Understanding Modern Money

Book: Understanding Modern Money, by L. Randall Wray

Description

"In this innovative and very practical book, Randall Wray argues that full employment and price stability are not the incompatible goals that current economic theory and policy assume. Indeed, he advances a policy that would generate true, full employment while simultaneously ensuring an even greater degree of price stability than has been achieved in the 1990s" (http://pavlina-tcherneva.net/links.html)

Review

Extensive review from Tadit Anderson:

"The purpose for this set of two flyers is to describe what can be done when a sovereign nation restores its ability to issue fiat debt free money. A very important point to remember here is that the US already has a fiat based currency. "Fiat," as a word means "by declaration." The odd pieces are that although the U.S. has had a fiat currency since 1971 and the banking management practices reflects that fact, the conduct of fiscal policies continues to assume that we are still operating with a gold based currency and that we have to borrow our money into existence.

Monetary reform is an important agenda for ethical, economic, and political reasons and to undo the privatized franchise by which our economy has been based upon a debt based currency. Ending the enormous unearned profits acquired by the means of the privatization of our sovereign currency is important The resistance to monetary and fiscal reform is based upon the fear of established interests of losing both the private control that the monetary franchise allows and the enormous profits that result from that private control. The primary policy conclusion that comes out of this analysis is perhaps shocking, but it can be stated simply: It is possible to have truly full employment without causing inflation."

A number of concepts that are important in the current economic debate. When these ideas are looked at from the perspective of modern monetary theory and functional finance, they take on implications different from the privatized and gold era perspective. The list of concepts includes government deficits, the value of the currency, monetary policy, government bond sales, employment policy, exogenous pricing versus endogenous pricing, the tax liability validation of fiat currency, and using employer of last resort labor as a valuation buffer. This process further presents a series of definitions including "state money," "commodity money," "fiat money," "bank money," "the monetary unit of account," and "full employment."

The nature of the of money that circulates within a sovereign economy makes a major difference in how monetary and fiscal policies are structured. The conventional concept of money includes the assumption that money is based upon the value of precious metals and thereby there is an intrinsic scarcity. Because the need for currency often surpasses the availability of that currency, on a one for one basis, there are certain ways that the apparent amount of money in circulation can exceed the actual amount precious metal available. The actual value of modern money is determined by that which is accepted in the payment of taxes by the sovereign government. The second characteristic of money is under a fiat system which is useful is that it is used as a unit of accounting.

Under the specie convention and different regulatory standards specie based currency can be leveraged. The k through 12 version will allow nine dollars of debt based money to issued for every one dollar held on deposit. The amount of money or specie held in reserve is described as the reserves for whatever type of money or bond are issued Under certain extreme and even questionable situations the leveraging ratio can be as much as 1 "real" Dollar to 70 dollars or more of leveraged, ie fictional money.

Under the specie era model it is assumed that the rate of debt being created is more that the amount of funds being deposited and then used as reserves. Under the same specie era model the institutions of central governance are assumed to operate similar to how an ordinary household would sustain. Funding of programs and projects are then believed to happen by a process of either collecting taxes and/or borrowing money from privately held banks. before programs and projects are funded. Under the simple version of this specie model when an individual or a government borrows money from a bank the amount that is paid back over time is actually the principle and the interest. The principle was fictional debt based money that was leveraged into service. The interest percentage, however it is calculated, only represents a small portion of the short term profit for the bank. As a loan's interest is compounded over time, the original principle will dwindle as the interest rate adds to the running principle.

A related piece is that mortgages do not represent loans from banks or mortgage companies. It is your signature on the mortgage contract which makes a mortgage contract valuable. Under a fiat and debt based currency, money is put into circulation largely by making a ledger entry into a loanee's account. This is partly possible because a majority of our "currency" in circulation is actually neither paper currency or coinage. Under a fiat system currency cannot not be directly converted into precious metal anymore than buying it at the current market value which as a commodity it value is determined by supply and demand.

