Introduction to the Problem with Modern Monetary Theory (MMT)

13 thoughts on “Introduction to the Problem with Modern Monetary Theory (MMT)”

1. I have reason to believe we have a lot of interests in common: Jaynes, metaphors, Kant. Please contact me at schuller@alpheus.org. Would love to exchange ideas.

2. Pingback: Bibliography Monetary Theory and Reform | Alpheus

3. I totally agree that the serious differences between MMT and the monetary reform movement have to be taken into account. Huber recently wrote another good paper. See the post script above.

4. I agree. Taxes are paid initially with ‘bank money’. The problem is that MMT does not have a role for correspondent banks as currency exchangers: exchanging commercial bank dollars for reserve balance dollars. So, they do a lot of hand waving when the dollars get to the T&L banks about how the ‘bank dollars’ become ‘reserve dollars’ deposited in the Treasury’s TGA account. A letter I got from a high official in the monetary division at the Fed said that when a bank’s bid at the Public Auction won the bidding the broker had to take the dollars to a correspondent bank to settle the acquisition of the security. For a long time I wondered what this was, until I read that correspondent banks do foreign currency exchanges for banks. Why not have a correspondent bank have stocks of reserve dollars and commercial bank dollars for use of currency exchanges 1:1 between these two forms of dollars? Private (National government chartered Banks) create their dollars out of thin air to make a loan (purchase of the security (IOU) from the Treasury)then appear at the auction with a broker who facilitates the auction process. When the auction is won, the broker and the bank take the notification of winning the bid to a correspondent bank, where the purchase is settled by having the correspondent bank exchange the bank dollars for reserve dollars, which are to be forwarded to the Fed to deposit in the Treasury’s TGA account in return for the Fed’s getting the security from the auction to be placed in a securities account at a bank dealing in securities accounts under regulation by the Fed.

   This explains for me how bank dollars become reserve dollars in the TGA (Treasury’s General Account). Now, all I need is admission by some correspondent bank that this is what it does. Fed, Treasury and correspondent banks keep this all a mystery obfuscated from comprehension by the public.

5. Werner didn’t need to go to the elaborate process of making a 200.000 euro loan to establish that the process creates dollars out of thin air. But it was vivid evidence for those who could not see in the processes used by the banks in making loans that the dollars would come from nothing. And the use of a small German regional bank is not evidence that all banks create dollars out of nothing when they make loans. I even imagine there may be some Eurozone banks who still practice fractional reserve lending of a portion of the banks’ deposits, because my experience with some European monetarists is that they recoil at the existence of new euros created out of nothing like Werner did.

6. So National Banks are sovereign banks. I don’t know if in the UK the banks are Crown banks, but there must be some legal provision that makes the pounds ‘sovereign’ money when produced by the ‘private’ commercial banks. Otherwise there is no criterion for counterfeiting. MMT treats ‘private banks’ as all nongovernmental banks, and ignores the existence of the National Currency Act of 1863 and the National Bank Act of 1864 which created charters for banks to become government banks distributing ‘greenbacks’ (government dollars). Bank of America and Wells Fargo are National Banks, as are some 1500 other ‘private banks’ throughout the United States. Once we see that they have been given the role of dollar creators, while the Fed buys US securities with dollars created out of thin air to enable them to be exchanged for securities that will be sold to investors, then we can see that they are sovereign dollars. Investors buy the securities with dollars taken out of circulation, but the investors’ dollars received by the government are not spent, so these dollars can be used to redeem the principal on the securities when they mature. That cancels the national debt on these securities. And it is the way the government can eradicate the national debt: convert all US securities to investor held securities by buying them and exchanging them at the Treasury for new securities to sell to investors. The only risk is inflation, but if done at appropriate times that are deflated in amounts needed, inflation need not be a major problem.
   BTW, when Fed buys securities from banks, its dollars are extinguished when the banks’ loans to the government in the purchasing of the securities also are extinguished. So the Fed’s dollars are not inflationary when it makes these purchases. When the investors’ securities are redeemed their dollars go back into circulation from whence they came and may be inflationary.

