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On Public Credit and the Printing of Money

by ChrisCook Sat Feb 26th, 2011 at 05:22:31 AM EST

I made the following response to someone in a forum on 'Public Banking' who was repeating the fallacy that money is debt.


I'm afraid you share a fundamental misconception in relation to the money created by banks, which is in fact a credit instrument, not a debt instrument.

When private banks create credit they create a virtual IOU as an accounting object. This interest-free IOU is a 'look-alike' of the interest-free IOU issued by Central Banks, and is routinely exchanged for such notes and coin in private hands when they are 'deposited' in the banks. It is currency created as an object or thing to which account owners have title.

When a private bank lends this currency into existence it is creating BOTH the currency AND the interest-bearing loan relationship with the borrower under a debt contract. The currency is not the debt, but a credit instrument identical to those issued by government.

The debt is created in exchange for the use over time of the currency. When a private bank spends currency into existence it creates virtual credit instruments, and 'deposits' these into the accounts of suppliers, staff, management or shareholders by crediting them with an entitlement to these virtual assets.

These credit instruments/IOUs are accepted by governments in payment of taxes, and that is what gives them their value. There is functionally no difference between an invoice issued by a private business for private services rendered, and a tax demand issued for government services rendered. Likewise, the issue by government of an undated IOU redeemable against taxes is functionally equivalent to the issue by a private business of an undated IOU redeemable against goods and services. eg Air Miles, Store Loyalty points, or the well known DeliDollars.

Government IOUs differ from private ones in that they are made universally acceptable against debts by 'legal tender' laws aka by government fiat.

So in a nutshell, governments do not create debt when they 'print money' and spend it. Government IOUs are in fact credit instruments analogous to a form of undated non interest-bearing redeemable preference share.

Of course, these credit instruments must be issued and spent sensibly, and not in relation to existing assets, where they will cause inflation as the private banks demonstrated by creating the property bubble.

In my view public credit need not be inflationary if used to facilitate the circulation of goods and services and the creation of new productive assets, such as affordable housing; renewable energy and energy saving projects; infrastructure such as transport, schools and hospitals, and of course on training and education of the population to enable them to create these assets.

Such public credit creation should be professionally managed by service providers with a stake in the outcome, and accountably overseen by a Monetary Authority (as in Hong Kong, where there is no Central Bank). Once productive assets are created with public credit, they may then be refinanced by private investment in long term credit based upon their productive value (eg rental flows and energy flows).

In this way pension investment will enable the public credit used to create new assets to be retired and recycled. Likewise, the newly productive workforce will pay taxes, which again will retire and recycle the public credit which made the workforce productive.

Display:
I find it useful to back to the origin of our paper currency.  You deposited gold or some such at a banking house, and they gave you a receipt for it.  You could then make purchases against that receipt, and the seller could go to the bank and get "real" payment.  Barring fraud, when the gold was gone, the receipt was used up and no longer valid.  Eventually the receipts turned into notes of standardized amounts to make them easier to use.  Then governments took over the note-making business, and while there was still a stash in Fort Knox, the real backing for government-issued currency was and is the revenue authority.  Instead of ultimately going to the bank and redeeming for gold, you go to the government and pay your tax obligation.  And, unlike a gold deposit, the tax obligation continuously renews, so the notes don't expire but keep circulating.
by rifek on Sat Feb 26th, 2011 at 11:51:09 AM EST
It would then be even more useful to go back to the origin of the precious metal currency. The government originally collected taxes in kind.

So you take your wheat to the local temple/royal storehouse, get a clay tablet receipt, then take it to the tax registry to get it registered.

How this became a medium of exchange is obvious ~ if you take a couple of extra measures of wheat in, you could use a tax receipt to buy a pot or a tool from a peasant who is a more skilled artisan, and they in turn do not have to spend as much time in their fields and can spend more time on their craft.

But while clay tablets are fine as receipts to be held in a jar in a house, they are substandard as a medium of exchange. Also, clay tablets are prone to forgery. And once the tax receipts are accepted as medium of exchange, the temple or king can use them to obtain supplies other than those that they have traditional taxation rights to.

So metal money is the switch of clay tablet tax receipts into reusable metal tax receipts, that were better suited to also being used as a medium of exchange.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Mar 9th, 2011 at 07:22:55 PM EST
[ Parent ]
BruceMcF:
So metal money is the switch of clay tablet tax receipts into reusable metal tax receipts, that were better suited to also being used as a medium of exchange.

