Discussing MMT under the federal reserve system

Modern Monetary Theory is a school of economic thought that explores the effect that state monetary powers have on the economy. Let’s be clear, MMT is not a theory of banking and money, but rather a theory about economies, specifically, it claims to finally elucidate the causes of domestic recessions or prosperity and business cycles.

MMT pickups up where Keynes left off. Keynes emphasized the ability of the government to counteract the instability of private business dynamics in the marketplace. Government can buy low and sell high at the highest level, to keep things stable. When the business world begins a firesale, ignoring labor and people and hoarding resources(buying always involves acquiring something and abandoning something else), because of businesses’ lack of foresight and inability to maintain social order and common wealth, government has the investment oppportunity of a lifetime. MMT’s key claim is that when government participates in the economy, it not only counteracts the instability of the business world but can also directly create domestic wealth.

So MMT is not a theory of money or banking, but rather an economic theory. Specifically, it is about the relationship between markets and government. Mainstream economics largely ignores debt and money, instead only focusing on production and consumption. In neoclassical theory, debt only moves purchasing power between parties. You are safe to ignore debt in an economic context, they argue, because it doesn’t really change the amount of wealth, only who controls it.

So behind the scenes neoclassical theorists are arguing that debt doesn’t matter, but publicly they are warning, with cries of terror, about excessive government debt. This is inconsistent and disingenuous. The best example of this is the recent complaints about Bernie Sander’s economic plan. Critics go beyond disagreeing with the specific projections and claim it will create unsustainable government expense.

Because MMT is not a theory about money and banking, but rather a theory about the effect that money, banking, and government have on the economy, it often simplifies our money and banking systems for pedagogical ends.

In these explanations, money is created when the treasury spends money and destroyed when it taxes. But strictly speaking, this is not how the U.S. federal reserve system works in its current design.

The U.S. dollar comes from the federal reserve bank. The federal reserve is what is called a central bank. This whole system was created because long ago bankers realized they couldn’t keep their shit together without government help. It’s not that they’re evil and conniving(sometimes true), but rather that they’re impotent. The private banking system is inherently flawed, because it makes promises based on maintaining domestic social order, but lacks the power to maintain this order itself. Banking relies on government and rule of law and government power to enforce contracts.

“So how can we fix the instability of the banking system?” these bankers asked. Not surprisingly their answer was a superbank. When you have a hammer, everything is a nail. Banks operate by storing wealth in different forms. The keep some reserves of cash or commodities, but most of their wealth is in contractual assets like mortgages and loans.

If an economy struggles, those mortgages and loans go bad, because people can’t earn money, and all the pressure falls on the assets that banks store as reserves. Those reserves aren’t intended to be long term storage for your wealth, only a temporary tool to meet the day-to-day demands of account holders. If people stop trusting the bank(as they should, based on their impotence and poor design), its reserves are completely inadequate. Because banks are built on a bad abstraction with no good way to devalue the asset they issue, and powerless to create the conditions they depend on for success, they fail completely and dramatically.

If banks were designed so as to communicate to customers that access to the wealth represented by their account balances was limited by the bank’s ability to exchange it’s different forms of wealth, we wouldn’t have this problem. People know how banking works, but banking processes and protocols fail to incorporate this asset exchange dynamic into the interface presented to customers. In case of crisis, banks should have policies for limiting access to account balances or temporarily or permanently devaluing balances. This is better than complete failure. Ideally, a bank should never have to use these measures, but having them in place is better than the alternative.

If people had experience with computers when they designed banking, and the depth which that forces us to explore abstractions and communication protocols, banking would have never had had these flaws. Our money systems would have better design today. Bank “runs” can be avoided by effectively incorporating graceful degradation. When something fails, you need to be honest and upfront and proactively manage the failure in the most appropriate way. When a bank’s commodity or currency reserves become stressed, it needs to have a plan of action in place that customers understand and can anticipate.

So MMT struggles to explain a badly concieved money and banking system. Who doesn’t? It can be forgiven if it starts its explanations by describing first how our monetary system should work, and then only through careful investigation can one correspond that ideal to actual monetary operations.

Our modern money systems are excellent. Don’t misunderstand me on that point. But they have evolved from something that was imperfectly designed. We’re left with confusing vestigal crap to deal with. I mean, the gold standard was abandoned basically overnight. That’s not the best way to do things.

I follow bitcoin. It’s interesting seeing all their design and governance problems. As much as they struggle, it seems like they’re at least addressing issues head on. But they make the same fundamentally flawed promises that banking makes. They depend on an ecosystem of rule of law without the power to maintain that system themselves.