7. So National Banks are sovereign banks. I don’t know if in the UK the banks are Crown banks, but there must be some legal provision that makes the pounds ‘sovereign’ money when produced by the ‘private’ commercial banks. Otherwise there is no criterion for counterfeiting.

8. For some reason MMT thinkers have generally overlooked or ignored the fact that the National Banks were created by the Abraham Lincoln administration with the aid of Congress in creating a federal charter for commercial banks, known as the National Bank Act of 1864. That act empowered National Banks to lend the new National Currency of the National Currency Act of 1863. Congress would set the limits on dollars created, initially it was $400,000,000. Treasury would draw on that authorization to have the mint print up several millions of dollars as needed. National Banks were tasked with driving out of circulation the numerous bank notes of the private banks. For awhile the National Banks were successful in this until state banks adapted to the situation and became competitors of the National Banks. Somewhere the National and private banks got Congress to limit issuing the greenbacks of the national currency and obtained the power to lend dollars to the Treasury for deficit spending. Somehow the National Banks became joined with the other private banks in the minds of bankers. But for MMT purposes the National Banks should be recognized as federal-government chartered banks with power to create new dollars when they make loans to borrowers. That means Wells Fargo, Bank America, and the 1500 or so National Banks serve government objectives, and if they don’t someone at the Comptroller of the Currency is not doing their job. The CoC was created in the National Bank Act to regulate the currency and the National Banks.

9. Response to Cornelius:

   “As an ordinary American who continually struggles as most people do with debt, I think what we need is greater public spending for public and community purposes, lower and more progressive taxation for the purposes of giving national money value, preventing aggregate inflation and correcting upward distribution of wealth and income through extraction, and a banking system that provides credit without usurious lending for productive rather than speculative purposes.
   Is it impossible for both sides to agree to emphasize these types of policies? Or is winning a pedantic argument more important than the dignity of human individuals and communities along with the preservation of the planet?” (Cornelius)
   Your above statement of intent in the first sentence (above) is the goal of monetary reform, and there shouldn’t be much argument about it among people truly wanting monetary reform. Of course the financial institutions see it as a threat to their existence and see it quite differently. However the second sentence (above) is troubling. It isn’t a pedantic argument. I have been studying monetary reform for a number of years now and there isn’t any use in my making the same arguments that Govert and Nick have already made. But to sum up my study on monetary reform, MMT is a watered down system of monetary reform and doesn’t go far enough to fix the problem. The conspiracy theorist in me says that it is backed by the financial institutions as a stop gap to real monetary reform. So getting down in the details and pointing out the problems is a big deal. My experience is that if you really study the problem you will find that Professor Huber and AMI and the NEED act are the right way to go.

10. “MMT makes the distinction between bank money and government money. MMT says the government accepts only its own money, not bank money, in payment of taxes and other fees”.

    My response:

    Whatever musical money chair changes happen between the IRS, the FED, my bank and the treasury after I paid my taxes, fact remains that the IRS accepted my bank money for satisfying my tax obligation. Someone, or something, compares my paid amount with the required amount and makes a determination whether it is correct. If I did not pay enough it will let me know and demand the difference, if I paid too much they might be so kind to send me back the over-payment. And if my check bounces I’ll be in trouble. You seem to highlight the esoterica of the clearing mechanism and I am highlighting the payment from the payer’s perspective. My point is that the IRS accepts the bank-money backed check. Your point is that after the clearing mechanism has done its job, the government actually did not receive my bank-money. This is a contradiction and I propose to solve it with common sense and just say that, after all the numbers, assets, liabilities, reserves and what have you not, have cleared, I did pay my taxes with the bank-money at my bank and the IRS accepted it.

11. Response to John O’Connell comment on MMT (edited):

    I have read MMT posts and always leave scratching my head. MMT to me lacks clarity and this continues after reading your comments. If I may try and address some of the confusion.