Another detail is that the banking reserve process does not operate according to the fractional reserve principles as defined that was used while specie and debt monetary model operated. The scarcity of gold has in a sense been replaced by a scarcity of loan applications that are judged to be a profitable risk. What actually happens under a privately controlled monetary system is that a loan application is reviewed based upon whether it represented an good opportunity for a banking investment on some basis. and then after approving the loan the bank borrows funds from the central bank, in the case of the US it is the US Federal Reserve, to cover the reserve requirements. Because the US Federal Reserve is now operating under a zero interest rate policy (ZIRP). this money is being put into circulation on a even higher net leverage ratio. The ZIRP is a significant side issue in this context, because the central bank has no requirement.

Given that the US congress voted in 1913 to both set up the US Federal Reserve and turn over the issuance and management of the economy in large part to the privately owned corporation the US Federal Reserve, this decision could in principle be reversed as being un-Constitutional, which it is. The problem is that these finance sector corporations by having the power to create fiat money on their own authority their corporate "free speech" is potentially endless as contributions to the political campaign funds, and thereby their influence upon politicians will always be greater than the free speech of natural citizens, until this franchise is removed.

Taxation at the federal level within the principles of fiat sovereign currency is largely a method of controlling the excess accumulation of wealth. When taxes are collected by the U.S. I.R.S. those amounts are simply deleted from the tax payer's accounts. Again, under the specie based currency, those taxes were held and then disbursed for Federal government programs and projects. And again, to remind you, we do not currently have a specie based currency, so it ends up being fairly ignorant to continue imagine that the current fiat currency serves in the same way a specie based currency. So the deficit terrorism threatening austerity and even deeper privatization is based upon a specie era monetary model, and is thereby false and clearly a fear tactic based upon disinformation.

Because we could be operating under a sovereignty based version of fiat currency, we could have the government act in a counter cyclical way to increase the demand for goods and economic exchanges by putting currency into circulation through the funding of projects and programs directly. Part of the problems of debt based money is the enormous profits being made off of a social institution to facilitate exchange. Another is that the expansion of currency in circulation is that debt based money is erased from people's accounts once the loans are either paid off or defaulted on. Debt based currency is not designed to serve in a relatively permanent fashion to maintain the illusion of scarcity.

Based on understanding how sovereign fiat money actually is used would allow the Federal government to extend funding to states on a per capita basis for the construction of roads, mass transit, bridges and other "hard" infrastructure to put people back to work which would increase demand for products. This same process can be applied to social infrastructure such as national health care, education, and pensions. Further, an employer of last resort (ELR) process could be established, whereby individuals who wanted to work could be provided a living wage for advancing any number of needed projects toward building communities. This would remove the expense of funding most unemployment benefits and most social welfare. This would also support the cultivation of a work ethic and of being involved in some sort of productive process. This could also be used to incubate new industries until that establish a virtuous process of productivity and trade.

The ELR process would also have other benefits. At the level of economic models labor would no longer be treated as a commodity without any connection to the consumer demand represented by labor as participants in an economic process. As productive industry is able to re-establish itself, the need for ELR labor will diminish greatly, and people can be hired into expanding productive activities.

Banking would be largely reduced to a social utility, where it could actually participate in the development of productive industries, rather than basing its profits on the degree to which wealth could be extracted from a community.

When we align the nature of our economics and the capacities of modern money with the policies of governance as a socializing agenda significant changes will be possible. This change will require reform and education on several levels. In effect the precious metal era economics tends to be structured to serve concentrations of private interests, particularly as in the cynical version of the "golden rule," which is "those who have the gold make the rules." One of the major contradictions of conventional economics is that the actual banking and monetary processes operate much closer to a chartalist view of money than to precious metal centered assumptions. This includes the leveraging allowed by way of the legitimization of the fractional reserve process which in other contexts would be described as a fraud." (http://economics.arawakcity.org/node/674)

...

