Tag Archives: money

A central dysfunction: house price inflation, stagnant economy

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[Published at Pearls & Irritations, 7 Nov]

The problem with the housing bubble is not a shortage of housing, the problem is an excess of money. The solution is to restrict the amounts banks can loan. The solution is a credit squeeze. But it would have to be done carefully and the government would have to be willing to spend.

The housing market is rebounding. It is through the slump. The downturn is over and the market is making gains. So say the media reports, written by the property industry. Rising house prices are good.

Except they’re a disaster for everyone else.

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How Banks Create Money Out of Nothing, and Why It Matters

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[This post replaces an earlier one, which does not properly reflect modern banking practice.]

coinsmedievalFor most people the question of where money comes from is probably a bit mysterious, that is if the question ever even occurs to them. They might recall that notes and coins are produced at a mint, owned by the government. However notes and coins comprise only a small percentage of the money circulating in a modern economy. The rest exists only as accounting entries in banks and other places. In other words it exists only as numbers in computers. How does all this money come into existence?

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Trying to Clarify Modern Money Theory

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coinsmedievalModern Money Theory is about how our monetary system works in the complicated real world – with a central bank, government spending of new money, private bank lending leveraged off the government “base” money, and the central bank and government kept separate by complicated rules allegedly to ensure “sound” money.  It is such a convoluted subject that there are about as many accounts of how it works as there are “experts”.  MMT cuts through a lot of that to a story that makes good sense and is quite contrary to a lot of things said by politicians and mainstream economists.  So MMT seems to be a very good thing.

Yet the most accessible book on the subject, Modern Money Theory by L. Randall Wray, concludes with the Chapter What is Money? that I find to be convoluted and confusing.  Much of it is built on the assertion that “goods cannot buy goods”, which I find mystifying.

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Nature and Roles of Money and Banks

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[This article is based on extracts from The Nature of the Beast: how economists mistook wild horses for a rocking chair eBook.  Guest-Posted on Steve Keen’s Debtwatch site 1 June.]

Any discussion of the nature and role of money in modern economies typically brings out a plethora of confusing or conflicting theories, claims and counter-claims about what money is, what role it plays, what dysfunctions it might be responsible for and how they might be fixed.  One common set of claims is that money is a unit if account, a medium of exchange and a store of value.  I argue the first property is a trivial one and the last is only true if the money is wholly or in part a real commodity, like a pig or some tobacco.

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How Free-Market Fundamentalists are Hopelessly Wrong, III: money, debt and blindness

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Part I presented the evidence that economies in the free-market era delivered only mediocre performance before crashing in the disastrous Global Financial Crisis.  Part II showed how the standard theory of free markets bears no useful resemblance to real economies, and its application amounts to pseudo-science.

Returning to the GFC now, there is a particular reason free-market economists claim the GFC was unforeseeable:  debt and money play no role in their standard equilibrium economic models.  They claim one person’s debt is another person’s asset, and so aggregate “demand” is not affected by debt.  This would be true in a barter economy, or if the banking system was based entirely on savings, for only in those cases would the extra purchasing power of the borrower be balanced by the reduced purchasing power of the depositor.

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How to crash an economy – some monetary parables

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[Another sample from The Nature of the Beast, from Chapter 11:  Economic Fire.  Another downloadable instalment will be available after Easter.]

Almost every institution involved in the financial system is, in the jargon, highly leveraged.  This is as true of old-fashioned banks with fractional reserves and mainstream banks with capital adequacy requirements as it is of shadow banks.  What does “highly leveraged” mean?  It means that you are betting a small amount on a large return.  If the return is positive, you make a handsome profit.  However if the return is negative you lose not only your stake but potentially everything you own.

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How Banks Create Money Out of Nothing (Dated version)

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Update Dec 2015. This version does not reflect the way modern banks work. A new version is posted here.

[Update 18 March 2010: this is the text-book explanation, but Steve Keen argues persuasively that this is only a minor part of the modern money creation process, most of which is beyond the control of central banks. See Kevin Cox’s comment below, including his proposed remedy.]

A little-known or poorly understood fact about our banking system is that banks create money. Out of nothing.

That in itself need not be a bad thing. We need a medium of exchange, which is the basic function of money, and the money has to come from somewhere. However the creation of new money is buried within our fractional-reserve system of banking. This makes it invisible to most people. Also, banks create the money in the course of making loans, which means they can charge interest on money they create at essentially no cost to themselves. That is a guarantee of unearned profits, even apart from the myriad fees banks charge for other services.

Because the fact and the process are obscure, I post here an explanation of how it comes about.

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