I thought that the role of government in relation to metal money was in standard setting/assaying through a Mint. So people would bring eg bullion to be minted into coins which may well have been acceptable in settlement of tax obligations, but that did not make them tax receipts.

The key point that is generally missed is the difference between the credit instruments/IOUs which banks emit/issue as currency, and the equal and opposite obligations (deposits/loans) which come into existence in respect of the use over time of these (pretty much baseless) credit instruments.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Mar 9th, 2011 at 09:31:58 PM EST
[ Parent ]
The key point that is generally missed is the difference between the credit instruments/IOUs which banks emit/issue as currency, and the equal and opposite obligations (deposits/loans) which come into existence in respect of the use over time of these (pretty much baseless) credit instruments.

The value of currency is based on the value of associated obligations. Banks can issue credit and thereby assume new obligations rather freely - as long as account owners do not use the entitled credit en masse. And even if banks get into problems with meeting their obligations, the government would routinely bailout them (especially the "too-big-to-fail" ones): they just assume the oversized banks' obligations with rather symbolic benefit of partial ownership or what?

There are still deep social problems with modern banking practices. The value of banks' obligations is quite hidden by traditionally solid reputation and bailout guarantees. Their debtors' obligations are open to free market and are made quite secure by stricter bankruptcy laws (adopted or copied just in time for the downturn). For example, the Swedish crone has been going up against major currencies recently, which is an indication that the control of mortgage payments from the Baltic states is pretty good. The crisis intensifies obligations but gives comfortable relief to the entitled side. Some have to work hard and give almost everything to bubbled loan payments (and a little more for taxes), hence some can make nice living just by collecting their creditor claims. The banking side does not show any soreness from the crisis. Relatively, they are doing only better. Plus the governments are demonstrating that they would rather default on their social obligations than on bonds. It is an easy guess who controls political decisions.

by das monde on Wed Mar 9th, 2011 at 11:08:36 PM EST
[ Parent ]
The public mint is thousands of years later in the evolution of money.

Certainly when talking about Medieval Europe, it was an established right of kings to collect seigniorage on gold or silver brought to the mint, and this became even more important in the early modern period as Europe advanced from peripheral to semi-peripheral status on the back of Spanish silver and the ability to buy into the East Asian carrying trade, with the need for silver for East Asian and South Asian finance leading to the use of gold for circulation within the Atlantic economy, focused as it was around wheedling silver out of the hands of the Spanish.

But relying on private individuals to bring metal into the mint is a fairly peculiar institution in a world historical context, even if by accident of Peninsular West Asians stumbling upon two large mountains of silver in the Americas their peculiar institutions were spread around the world in the several centuries of their rise as expanding semi-peripheral states and then the "long century" of Peninsular West Asian dominance in the world economy.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Mar 9th, 2011 at 11:32:19 PM EST
[ Parent ]
BruceMcF:
Certainly when talking about Medieval Europe, it was an established right of kings to collect seigniorage on gold or silver brought to the mint,

I think that you mis-understand seigniorage, which is the difference between face value of currency and its production value.

If an amount of gold (say an ounce) was worth one pound sterling, then someone would bring an ounce of gold bullion to the Mint, and it would be assayed and stamped for a fee, and would become currency. No seigniorage there.

If the gold bullion were the King's there's still no seigniorage provided the exchange value of one ounce of gold = the exchange value of the abstraction which is one pound sterling. But of course, Kings were tempted to cheat, by milling and clipping the coins, or alloying the metal and thereby generating seigniorage and inflation since more currency is chasing the same goods.

By contrast, if there is a glut of gold (as there was in Spain when they looted the new Americas) then sterling inflation sets in by another route, since people require (say) 2 ounces of gold for the original 'pound's worth' of sheep, cattle or whatever it was, instead of one ounce since more currency is again chasing the same goods.

Seigniorage is the difference between the exchange value of the underlying commodity, and the exchange value of the currency - both by reference to the Numéraire.

So the copper in a 25c quarter is worth maybe 10% of the face value of the coin and the difference is seigniorage.