Bitcoin has dramatically demonstrated the possibilities of decentralized, disinterested, and voluntary governance. But like the trust-fund kid who eventually gets his act together, bitcoin is dependent on a lot of assistance. Furthermore, I don’t think governance is possible without personal commitment and public participation. Bitcoin won’t succeed if it tries to be completely disinterested. It has enjoyed success because people are committed to its purpose.

Anyway, how can MMT accurately describe money and banking under our current federal reserve system?

There are two forms of the dollar. A fed dollar and the treasury dollar. The fed dollar is what we normally think of as a dollar. It comes from the banking system with the federal reserve its center which operates under the authority of congress.

The fed issues an asset. No one seems to have a problem with that. Everything is tracked and accounted for. Money is never simply printed, it is bought and sold: exchanged as I have described previously when discussing banking. What people struggle to accept is that the treasury also issues an asset, and that asset is just as good, if not better than the fed’s dollar. This is because the treasury has taxation authority and other public authorities, while the Fed is a relatively impotent bank.

Federal treasury spending is not merely consumption, it creates wealth! It is one of the few activities that really creates wealth after your TV is obselete and your car breaks down. The imperfect initial design of money and banking has actually lead to a really clever mechanism for parallel creation of wealth and assets.

When the treasury creates money, it does so by issuing bonds. Those bonds begin their life as a savings asset, and the supply of circulating currency is not immediately affected. The treasury collects dollars to be saved and recirculates them by investing in worthwhile public efforts. Meanwhile bonds are issued. One form of the dollar comes in, two forms of the dollar go out. The supply of dollar assets doubles by using two different forms. That’s how the treasury creates money.

Money can have lots of different forms, but modern money is all about contractual relationships. It involves mutual commitment and investment. All forms of money creation are like this: bank lending, issuing stock equity, and selling treasury bonds.

How do we know if the investments pay off? That’s where people get confused. A banking investment pays off on the bank’s balance sheet. They maintain solvency by controlling assets valued enough to cover their liabilities. Donald Drumpf(Trump) highlights how this can sometimes be arbitrary. He states that his net worth depends on how he feels on a particular day. When your only value is your public image, that’s an accurate assessment. Banks usually try hold to assets that represent something more tangible and reliable than Donald Drumpf’s public image.

A business investment pays off through appreciation of stock. But public investment pays off by maintaining stable currency value. It’s boring and undramatic.

In accounting terms, things look worse with a valuable dollar. When the dollar is valuable, the “debt” of the U.S. treasury looks bigger. But this is what we want. We want people to have real wealth that is backed by a stable system.

For the U.S. treasury, you cannot assess solvency in the traditional sense because tax obligations are ongoing. Bank loans get paid back eventually, but taxes are forever. Investment success doesn’t manifest in asset appreciation the way it does with stocks. We want the dollar to maintain a stable value, not deflate. When the treasury makes good investments people complain about the national debt and the Fed complains it can’t hit its inflation target.

Meanwhile, the treasury is making good investments, but not sufficient investments. The economy is pretty idle or at the least underengaged. So long as we have people and resources idling, why the heck are we trying to inhibit the treasury from investing in worthwhile public purposes?

Taxes fund federal spending, i disagree with MMT statements to the contrary. Taxes are key. Taxes allow the treasury to maintain ongoing solvency with perpetual defecits. But taxes don’t limit federal spending. Our imagination and will to invest publicly limit spending. Our misunderstanding and misconceptions limit spending. We are letting our saved wealth in the form of treasury bonds limit our spending. We have so much wealth, how could we possibly have any more? Treasury bonds are not debt, but a manifestation of mutual commitment and public wealth.

Wealth depends on contracts and public context including rule of law and political processes. Much of this wealth would survive changes to government, but it would not be unaffected. The government’s relationship to markets and wealth goes far beyond its taxation authority. It defines or formalizes the entire context within which wealth exists. Its authority is not limited to collecting taxes but also includes defining laws which create the boundaries of wealth and ruling on disputes contesting those boundaries.

Taxes fund federal spending, but they don’t limit federal spending. In my last post I drew a triangle showing the three supports of the dollar’s value. They are public investment, public taxation, and private sector production.

The Fed may issue the dollar, but the treasury has taxation authority and a mandate to finance and support public efforts that are executed with governmental authority. Our economy depends on our will to have continuous generous public investment, even when we allow people to save dollars far beyond what they must pay in taxes.

Compared to private investment, public investment doesn’t tend to cause bubbles. This is for a few reasons. Dollar value is intentionally stable, it does not fuel mob mentality, but is rather the harbor of safety when mob thinking has failed and bubbles pop. Taxes stabilize the circulation of dollars. If things get too hot, we collect more taxes and keep things in check.

I subscribe to MMT as an economic theory. If our currency and general system fails it will be because of poor political choices, not because the U.S. treasury was powerless to create more wealth or exercise authority over the wealth that currently exists in this country.