    “1. MMT makes the distinction between bank money and government money. MMT says the government accepts only its own money, not bank money, in payment of taxes and other fees.” (John O’Connell)

    My understanding is that 90% or more of what we use for money in the U.S. is debt-money created by banks when they make loans. It exists only as a loan and is extinguished or wiped off the bank’s books as the loan is repaid. This bank created debt-money is what is used everyday in our economy, including the payment of taxes. It is not sovereign money created by the government as it should be, but it is what we are now forced to use because it is our money supply.

    Professor Richard Werner’s 2015 paper
    “A lost century in economics: Three theories of banking and the conclusive evidence”
    https://www.sciencedirect.com/science/article/pii/S1057521915001477

    provides and in depth examination of the theories of banking (money creation) along with an empirical test proving that banks create what we use for money.

    “How do banks operate and where does the money supply come from? The financial crisis has heightened awareness that these questions have been unduly neglected by many researchers. During the past century, three different theories of banking were dominant at different times: (1) The currently prevalent financial intermediation theory of banking says that banks collect deposits and then lend these out, just like other non-bank financial intermediaries. (2) The older fractional reserve theory of banking says that each individual bank is a financial intermediary without the power to create money, but the banking system collectively is able to create money through the process of ‘multiple deposit expansion’ (the ‘money multiplier’). (3) The credit creation theory of banking, predominant a century ago, does not consider banks as financial intermediaries that gather deposits to lend out, but instead argues that each individual bank creates credit and money newly when granting a bank loan. The theories differ in their accounting treatment of bank lending as well as in their policy implications. Since according to the dominant financial intermediation theory banks are virtually identical with other non-bank financial intermediaries, they are not usually included in the economic models used in economics or by central bankers. Moreover, the theory of banks as intermediaries provides the rationale for capital adequacy-based bank regulation. Should this theory not be correct, currently prevailing economics modelling and policy-making would be without empirical foundation. Despite the importance of this question, so far only one empirical test of the three theories has been reported in learned journals. This paper presents a second empirical test, using an alternative methodology, which allows control for all other factors. The financial intermediation and the fractional reserve theories of banking are rejected by the evidence. This finding throws doubt on the rationale for regulating bank capital” adequacy to avoid banking crises, as the case study of Credit Suisse during the crisis illustrates. The finding indicates that advice to encourage developing countries to borrow from abroad is misguided. The question is considered why the economics profession has failed over most of the past century to make any progress concerning knowledge of the monetary system, and why it instead moved ever further away from the truth as already recognised by the credit creation theory well over a century ago. The role of conflicts of interest and interested parties in shaping the current bank-free academic consensus is discussed. A number of avenues for needed further research are indicated”

    “2. MMT says “Fractional reserve banking” is not a valid description of the current banking system. Yours is the “positive money” view, I think, which is different from MMT. MMT believes banks should be regulated better, but that it is up to the government, not the banks, to be counter-cyclical about money creation. As for being oblivious, you should read Bill Black, an MMT banking regulator.” (John O’Connell)

    Again, the Werner paper talks about the three theories of banking.
    1. The currently prevalent “Financial Intermediation of Funds Theory” is that banks loan out deposits already in existence. In other words, they operate exactly like we were all taught in school. Those of us advocating for monetary reform of this system being just about the only ones who correctly understand that that this is not how the system works.

    2. The “Fractional Reserve Theory” says that banks don’t individually create money, but the entire banking system does collectively through multiple deposit expansion or the money multiplier effect. The Federal Reserve explained the historical nature of the fractional reserve theory and at least from 1961 till 1994 claimed that it was how our money was created.