The seigniorage involved in the issue of a dollar bill is the cost of printing the dollar bill. The seigniorage of virtual currency - whether created by private banks as private credit, or by Public banks as QE, or Treasuries (the Social Credit concept) - is 100%, and from this income, system costs must be deducted.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Thu Mar 10th, 2011 at 09:53:49 AM EST
[ Parent ]
... and dropped the origin. Originally (Rolnick, Velde and Weber 1997: 9):
Coins were produced by mints. (See Saulcy 1879-92, vol. 1, pp. vii-xvi; Blanchet and Dieudonné 1912-36, vol. 2, pp. 7-20; Spufford 1988a.) By the late 13th century, all mints within a given political entity were under direct control of the sovereign. The mints were run as businesses by private entrepreneurs, who leased the physical plant and capital equipment for fixed terms. Individuals (goldsmiths and moneychangers) could come to a counter at the mint and deliver their metal (bullion, old coins, silverware, and goldware), and they would be paid back, within a few weeks, in newly minted coins of the same metal they brought in.3 They always received back less fine metal than they brought in. Part of what was withheld by the mint paid for production costs and was called brassage. The rest was sent to the sovereign as profit, or tax, and was called seigniorage

So when you say:

If an amount of gold (say an ounce) was worth one pound sterling, then someone would bring an ounce of gold bullion to the Mint, and it would be assayed and stamped for a fee, and would become currency. No seigniorage there.
You are saying, "it would be assayed and stamped for a fee (that consisted of the return to the mint, called "brassage", and the tax to the king, called "seigniorage"). No seigniorage there.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Thu Mar 10th, 2011 at 10:10:18 AM EST
[ Parent ]
Right. Interesting reference and history.

But in fact something of a distraction, really, in an age of virtual currency issued ex nihilo.

To me the key point is that people firstly have the credit instrument - as accounting objects - confused with obligations/relationships which exist in respect of the use over time of these credit instruments.

The second point is that the numeraire - which is an abstraction - need not in fact be the currency.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Thu Mar 10th, 2011 at 11:05:51 AM EST
[ Parent ]
No, it need not be, and when the link between the store of value, medium of exchange, and standard of deferred payment functions of a money are broken, then that poses a challenge regarding what the unit of account should be.

However, so long as taxes are due in sovereign money, and that sovereign money does in fact function as a medium of exchange, store of value and standard of deferred payment, it will tend to be used as the unit of account.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Mar 10th, 2011 at 12:07:32 PM EST
[ Parent ]
... as opposed to the "Just So" stories that are fundamentally lies spread by mainstream economist to obstruct inconvenient truth, that their models do not work with actual money, so they have to incorporate into their models a fictitious analogue that bears a surface resemblance with money but is in fact no such thing.

From the beginning, local money gained its value through being a means to meet tax obligations. The reason that the pound stirling did not drop out of circulation entirely during the Great Debasement was because of the demand for liquidity.

With the rise of reserve banking and the evolution of bank deposit liabilities that function as horizontal money, the eventual regulation of commercial banks by a central bank of settlement led to a second foundation for the value of vertical money is the need to use sovereign currency to settle payments through the central bank of settlement.

But that did not eliminate the function of tax liabilities as a foundation for the demand for sovereign money, but rather served to augment it.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Mar 11th, 2011 at 11:04:22 PM EST
[ Parent ]
Here is some take on the banking history from the 18th century on. Clay tablets and silver mountains were for innocent times.  
by das monde on Thu Mar 10th, 2011 at 12:57:51 AM EST
[ Parent ]
Yes, its common to pick up actual monetary history in the 1800's, in the Atlantic system, and then replace monetary history from the beginning of money to the 1800's with myths and fairy tales that are fabricated to support monetarist fictions.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Thu Mar 10th, 2011 at 10:12:57 AM EST
[ Parent ]
A good diary Chris. I know that I do not have the background to understand the implications of what you say, but it is important to know that there is pushback on the bad ideas being used against us

keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Tue Mar 8th, 2011 at 08:19:22 AM EST
I particularly like your comments about those uses for which freshly created money can be put without creating inflation and strongly agree. Whether by  printing notes or crediting checking accounts the potential for inflation is strongly dependent on the reliability with which the purpose for which the money was created results in a new revenue stream so as to make the investment "self-liquidating". I would suppose that even precious metal coinage for money could create the potential for inflation, especially since the development of multi-location merchant and money-changer families and organizations, as these almost inevitably turn into "fractional reserve" gold based monetary systems.

If new money is used to create new productive assets the result is an expanded economy, not inflation. If it is used to buy up existing assets and thereby drive up the price of those assets, this is inherently inflationary. That Greenspan denied that this could be seen and avoided is, at best, disingenuous and pathetic, but more likely, deliberately obfuscatory in pursuit of a dark political agenda.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Mar 11th, 2011 at 11:12:02 AM EST
[ Parent ]
ARGeezer:
I would suppose that even precious metal coinage for money could create the potential for inflation

The inflow of American silver caused lots of inflation in western Europe. It has in particular been credited with transforming the dominant class in England from land based, warfare nobility to money based, commerce nobility.