"Decisive in the process is that the state also defines the currency accepted by the state as payment in which taxation levies must be paid. The exchanges between private individuals is less important though significant in the taxation of those transactions, and as legal tender. This establishes a ranking of convertibility that places the currency in which payment of taxation is accepted as the highest form. Knapp's concept of money is what the sovereign concept of money evolved toward nearly seventy five years after the publication of Knapp's theory. Knapp also recognized the probable difficulties of trade between sovereign nations.

It is the state that determines what thing or token will be accepted in the payment of taxes or as currency. State money is identified as taking three forms, commodity(usually specie based), fiat money, and managed money, the last two also combine as representative money. Depending upon the state enfranchisement of centralized and member banks, state money, bonds, and securities would be used as the basis for held reserves. "In summary, with the rise of the modern state, the money of account is chosen by the state, which is free to choose that which will qualify as money ('the thing' that answers to the description). This supersedes legal tender laws -- which establish what can legally discharge contracts -- to define that which the state accepts in payment for taxes at its pay 'offices.'

The state is free to choose a system based upon commodity money, fiat money, or managed money. Even if it chooses a strict commodity system, the value of the money does not derive from the commodity accepted as money. '[f]or Chartalism begins when the state designates the objective standard which shall correspond to the money of account.' ... '[M]oney is the measure of value, but to regard it as having value itself is a relic of the view that that the value of money is regulated by the value of the substance of which ut is made, and is like confusing a theater ticket with the performance' (from John Maynard Keynes )

The endogenous approach to money supply is characterized by two elements, first, that the supply of money expands to meet the demand for money, and second that the central bank exercises no direct or discretionary control over the quantity of money. It is only in the twentieth century that the majority of economists came to accept the "exogenous" view of money creation and that the central bank can directly control the quantity of money and can be assumed to be fixed so that it does not respond to demand.

Hyman Minsky presents a successive nesting process of bank monies which rely on the primacy of state money. The emphasis of both Minsky and then Lerner are presented as focusing on how in a normally, well-working economy money is actually exchanged and tied to their acceptability by the state. The emphasis here is upon the functional nature of money, monetary policy, fiscal policy, taxation, and banking.

An interesting piece of actual history is a comparison of the opposing monetary and fiscal policies of the Union as compared to the Conferation of southern states during the US Civil war. This comes by way of an analysis done by Abba Lerner. In short the results of that conflict seemed to have been more determined by the functional versus dysfunctional natures of the widely different monetary and fiscal policies than even the military strategies resulting in massive casualties. This bit of history establishes the validity of fiat currency, the "Greenback," by the Union both during the US Civil war, then upto 1869, and then from 1884 forward.

It is necessary to compare "conventional" wisdom regarding these issues to the examination of these utilities as they are used which turns conventional wisdom upside down. Abba Lerner approached these processes according to their actual effects, and it makes for a startling different view of the general processes. He does make a distinction between "fiat money" and "bank money." Fiat money as only being issued through spending by the government. Bank money as being issued by banks as a product of a contract of indebtedness to a bank. This is generally described elsewhere as debt based money. Fiat money in this context would be debt free money issued by a sovereign government.

Being that bank money is created upon the prospect of profitability, and then any necessary reserves are acquired after the fact. This clearly establishes an unstable process relative to the amount of which money is in circulation. To the extent that fiat money is spent into circulation to greater or lesser effect relative to the scarcity of currency within a community. To the extent that the leverage process would be abused both to put bank money into circulation and remove both it and the interest upon payment. It seems that the influence of Hyman Minsky's observations of the destabilization of an economy enters out of the innovation of unregulated financial instruments and from the deregulation of familiar instruments. In this context there should be a question regarding limiting the creation of bank money both by using fiat money to establish a general lack of currency scarcity and by regulation of the banking leverage ratios. The mechanism by which the amount of private savings that might be held, also effects the availability of credit. It seems that the deregulation of banking industry generally has favored the profitability of bank money over fiat money at the expense of the general population.