    Who Creates Money?
    “…The actual process of money creation takes place primarily in banks…

    It started with goldsmiths. As early bankers, they initially provided safekeeping services, making a profit from vault storage fees for gold and coins deposited with them. People would redeem their “deposit receipts” whenever they needed gold or coins to purchase something, and physically take the gold or coins to the seller who, in turn, would deposit them for safekeeping, often with the same banker. Everyone soon found that it was a lot easier simply to use the deposit receipts directly as a means of payment. These receipts, which became known as notes, were acceptable as money since whoever held them could go to the banker and exchange them for metallic money.

    Then, bankers discovered that they could make loans merely by giving their promises to pay, or bank notes, to borrowers. In this way, banks began to create money. More notes could be issued than the gold and coin on hand because only a portion of the notes outstanding would be presented for payment at any one time. Enough metallic money had to be kept on hand, of course, to redeem whatever volume of notes was presented for payment.

    Transaction deposits are the modem counterpart of bank notes. It was a small step from printing notes to making book entries crediting deposits of borrowers, which the borrowers in turn could “spend” by writing checks, thereby ‘printing’ their own money.”
    Modern Money Mechanics
    A Workbook on Bank Reserves and Deposit Expansion
    Printed from 1961-1994
    The text above is from the last revision, June, 1992
    Federal Reserve Bank of Chicago
    https://upload.wikimedia.org/wikipedia/commons/4/4a/Modern_Money_Mechanics.pdf

    From 1961 till at least 1994, the Federal Reserve subscribed to the fractional reserve theory of banking: banks could lend out more notes (money) than the gold reserves they held in their vaults. The figure often cited for the early banker/goldsmiths was that they would lend out ten times the actual gold they held in their vaults.

    The underpinning for the United States monetary system is thus a fraud. Based on a fraud first perpetrated in the Middle Ages that lenders could issue notes or money, at a rate of ten times the actual gold they held to repay the notes. They could do this why? Because they could get away with it. They certainly did not then, or now, explain the fraudulent nature of their scam to the public.

    Merriam-Webster Online Dictionary defines “fraud: deceit, trickery: an intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right.” The truth has certainly been perverted by keeping the nature of the private creation of our money from the public. This was done in spite of the fact that for thirty three years the Federal Reserve did publish an obscure pamphlet Modern Money Mechanics that proudly explained how the fraud began.

    The overall ignorance of our citizens on how money is created by private banks is all the evidence that is needed to show the effectiveness of the Federal Reserve in the perpetration of the fraud. The something of value and the legal rights that we have lost? Our freedom from debt peonage and the theft of a free people’s right to determine how our money is created and for what purpose it is created.

    The Fractional Reserve Theory is the philosophical underpinning in which the Credit Creation Theory of Banking is based.

    3. The “Credit Creation Theory of Banking” was widely understood a century ago as how our money is actually created. Professor Werner’s empirical test proves that banks currently create what we use for money from thin air when they make loans.

    In 2014 the Bank of England’s Quarterly Bulletin paper concurred:

    “This article explains how the majority of money in the modern economy is created by commercial banks making loans… Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”
    “Money Creation in the Modern Economy”
    Bank of England, Quarterly Bulletin, 2014, Q1
    Michael McLeay, Amar Radia and Ryland Thomas
    Bank’s Monetary Analysis Directorate
    http://www.monetary.org/wp-content/uploads/2016/03/money-creation-in-the-modern-economy.pdf

    “3. MMT certainly is aware of the history of money before commercial banking, and states that governments today spend money into existence free of interest just as they did in the era of coins. And that the issuance of bonds is unnecessary.” (John O’Connell)

    Those of us advocating for sovereign money and the NEED Act in the U.S. believe that our government should create and spend all money into existence, interest and debt free. The NEED Act also calls for the repayment of our federal debt as it comes due. I would assume MMT also does.

    Correct me if I am wrong, but I believe that MMT is quite content to continue to allow banks to create money through the current Credit Creation Theory and process. This happened during the Civil War when the debt-free Greenbacks were created to finance it. The banks were allowed to simultaneously continue to create debt based money and eventually used their tremendous power to quash the Greenbacks and return to bank creation of almost the entirety of our money supply. The lowly coins being the only money created by our government in which the seigneurage (value of the coin or bill in excess of the cost of minting, engraving or creating on a bank ledger or computer) belongs to the people through our government. Partial reforms of fraudulent debt-based money systems have never worked before and there is no empirical reason to think that they will now.

