I was reading Steve Keen on Minsky yesterday, as you do on Boxing Day. This is from his PDF on Minsky without formulas, which is available as a download, I think:
What follows thereafter is entirely comprehensible if you do know double entry and have some familiarity with modelling on a computer. For the rest of the world? It will be hard going.
However, I share the quote for a reason. Steve rightly says:
To really answer [the question 'How are you going to pay for it?'] you have to understand the dynamics of our monetary system—and that means you have to understand double-entry bookkeeping, because that's the way banks and governments create money, and keep track of financial transactions.
For that reason, I am going to have to explain the double-entry of banking in the forthcoming book. But nothing like the way Steve does with a Godley model. That's not to say they are wrong because they are not. It is because most people will not follow them, and everyone has a right to know this.
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I think the vernacular expression is: “you nailed it!”
Thanks for that.. I can’t wait
Yes, I agree….. but the list of things to include might get very long!
For me, the key point is that someone’s asset is someone else’s liability. I like the story told during the Irish banking crisis of the German Tourist going into the hotel looking for a room. He places his EUR50 note on the counter but just before he agrees to take the room he wants to inspect it. Whilst he is upstairs the hotelier takes the note and uses it to pay off his dect with the butcher, who in turn repays the baker who in turn repays the candlestick maker…. who then settles his bar bill at the hotel by placing the EUR50 note back on the counter at the hotel. The German Tourist decides they don’t like the room so takes back the EUR50 and head off elsewhere…… no income for the hotelier but nobody in town is indebted anymore.
But “if every asset has a corresponding liability, then what liability corresponds to the EUR50 note?” …. and this is the crux of the matter. If you INSIST that balance sheets must balance always and everywhere then you must say that the note is a liability of the issuing bank. But a liability for what? It makes no sense as there is no obligation to redeem in anything other than money?
This hopefully sows the seeds of the idea that creating money is not a “zero sum ” game. It is useful today and is not an obligation in the future… and if money creation is used judiciously (ie. to avoid inflation) then everyone benefits.
Does it inevitably create inflation like Venezuela? No – look at Japan. The key difference is not money creation but political/governance issues.
You are on my direction of travel
As long as the £/$/Y/EUR50 note can be used to purchase things that people need/want (use value) then nobody will present it to the issuer to have it redeemed. For a currency to be viable/acceptable/useful it has to be used to employ available resources productively so that those use values can be created. It’s a Yin/Yang relationship which is ultimately wholly dependent upon trust and the maintenance of trust. Once people start queuing at the door of the currency issuer to have their money (promises to pay the bearer on demand) redeemed then the currency and the state will be in serious trouble.
Yes, whenever we have been on a gold standard (or similar), that has always been the key point for issuers of bank notes (whether government or private). Trust was easily measured in the desire (or otherwise) of people to hold notes rather than metal.
In a fiat age this is not so simple but is seen in FX markets…. quite vividly in the Turkish Lira market recently.
Now, the collapse of that currency is a symptom of Turkey’s broader problems, not the cause….. but, as someone that embraces MMT as “fact”, I do wonder how FX fits into the “theory”.
I think there is more thinking to be done on this. If a small nation chooses to embrace MMT will FX moves cause problems that create a negative inflationary spiral? Or is a devaluation a stabilising influence as players adapt to new terms of trade?
Important work to be done for the UK (and Scotland, too ??).
Yes…..
“[C]reating money is not a ‘zero sum’ game. It is useful today and is not an obligation in the future…”.
In your German tourist case the money continued to criculate after all the debts were cancelled. What continued was the circulation of money, not the debts. But money is a hierarchy, and in a fiat currency when you reach the top of the hierarchy, and the issuer of last resort holds the ultimate ‘promise to pay’, in what sense is there a real liability for the sovereign issuer of its own currency? Perhaps only a liability in the ultimate sense that the system depends entirely on public confidence in the (last resort) issuer; and that is, surely entirely a matter of psychology, not mathematics, or accounting?
The history of Exchequer tally-sticks (from the 13th century on) is germane here I think, because the Exchequer received payments and borrowed credit without any money changing hands. Tally-sticks provided the principle of the “stock” (gilts; from the split in a hazel stick into ‘stock’ and ‘foil’). It cut both ways however, as Jenkinson (an established authority on Exchequer tally-sticks) pointed out long ago; because they were used both to raise money and lend money: “This change, which has been, in the past, undeservedly neglected by students, consists, to put it briefly, in the discovery that the tally of receipt might be used for purposes of issue” (‘Exchequer Tallies’, 1911). The tallies became effective circulating Bills of Exchange as well as payments of dues or taxes. The Bank of England was partly capitalised through Tallies. They were still being created in the Exchequer for use in 1826 (in spite of having been abolished formally in 1783). By the end the system was a “confused farce” (Jenkinson), and captured by sinecures. They were finally disposed of in the furnaces of Parliament in 1834; which was so badly executed it completely destroyed the Houses of Parliament. Pugin built a pastiche mediaeval fairy-tale to replace them. A Tally ceased altogether when stock and foil were executed, by being brought back to fit together. Who knows whether all the tallies that burned in the conflagration had been executed? We may suppose that any lender would have ensured redemption of his loan; but would somone who owed the Exchequer necessarily hasten to repay, knowing the Exchequer Tally had been destroyed?
