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Monthly Archives: February 2012

There’s been a lot of keyboard punches thrown recently over the concepts of Savings and Investment. To sum up, Modern Monetary Realism (MMR) has accused Modern Monetary Theory (MMT) of overlooking the importance of business investment as a driver of global savings. While I might agree with this critique to a point, I think it in turns overlooks an important MMT point which MMR would be well-served to poach.

As a quick background–because I haven’t said much about Savings (S) or Investment (I) on this site yet–the idea is that Investment (no matter what it’s original source, public or private sector) becomes Savings as a “leakage” in demand. As a simple example, when you receive your paycheck from your employer, it is immediately kept in your accounts as “savings,” until you on-spend it at the grocery store as consumption, at which point it becomes savings, or “retained earnings” of the store. Any income you don’t spend over the long term remains your savings.

Now, it is not well understood that both the private business sector and the public Government sector work, essentially, from negative equity positions to act as the source of net worth for the private household sector. This is the point that MMR is making. But likewise, the business sector needs revenues as a source of cash flow to feed their original investment. As investment becomes savings, an increase in new investment is necessary to provide those revenues.

The point that MMT makes is that the Government sector has a special position as the issuer of the Monetary Base (currency and bank reserves) in the economy. They can, essentially, create new investment whenever necessary while their needs for revenue to fund that new investment is, in a very real sense, relaxed. A business which is short of revenue will not make new investment until revenues pick up. A Government has no such restriction, and, in times of a shortage of new business investment, must step in to fill the gap. It’s failure to do so on a sufficient scale results in recession. In this way Government becomes the Investor of last resort.

According to mainstream economics, customer deposits allow banks to on-lend those deposits and make loans. Banks then hold a portion of those deposits in “reserve” for customer withdrawals. You may have heard of this referred to as the “money multiplier.”

The reality is, of course, exactly the opposite: banks don’t need deposits to make loans because the loan itself creates the deposit.(1)

Banks make their loan determinations based on the credit-worthiness of the customer, their capital requirements (2) and the cost of obtaining any reserves it would need ( if any) after creating the loan.

This is called endogenous money, because the money supply is determined by the preferences of actors in the real economy. For example, your need to spend on credit expands the money supply and didn’t come from anyone else’s pre-existing deposit. So the appropriate causation says: Loans Create Deposits. Banks create loans ex nihilo (out of nothing).

(1) Marc Lavoie, Credit And Money: Overdraft Economies, And Post-Keynesian Economics, pp 67-69, Money And Macro Policy, ed. Marc Jarsulic, 1985.

(2) SEC rule changes in 2004 make even capital requirements a suspect drag on bank lending, particularly for investment banks.

What is it about Modern Monetary Theory (MMT) that renders ordinarily brilliant economists incapable of comprehension?

Superficially, it appears that MMT is too radical for these mainstream stalwarts to address face to face. I won’t mention all points of contention between MMT’ers and the rest of the economics world. But specifically, MMT’s denial that taxation and bond sales fund government expenditure never gets ink spilled by the likes of Paul Krugman, Dean Baker or Robert Murphy. It’s simply too much for public discourse to address the state theory of money, despite the fact that its blindingly obvious now that that’s how it works.

In reality, MMT is really pretty tame as far as it goes. When you really dig down into it, MMT is hardly about the re-distribution of wealth from upper classes to lower classes which would ordinarily disqualify it from public consideration. The essence of MMT is that, if we take an honest look at how the monetary system operates, it’s easy enough to see that we can raise the floor for everyone, and it often goes out of its way to say that the rich don’t have to be worse off for it. It’s a construct.

In any event, none of this is out of the comprehension levels of the aforementioned economists or our political and media public figures. They just simply leave it out when talking about MMT, toning it down for the public into just “good old Keynesian economics,” as Dean Baker says.

All of which goes to show that the whole thing–and by that I mean anything which reaches the level of public discourse– is just a charade. In the words of Pete Townshend, it’s an “eminence front. It’s a put on.”