    The power to create our money belongs to the people through our government. The Constitution calls for and just common sense does. The banks would then loan money already existence, just as most people mistakenly think they are doing now.

    I’ll let Positive Money speak for themselves. I support the NEED Act put into the U.S. Congress in 2011 by Dennis Kucinich. Read it you might like it.
    http://www.monetary.org/wp-content/uploads/2013/01/HR-2990.pdf

12. Not an expert but have found both MMT and AMI/PM to be helpful and insightful. Separating the the pissing contest from the real difference is, however, a is a burdensome task. Here are my “lay” and certainly fallible observations.

    Agreement: Sovereign money interest-free spending by national governments is possible and much needed, especially in a time when private consumers and businesses are drown in perpetual interest laden debt. Moving from the academic to the practical both schools ought to issue joint statements condemning all forms of austerity politics as economically ethically disastrous, support political candidates who understand and advocate for sovereign money spending and disavow the propaganda and practice of not spending without tax increases, borrowing or offsetting budgetary constraints.

    Disagreement and/or confusion: Role of Banking
    Is the Federal Reserve private or public? It is a centras l bank created by the federal government and run by private bankers who control most of the money supply and are therefore able to dictate who is elected to congress. The federal government could spend more money right now without borrowing or taxing or offsetting and it could also regulate banks in a people friendly way but it chooses not to. Making the federal reserve more accountable to the people without being subject to the whims of congress is difficult but achievable. Whether or not we need greater or lesser reserve requirements , separation of commerical and investor banks or more competition from not for profit credit unions snd community banks is up for debate. Personally, I think we need all three along with interest free government spending.

    As an ordinary American who continually struggles as most people do with debt, I think what we need is greater public spending for public and community purposes, lower and more progressive taxation for the purposes of giving national money value, preventing aggregate inflation and correcting upward distribution of wealth and income through extraction, and a banking system that provides credit without usurious lending for productive rather than speculative purposes.

    Is it impossible for both sides to agree to emphasize these types of policies? Or is winning a pedantic argument more important than the dignity of human individuals and communities along with the preservation of the planet?

13. You need to study more.

    1. MMT makes the distinction between bank money and government money. MMT says the government accepts only its own money, not bank money, in payment of taxes and other fees.

    2. MMT says “Fractional reserve banking” is not a valid description of the current banking system. Yours is the “positive money” view, I think, which is different from MMT. MMT believes banks should be regulated better, but that it is up to the government, not the banks, to be counter-cyclical about money creation. As for being oblivious, you should read Bill Black, an MMT banking regulator.

    3. MMT certainly is aware of the history of money before commercial banking, and states that governments today spend money into existence free of interest just as they did in the era of coins. And that the issuance of bonds is unnecessary.

    4. Many MMTers are quite critical of the FIRE sector, and disaggregation of it from the rest of the private sector is sometimes useful, especially when explaining banking and advocating policy. But it isn’t useful in the macroeconomic view of sectoral balances.

    “Contemptuous” might be a bit strong, but MMT does say that QTM is wrong, and sound finance is irrelevant to a monetary sovereign. Apparently, though, you have not grasped the reasons that they say so.

    MMT is far from being “irresponsibly lackadaisical about debts, deficits and the power of the financial sector over the state.” MMT is very much aware of the perils of private sector debts, and knows that deficits matter (just not in the way you think). Again, see Bill Black for the MMT view of the financial sector and the current state of its regulatory agencies.

    Keep studying MMT. When you understand it, you may still prefer Positive Money, but your preference doesn’t constitute a criticism of MMT. If you do gain an understanding of MMT and can cite any valid criticisms, I am sure MMTers will be eager to hear them.

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