The Tally sticks did not quite work like a fiat currency, because currency then was typically coin and high-value commodity; therefore scarce. That no longer applies in a fiat currency – but in a digital, contactless age we have taken a further step; thus, in what sense does an eletronic digit ‘circulate’? Is not each transaction more like the Tally stick cycle, of split and reform? Money at this level in the hierarchy instantly appears, and promptly disappears. What we have is a long, complex chain reaction in consequence of the event – expressed in debits and credit through a labyrinthine financial system, turning in the process into a a time delayed sequence of hedged receipts and payments (on a vast, consolidated scale by banks and financial institutions).
What i left out of account altogether is FX; the money beyond even the sovereign issuer. That is another matter.
My random post-Christmas musings on the matter in hand, perhaps best left unshared!
Thank you
The Minsky software is very sophisticated. I am on the developers/testers list although I haven’t contributed anything for a long time. In principle it could be used for much more than economic modelling.
From what I know of double entry book keeping from working in restaurants and retail I whole heartedly think that that is a good idea. Why? Because it explains where the money is coming from and what it is spent on – and perhaps an opportunity to deal with taxation issues properly for once?
Yes….
Doesn’t double entry highlight the money creation issue though?
It is something I am very aware of my lack of personal expertise in (I have a little familiarity with accounts as school governor and charitable trustee) but my understanding is that if income and expenditure don’t line up, the difference will be reflected by a change in either reserves or debt. Mounting debt doesn’t look good for any accounting entity whether business or government – how can the special ability of a government to create money in its own currency be reflected in accounts that still follow the normal double entry rules?
(My apologies if this is explained in a blog I missed).
Money is not a liability for a government
You are assuming it is
‘Money is not a liability for Government’.
I like it. I like it a lot.
It is a credit on its balance sheet but not a liability
I know (and have learnt from you) that it isn’t. But it seems to me the nature of double entry accounting has to lead to what looks like a scarily increasing liability.
How can accounting reflect the true situation without it looking like government expenditure in excess of taxation is a liability?
It seems to me that making sense of government accounts depends on accountants following rules – which are the rules of micro-economic accounting. How do those rules need adapting when we are looking at macro-economics of a currency-issuing government?
Give me a little time
Im both fascinated & confused by the double- entry surrounding the transaction of the CREATION of money in the Govts books
( 1 ) is it accounted for on the creation ? ie Dr. what ? & Cr. what in the GOVTS books or
( 2 ) when the money created is used ,say, when the Govt pays a bill ? Dr, supplier Cr. what/who cash ? / whose liability is invoked ?
its unlike anything else in accountancy — the creation of an asset without a c orresponding credit/liability
I promise I will get to this…..give me a few days….
@ Jonathan,
“How can accounting reflect the true situation without it looking like government expenditure in excess of taxation is a liability?”
This is a good question and one that I’ve been thinking about in connection with the size of the National Debt. Do we count the bonds, or gilts, held by the BoE?
There does seem to be general agreement that they do if they are held by some entity outside government. The suggestion is that they don’t if they are held by the BoE because it is effectively a part of government.
So let us conduct a simple thought experiment. A commercial bank owning £1 million worth of gilts agrees to sell them to the BoE. So now the Treasury owes the BoE, rather than the bank, £1 million. The BoE puts the £1 million into the bank’s reserve account so the BoE now owes the bank £1million. Therefore the BoE is all square. The Treasury still owes £1 million and the bank is still £1million to the good.
I haven’t included the very small interest payments or yields on the gilts but this is the only difference which can easily be rectified by the BoE offering to pay some small interest on reserve accounts.
So nothing has really changed. Either bonds and issued money are both liabilities or neither of them are. The difficulty is in the word ‘liabilities’ which for you and I have to be repaid but the term doesn’t have the same meaning for a currency issuer. The currency issuer has to issue currency and so issue liabilities.
If the currency issuer was a single person, such as an all powerful dictator, then on the basis of pluses and minuses he/she would be the poorest person in the country.
I have already answered this
Jim Clark – while Richard has previously discussed the issue of the BoE buying back gilts, you trigger another question in my mind which I will try to put into words to see if there is an explanation for.
In principle, the £10 note in my pocket represents a liability on the government (or BoE which is the same thing). After all it states “I promise to pay the bearer on demand…” and though it is difficult to see how they could repay it except with another £10 note, they will redeem its value in the sense that they would allow me to use it to pay tax owed. But in that case, is my money in a building society any different? It may only be a figure in an electronic spreadsheet, but I can use it to pay tax – and in fact the government would prefer me to pay my tax by moving numbers from my spreadsheet to theirs rather than turn up with currency notes.