A vote for PES is a vote for EPP! A vote for EPP is a vote for PES! Support the coalition, vote EPP-PES in 2009!

by A swedish kind of death on Mon Mar 14th, 2011 at 09:36:22 AM EST
[ Parent ]
Even more critical in that transformation was the use of the silver to buy into the carrying trade among the core economics of the day, in east asia. This was doubly reliant on commerce ~ first, to find luxury goods to persude the Spanish to hand their silver over, and second to engage in the carrying trade itself.

The fact that silver was a flow commodity ~ from production in the two giant mountains of silver in Mexico and Peru through the Atlantic trading system to buying into the carrying trade in East Asia ~ and the fact that this was happening between sovereignties rather than within one, is largely responsible for the settling on gold as the international commodity for settlement within the Atlantic trading system.

All too often, accounts of what was going on within the Atlantic trading system are written as if Peninsular West Asia were already core economies in the 1600's or 1700's, when it was clearly not until the 1800's that the center of the international economic system shifted to the western side of Asia.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Mon Mar 14th, 2011 at 03:35:15 PM EST
[ Parent ]
It seems to me that you are performing a vital public service in educating the public in the true nature of money and banking.  I have otherwise intelligent friends who still think that every penny the banks lend is somebody else's money deposited in the bank.

Your analysis also highlights the extraordinarily privileged position banks have in modern economies whereby they can create credit ex nihilo and then charge interest on it - money for nothing, and from nothing, essentially, but leading to increased wealth for bankers.

It was this logic which led Irish banks, and Anglo Irish in particular to create mountains of credit, unrelated to any rational productive purpose, to create property bubbles and great private indebtedness amongst house-buyers now in negative equity.  And to add insult to injury, the public was then expected to pick up the tab.

So whilst the public finances were only marginally irresponsible - public debt to GDP ratio was down to 25% of GDP in 2007, albeit partly because of inflated tax revenues deriving from property buble related financial transactions - it was private credit which ran amok - I have seen figures ranging from 200 to 400% of GDP.

How any regulator or disinterested economist could see that as sustainable, and witter about soft landings etc., is beyond me, but the point is that is was possible because there was and is great public ignorance about how such banking operates, and how it yields huge profits for the few - with the risks ultimately borne by the state.

I think there is an urgent need for a popular tome on the history of money to illustrate these points - not necessarily ground breaking original research, or theoretical advancements in the theory, but a popularisation of what is already known by intelligent commentators like yourself.

The problem is how do you make such a dry topic intelligible, interesting, and even amusing - something that could even be turned into a TV series.

How about "A short history of Money" - in homage to a Short history of Time?


Index of Frank's Diaries

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sat Mar 12th, 2011 at 07:53:04 AM EST
Thanks, Frank.

Frank Schnittger:

 I have otherwise intelligent friends who still think that every penny the banks lend is somebody else's money deposited in the bank.

In fact, that's just the monetary myth.

Equally corrosive, and entirely related, is the 'Taxpayers' Money' myth: 'Tax and Spend'. This has it that taxes are collected and then spent by the government.

The truth is of course that taxpayer's money has never been anywhere near a tax-payer, being spent into existence, and then (unnecessarily) 'funded' by the creation of interest-bearing credit by private banks.

Spending creates new deposits, and taxation in fact acts as a mechanism for taking money out of the economy and acts against inflation.

As an afterthought, Time (to pay) aka credit is the crucial component of a monetary system.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Mar 12th, 2011 at 09:38:20 AM EST
[ Parent ]
... space is a device that prevents everything from happening at the same place and time is a device that prevents everything from happening at once.

Though the impact is greater in econ grad school, for those few who look around and see that in the foundation mainstream model, there is no real space and no real time.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Sat Mar 12th, 2011 at 08:05:45 PM EST
[ Parent ]
I have otherwise intelligent friends who still think that every penny the banks lend is somebody else's money deposited in the bank.

That's because, as Galbraith said, the process by which banks create money is so simple that the mind is repelled.

So, in what may be my last act of "advising", I'll advise you to cut the jargon. -- My old PhD advisor, to me, 26/2/11

by Migeru (migeru at eurotrib dot com) on Sat Mar 12th, 2011 at 10:25:38 AM EST
[ Parent ]


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