be better if it printed the money itself?

2. Since much of the public ‘debt’ is just a consequence of this law which stipulates that only the Fed (a private bank) can create money from nothing-but not the Treasury- is the public debt at all important? Or irrelevant?

3. Finally, to what extent does the application of interest exacerbate inequality? Does the universal expectation of growth (implied by interest) make perpetual growth a requirement for our economy and hence, guarantee its unsustainability?

US Treasury

Federal Reserve

Accounting Fundamentals

• Here is what happens when $10 of interest is applied: Banker’s assets increase $10, and “Bob’s” liabilities increase $10. This is a net transfer of wealth of $10.

$100

IOU$110

“Bob”Banker

ASSETS LIABILITIES

$100 cash $110 DEBTASSETS LIABILITIESBob’s IOUworth $110

$100 cash(loaned to Bob)

Accounting Fundamentals• The application of interest makes the financial assets of

the banker and the financial liability of the borrower GROW EXPONENTIALLY.

• Assets still equal Liabilities in the aggregate, but the net financial wealth of the bank increases by the same amount as the net financial wealth of the borrower decreases.

“Bob”Banker

LIABILITIES

$110 DEBT

ASSETS

Bob’s IOUworth $110

Net transfer of $10

Accounting Fundamentals• Unlike governments and unlike banks, “Bob” can only

acquire the money to repay his liability from somewhere else. From where?

• In the aggregate, all new money comes either from the government (in the form of deficit spending) or from banks (in the form of private loans’).

“Bob”Banker

LIABILITIES

$110 DEBT

ASSETS

Bob’s IOUworth $110

Net transfer of $10

Linking Inequality and Debt

• New money (i.e. credit) is primarily loaned into existence by private banks.

• Because of the application of interest, total debt will always exceed the size of the existing money supply to repay it.

P+I(TOTAL DEBT)

MONEY (amount that can be used to

pay debts) <

Linking Inequality and Debt

1. The current system functions like a pyramid scheme: it is built on the expectation of infinite, exponential growth!

2. This is impossible, because aggregate financial wealth always nets to zero. (assets=liabilities).

3. Interest payments generally do not recycle back into the general population as earned income.

Linking Inequality and Debt

• COMPOUNDING INTEREST INEQUALITY• Compounding interest means that creditors

exponentially expand their claims on wealth.

Linking Inequality and Debt

• The debt pyramid is like a game of musical chairs: in the aggregate, the total liability of the borrowers can only be paid off (cancelled) with the creation of new money,

• New (net) money comes from only two possible sources: 1. Private banks, which will lend the money, thus

reinforcing the debt cycle, or 2. Government, which can deficit spend, i.e.

spend more than it collects in taxes, thus adding net reserves to the system.

Total Debt-to-GDP RatioUnited States (1976-2008)

1.8

2.0

2.1

2.3

2.4

1996 2000 2003 2007 2010

Total Debt to GDP RatioUnited States (1976-2008)

Year

Ra

tio

Income earned by the top 10% (1970-2010)

30.0

32.9

35.7

38.6

41.4

44.3

47.1

50.0

1970 1980 1990 2000 2010

Percentage of Total Income Earned by the Top 10 PercentUnited States (1970-2009)

Year

Pe

rce

nta

ge

Source: Picketty and Saez

CEO and Worker PayCEOs' pay as a multiple of the average worker's pay, 1960-2007

Source: Domhoff 2011

The United States does not “borrow” Dollars from China

• The United States cannot “borrow” dollars from China because China does not produce dollars!

• Instead, China trades their goods in exchange for US dollars.

$USDollars

Chinese Goods

The United States does not “borrow” Dollars from China

• Next, China trades these dollars for interest-bearing IOU’s (bonds) called Treasuries.

• Treasuries are just promises to pay back more dollars in the future.

• This is basically like moving one’s cash from a checking account to a savings account, that earns interest.

IOU Dollars(Treasuries)

$US Dollars

The United States does not “borrow” Dollars from China

• The bottom line: THE US GOVERNMENT NEVER NEEDS TO ‘BORROW’ THE CURRENCY (MONEY) THAT IT CREATES IN THE FIRST PLACE! (whether from China, or anyone else)

• Any currency-issuing government can ‘afford’ anything sold in that currency.

IOU Dollars(Treasuries)

$US Dollars

Holders of US Treasury Securities 2010

Individuals12%

Mutual Funds7%

Banking Institu-tions3%

Insurance Companies

3%

Federal Reserve11%

State and Local Govts

6%

Foreign48%

Pension Funds9%

Other2%

Here is some actual data on who holds US government debt.

More than half of the public debt in the US is owned within the US.

Instead of borrowing the funds, the Treasury could have 1. raised the money through taxation, or 2. printed the money itself, debt-free.

China26%

Japan20%

United Kingdom6%

Oil Exporters 5%

Brazil4%

Carib Bnkng Ctrs 4%

Taiwan4%

Russia3%

Hong Kong3%

Switzerland2%

Other23%

Major Foreign Holders of Treasury Securities 2011

The countries that own the 47% of foreign-owned Treasuries