Much of what Lerner demonstrated came out of the financing and pricing of commodities and labor by the US government during World War II, and those economic lessons were soon dismissed. Another portion came from the interrelating of the financial spread sheets of the US Treasury and the US Federal Reserve. All this was supplemented by Lerner's study of the fiscal and monetary policies of both the Union and Confederate governments during the US Civil War. I think that generally it has been amply demonstrated that Minsky was entirely correct that economic stability cultivates economic instability. By extension it is probable that Lerner was also right about the capacities under the insights of functional finance.

Economic illiteracy by multiple sources and the profitability of bank money obstruct change to a more functional basis. The obstructions to functional fiscal and monetary policies relative the benefits to the general population are primarily political. A similar analysis can demonstrate the inadequacy of monetary policies and how the banking actually operates as an institution.

The logic of the employer of last resort processes as proposed by both Minsky and Lerner. In this context there is a huge positive potential in stabilizing both retail prices and wages in a down cycle period and to avoid the multiple negative effects of using unemployment as a weapon against unionization and the expectation of higher wages according to productivity. The core suggestions are revolutionary, in the sense of the over-turning of long held assumptions. I have difficulty believing that these "conventions" were sustained solely out of ignorance, but more likely as a form of oligarchic dysfunctional finance.

The premise that labor should be a participant within an economy both as a producer and as a consumer, shifts the processes of economy from being privatized to being a fully public process. Counter cyclical employer of last resort paid on the basis of a living wage not based upon the errant piece of usury referred to as the Federal minimum wage. Because the nominal Federal minimum wage is substantially below the actual cost of a living wage, it represents a form of subsidy by the work force. The idea that in a down cycle period people might be productive in service to the community, rather than sustaining both a culture of idleness and idle profit is also revolutionary. Further, using the living wage as a basis of valuation of the currency is another major innovation and a humanization of economic processes.

Reserve requirements might be treated as an additional option for control. He doe not explore this possibility with any sense of completeness. Given that the established privatization of debt based currency and the lack of an integrated control over the creation of debt based bank money, the current system permits multiple drivers. The use of reserves to leverage the production of debt based money needs to be integrated as part of a fully coherent set of macro-economic policies in service of the public interest. A full reserve structure for all bank lending is the necessary solution. Under the condition of an adequate distribution of sovereign fiat money, debt based money would be not be necessary. Lerner's single driver metaphor can also be taken in the opposite direction toward the corporate takeover of the process of governance. This choice also offers a "single" driver for the most part, but it is exactly what we have now in the control of governance by corporations and particularly by the "finance" sector. This option is obviously hazardous because this particular driver is blind to every issue other than its own return on investment. It is also an extremely unproductive use of capital relative to the entire economy. It serves a fictional function other than acting as a wealth extraction process. Relying on a privatized central banking process to control hazardous driving by the application of monetary policy changes has been inadequate to limit primitive accumulation. Perhaps we can recognize this pattern by its current enactment in real time on a global scale.

Most of the changes necessary to making the economic processes functional require no specific reform, just changes in the way policy makers understand the capacity of the system they already have. The one large piece that is missing is an advocacy for the restoration of monetary sovereignty that was yielded in the establishment of the US Federal Reserve specifically to greatly eliminate the private franchise to create debt based money and to bring the control of central banking under the authority of the U.S. Treasury. The US Government must restore its ability to issue fiat and debt free money before Functional Finance can be made operational. In addition the deregulation banking and speculation must be restored and improved upon. Using Lerner's wisdom, going for a macro-economic drive requires that a coherent set of public policies be established to take control of the steering wheel and accompanied by knowing how the mechanism actually works and interacts with its environment. We will not have a coherent public agenda controlling the economy until the power to issue fiat and debt free money is restored to serve the public interest." (http://economics.arawakcity.org/node/675)

More Information

1. Money - History