Modern Monetary Theory

[melveyr]

Think of the income statement of the entire global corporate sector as one entity. They pay out wages, these wages are an expense on their income statement. Even if all of these wages turned into revenue, that would still not be enough to turn a profit.

This vastly oversimplified view that profits and wealth are ultimately created by flows of funds is simply incorrect.

The ultimate source of wealth creation is not the mere exchange of resources, paper money, or credit. Wealth is created by the combination of (1) ideas and (2) the harnessing of physical fuel sources like fossil fuel deposits, photosynthesis, etc. to make the ideas a reality.

The exchange of resources, money, and credit merely serves as "lubrication" for the moving parts in the engine of the global economy. The gasoline that ultimately powers the engine are the ideas and physical energy sources. What good is an engine with unlimited lubrication if the fuel tank is empty? Think of the printing of money as the injection of more lubrication into the engine. It certainly may help in some cases if the engine is grinding to a halt due to lack of lubrication, but it does not actually power the engine.

Profits are measured in dollars. Not economic value added. If I trade a skateboard for a bicycle, neither party profited. No dollars were exchanged. However, we each derived an economic benefit from the transaction. Profit is an accounting term.

[stone]

Tortoise, as melveyr said your initial argument was about accounting. You seem to have now moved to saying accounting is petty anyway . I agree that accounting is petty and in an ideal world we would all do great work that provided for all of our needs without giving a thought to money. The fact is though that none of us can sense what the other severn billion of us want and are capable of at any one time. That is why we need a monetary system just as an ant colony needs pheromones. Have you seen an ant colony on the TV when the pheromones stop working? None of them have a clue what to do, they panic and then starve.
An ideal monetary system would be one where what made sense from a financial perspective was what made sense if finance was not considered. I think from that view point it is hard to say that our global monetary system does a perfect job. What I find terrifying is that much of the policy debate about the monetary system seems to shirk the basic accounting. To my mind that is like building a large bridge without condidering the civil engineering calculations that show whether or not it will collapse.

[Tortoise]

I never said accounting is "petty," nor did I ever intend to imply that. And I fully agree that money (whether fiat, gold-backed, or free-market) is an absolute necessity for a modern economy. It would be absurd to suggest otherwise.

The authors of the paper "Where Profits Come From" derive an equation that identifies the sources of the economy's aggregate profits, and that's fine. I just doubt the equation can be used with any sort of useful accuracy, given the inherent difficulties of accurately measuring the macroeconomic variables in the equation and accounting for the mind-numbingly complex interrelationships between them. This problem also applies to many other macroeconomic equations.

This philosophical subtlety seems to be a key part of the debate between central planning advocates and free-market advocates. The central planners argue that it's possible for one person, or a small group of people, to plug various aggregate measurements into a macroeconomic model and thereby (1) understand all relevant aspects of the current state of the economy, along with its likely trajectory, and (2) use that knowledge to make fiscal and monetary policy decisions. Free-market advocates, on the other hand, think the economy is a system that is far too complex for any one person or group to understand at the minimum level necessary to make central planning a viable approach.

[stone]

Tortoise, I think it is possible to both recognize the benefits of the free market "wisdom of crowds" and also to recognize accounting identities such as wages not contributing to profits.  If we slip into a state where rather than having many small businesses who's owners spend the profits to having a few huge ones with a few huge owners who save the profits, then we need to be aware that we could end up sucking government into providing "stimulus" or whatever. I think preserving a free market requires policy that takes macro economics into account.

[moda0306]

Another great, if ballsy (saying Clinton surpluses caused recession & private-sector debt crisis), MMT article.

http://pragcap.com/visualizing-the-dest ... on-surplus

This one seems to be the "original" and raises a bunch of great points about how the government has to issue currency before it can tax it or borrow it.... this may have been previously posted.

http://pragcap.com/resources/understand ... ary-system

[stone]

A really clear interview that sets out what the MMTers are claiming:
http://hir.harvard.edu/debt-deficits-an ... ary-theory

[moda0306]

Excellent.

Doesn't solve all our economic problems or have some  moments, but it definitely creates a decent visualization of our system as it exists.

I'd love to hear the MMT'ers or Krugman try to explain the 1970's, because according to the Keynesians & MMT'ers, we weren't supposed to see rising rates and high unemployment and low growth at the same time.

[Gumby]

Here is a terrific analogy and explanation on how MMT sees the role of government spending and taxation in the economy:

"MMT (Modern Monetary Theory) focuses on the way monetary systems such as ours operate and the implications from this knowledge.

Is MMT advocating a free lunch? Is it saying that we can simply spend our way to prosperity? No! It instead identifies the real as opposed to imaginary constraints on economic growth.

Think about our economy as of a car that needs to get from where we're now to its destination – Prosperity! MMT recognizes that the car has a gas pedal and a brake pedal and a steering wheel that if used right can get us to our destination. Think of the gas pedal as injection of money into the economy (also known as "spending"), the brake as removal of money from the economy (also known as "taxation") The driver is the government and it can steer the car in various directions. Other countries have their own economies, so, think of other cars sharing the roads with yours.