Extrapolating from that, it looks as if any number denominated in pounds sterling in the spreadsheet of a registered financial institution can be seen as a liability on the government. Is that really the case? If so it makes a nonsense of the usual concept of a balance sheet, or conversely it justifies a different accounting convention being necessary for currency-issuing governments.
Maybe I have made some schoolboy error, I admit I am a humble schoolboy when it comes to economics. But I wanted to ask because it is part of the question of why a government isn’t driving itself to bankruptcy every time it creates new money to do something, and that needs to be explained simply and convincingly before people will trust that unintuitive approach.
I promise you I will get to this…
But the narrative needs some explanation and I have two academic papers to deliver next week. I got one done (enough) today but that was the easier
The other has to be done before anything else…
But, sad man that I m, I just knocked out 600 words on the new book before bed….
@ Jonathan,
“any number denominated in pounds sterling in the spreadsheet of a registered financial institution can be seen as a liability on the government. Is that really the case?
No. They are the liability of the issuing financial institution. According to Randall Wray the process of paying tax involves a simultaneous deduction from both the payee’s account and the institution’s reserve account.
Tax payments reduce currency outstanding dollar-for-dollar, since tax payments take the form of a deduction from the taxpayer’s deposit at her bank and an equivalent deduction from the bank’s reserve account at the Fed.
There is no need for a separate accounting system.
https://www.levyinstitute.org/pubs/Wray_Understanding_Modern.pdf
@ Richard,
It’s an interesting discussion but I am still having trouble reconciling the double entry aspect of money with a reluctance to accept that money is not a liability of the issuing government. Money is both an asset of the holder and a liability of someone else. Who can that be if not the issuer?
However, as said previously, a liability for a currency issuer isn’t the same as for a currency user. It can easily be cancelled by giving someone a tax bill. Only a currency issuer can do that.
It’s an asset of the holder
But is it capital of the issuer?
Or something else?
A credit on a balance sheet need not be a liability
I am working on a much fuller explanation of this
In response to Clive’s last comment, I have been thinking over Xmas about the debate which ensured on November 14th (https://www.taxresearch.org.uk/Blog/2021/11/14/there-is-one-issue-to-be-resolved-before-scotland-can-ever-consider-independence-and-that-is-what-currency-it-will-use-to-which-there-is-only-one-answer/) between Clive, John Warren, Tim Rideout and Richard. (Its been a good time for thinking due to socialising restrictions and lousy weather which has kept me indoors rather more than usual).
Anybody can create a currency – the problem is getting others to accept it – and this is the inescapable challenge for a new Scottish currency. I think it will take time for a new SCP to displace the GBP. Tim’s proposed voluntary procedure for allowing people to exchange £ for S£ on a 1-for-1 basis makes sense but I am having my doubts about whether a 2 months window is appropriate……it seems a rather arbitrary and rather short time scale. Perhaps maintaining a 1-1 peg for as long as possible (this will depend on UK monetary policy and other factors) would be a more pragmatic approach.
Perhaps even after lifting the 1-1 peg and floating the SCP it might be worth considering still offering Scottish citizens a 1-for-1 exchange if the SCP FX rate falls against the GBP.
For the SCP to displace the GBP will require trust to built up and that probably means that the SCP must be capable of delivering price stability for essential goods and services. If that is the case then independistas also need to think about issues such as Scottish energy market reform – including implementation of the SNP policy of establishing a National Energy Company. (Mike Parr might want to comment on energy market reform).
Thought also needs to be given to how Scotland embarks on a path towards greater food self sufficiency whilst emphasising nutritional quality and price.
Gaining control of prices in these two essential markets will be key to tackling poverty and I would expect that to be an important factor in getting the SCP on a firmer footing and into a position where it will displace the GBP.
Jim
This is not your best post – because it makes no sense
Sorry, but suggesting a fixed rate offer when the rate is floating really is absurd and a r3vioe fir disaster
Hence why a time limit is essential
@Jim Osborne
“It’s a Yin/Yang relationship which is ultimately wholly dependent upon trust and the maintenance of trust. Once people start queuing at the door of the currency issuer to have their money (promises to pay the bearer on demand) redeemed then the currency and the state will be in serious trouble.”
Reply
1. But doesnt MMT say that all you need to give a currency value is to impose taxes, fees and fines?
2. The only point of queuing outside the BoE with a sack of notes is to pay your tax bill, surely? Would this cause the state serious trouble?
3. If your “Trust” Theory of Money is correct, why does the pound currently have any value whatsoever ? – taking into account that we have the most incompetent and corrupt government in modern history, the Prime Minister is a serial liar, the Chancellor thinks he has “a moral duty to balance the books” and the BoE thinks that raising interest rates right now is good for the economy. Where do you find your “trust” in all that?
Sometimes I can’t bring myself to reply
Some comments remind me to have a life instead
@jim osbourne
No reply to my questions Jim?