The "deficit-hawks" believe that big deficits are always bad. Deficit is the difference between spending and taxation. So, their position is similar to a belief that too much pressing on gas (without counterbalancing by braking) causes crashes. While it is true that if you go too fast you are more likely to crash, pressing on gas and going too fast are two separate things. For example, when the car is going uphill or stalling, you really need to step on the gas to get it moving. So, deficit hawks in their myopia ignore the road conditions. They concentrate on numbers that are meaningless without a context. Additionally, their fear of spending prevents the economy from realizing its potential. Either they'd have you press on the gas very gently (spend less) or brake too often (tax more), without realizing that they might be causing the car to move too slowly and by the time you'd get to the destination Prosperity – if you got there – the rest of the world was there long ago and left to even further destinations.

The deficit hawks don't know how the car really works. They don't even understand that the deficit should be automatically adjusted to road conditions. Imagine if somebody told you you should never press on gas continuously without braking for more than, say, 1 mile. You'd laugh and say: this depends on where you drive and a myriad of other things!

What MMT is saying, is that you should not be shy to press on the gas when needed, to press on the brakes when needed and to steer the wheel as needed. MMT allows you to take the full potential of the car, without imposing arbitrary constraints (such as "pressing on the gas is bad" or "pressing on the brakes is bad"). Is there a fool-proof way to get to the destination? No, there is always an risk and sometimes the driver will make a mistake and sometimes crashes can even occur because of other driver's actions. But have you ever seen a fool-proof system?"

[Source]

[moda0306]

While I don't like the idea of thinking that government is driving the economy, I see what they're getting at with the analogy.  I think one has to accept first that currency must expand, before MMT becomes valid at all.  The idea that gold can be a legitimate currency for all world activity forgets that the need for a medium of exchange in the first place is a market failure of sorts, and if contracts are to be formed around a currency that MAYBE we need one that isn't tied to what we USED to see as a functional-enough currency for our economic levels.  Maybe it can much more efficiently be accomplished by creating a "print & tax game" like the MMTers visualize our system as.

The biggest thing to me to take away from MMT is that if the vast majority of  value created in society is traded for a currency, and not developed on ones' own or traded for other value (bartaring), then starving the economy of said currency will NOT bring about creation of real wealth.  This will leave more people sitting on their butts with nothing to do and previously-acquired debts to service, because an economy where everyone thought value was traded for dollars and little else is now being starved of that very thing as the private-money-creating machine (aka, leverage) retreats and the government tries to do the same.

Further, printing money (reserves) to buy money with different terms (short-term bonds), which is what QE is, is NOT fundamentally changing anything. If governments were to trade Ak-47s for M16s in wartorn Africa would we have "armed them?"  No, they'd have a different type of gun, that's all.  If we traded our nukes for North Korea's soviet nukes will we have given Kim a huge upper hand?  No.  He already had nukes... we simply traded him for ours.  Until QE starts buying things that are fundamentally different it's not going to accomplish much, and the nature of the fed is not to go out and buy foreclosed homes, so I don't think we'll see that soon.

So really, when the fed "expands the money supply" through QE when bonds and cash have similar terms, it's not expanding diddly... it's changing the terms of savings in existance to control lending rates.  If they bought pork bellies or beard trims for Bernanke, THEN they'd be expanding the money supply, because there'd be no offset by someone giving up their bond.  Conversely, running deficits is what seems to "expand the money supply," because you're mailing someone a check (M +1), taking a green piece of paper with a number on it from a saver (M -1), and giving that saver a piece of paper with a number and a term on it (M +1)... which all nets to (M +1).

That money turns into savings somewhere.  Maybe a little to person #1, a little more to his gardener, a little more to his grocer, and a little more to his auto dealer, but somewhere it becomes savings... the nice part is, all along the way it puts someone to work that would otherwise had wasted another day of their life in a world denominated in dollars, but with too few.  They'll try to make up for it by trading services with others and repairing their own cars, but this is extremely inefficient in a moder economy, and to me seems quite avoidable.

[moda0306]

http://www.nakedcapitalism.com/2010/05/ ... ation.html

Good post on hyperinflation in Weimar & Zimbabwe.

[moda0306]

http://futronomics.blogspot.com/2009/03 ... sible.html

Another great article on money supply, credit and hyperinflation... more detail in this one.

[melveyr]

Moda,

Have you check out "Understanding Modern Money" by Randy Wray?

It's one of the few books dedicated to MMT out there. Its worth buying off of Amazon.

[moda0306]

A decent critique of MMT, with some errors in my view but definitely worth reading to help the brain digest this.  I think a lot of his shots against MMT are misquoting it completely, but some of his points are valid.

http://pair.offshore.ai/38yearcycle/

melveyr,

I'll Amazon that sucker.  I'm currently reading like 4 books and need stop adding new ones before I finish old ones.

[stone]

moda, Bill Mitchell (on billyblog an MMT site) challenged Vince Cate (who's page you linked to) to a bet that no free floating developed world  currency would suffer hyperinflation in the next decade. I think Bill Mitchell suggested $1000. Vince Cate said he would only make the bet if it were denominated in silver .

[moda0306]

Hahaha... that's hilarious.

I think some of the critiques are "lazy," if you will, but I'd definitely like to see a debate between these two.

[stone]

moda, it was somewhere on billy blog in the comments after one of Bill's blog entries. I just tried to search for it but failed. I'm pretty inept at doing such searches and am using a clunky out of date browser. I'm sure it is in there somewhere though.