Isn’t this just a wonderful misunderstanding?

We need deficits to create money

Saving takes money out of circulation in our economy: it effectively destroys it. That is because money is only created be lending and since saving is the opposite of lending ( loan repayment having the same net effect as saving in economic terms) than a worldwide glut of savings leaves a shortage of something that we all need, which is money. UK money supply has fallen since the end of the quantitative easing programme in 2012. If this shortfall is to be made good then the only party capable of delivering the money we need to keep the economy going when the private sector insists, overall, on saving is the government and the only way in which it can create this new money is by running a deficit. This is the role of quantitative easing when the economy gets really tight: I would of course prefer People’s Quantitative Easing to any other form because this does, of course, direct the funds to productive investment for all the positive reasons noted in the previous section.

An incredible mish mash of fiscal and monetary policy. He’s saying that the government should spend more than it taxes because we need to create money, that is, expand M4 (which is itself MxV, roughly and around about). Then he says that he’d prefer to do this through PQE, which isn’t the government running a deficit at all, that’s expanding M1 (roughly, M) to thus expand M4 (again, roughly MxV).

That is, his preferred method of expanding the money supply doesn’t even imply, let alone prove, that the government has to run a deficit. And yet this is used as proof that the government must run a deficit in order to expand the money supply.

City University has some fun on its hands, doesn’t it?

62 thoughts on “Isn’t this just a wonderful misunderstanding?”

  1. He seems to have suddenly discovered Magic Money Tree (MMT) theory and, like everything else, doesn’t understand it.

    Not that it requires much understanding, since it is essentially print money and spend it.

    Which, as we know, always ends well.

  2. Interesting, isn’t it? He responds so fast and in such anger that he doesn’t bother to check his typos, which get worse and worse the angrier he gets.

    It’s almost as if he’s an internet troll who thinks that the only important thing is to get THE LAST WORD!

    This is going to be truly hilarious as he dissolves in public. When people realise that not only is he not an economist, he’s not even. Very competent accountant.

  3. The thing that leftist inflationists never seem to grasp is that however you create the new money (not actually money, but promisory notes, but let us not digress), it will end up in the hands of the people with a low marginal propensity to consume (to be terminologically Keynesian) after a couple of transactions. And thus concentrate the new wealth among those who are already wealthy; which leftist inflationists do not want to happen.

  4. well he’s got a point in there somewhere that traditionally seigniorage has created revenue for the state which means it gets to spend more than it taxes which implies a deficit in the taxes minus spending sense. As for PQE, if you are putting equity or debt into a public sector bank with printed money, well that’s not a million miles from public sector running a deficit either (money being spent, not covered by taxes)

  5. Oh dear the walking corpses are back denying that banks create money and the government has to pay to “borrow” off them when it could just create the money itself. NB I am no fan of Murphy myself, but you have to deal with the real issues he raises even if he doesn’t get entirely the right answers.
    Settle down there! We’ve just clipped a small iceberg but The Titanic is, as you know, unsinkable.

  6. DBC I cannot see anybody denying banks create (broad) money here (and central banks create narrow money)

  7. @IB
    The problem you describe is countered by speeding up the velocity of money: either by inducing inflation in a “Keynesian” manner or by the scheme Keynes plagiarised: Gesellian demurrage money which people couldn’t wait to spend (See Worgl and Swannenkirchen interwar and today the small scale Chiemgauer parallel currency nearby.In the latter place the velocity of money is 5.4 and the Euro 1.65)
    Where Keynes went wrong was in not stopping money being hedged into landed property where Gesell spent half his magnum opus dealing with the problem of land).

  8. “Saving takes money out of circulation in our economy”

    If the above were true why haven’t various eastern economies with a strong savings culture contracted to nothing?

  9. @l.e. (I have forgotten your real initials as vouchsafed by Frances Coppola)
    This blog’s comments start of with sneery remarks about the money tree which is a dead giveaway of the ” nobody can create money” heresy.You know their number : “money is deposited in banks by proper savers who pass it on at interest to proper businesses”
    There are numerous money trees and they are controlled by the banks.Go on and admit it straight out, (you only have career suicide to fear)!

  10. DBC Reed.

    On ‘walking corpses’ – I am guessing it takes a zombie to know one, right?Still banging on about the BOE paper – Jesus.

    On an unrelated topic. I assume you echo the thoughts of your pal Carol Wilcox on IRA sympathiser and Shadow Chancellor, John Mcdonnell:

    ‘How can Labour MPs not recognise the genuine humanity and intelligence of this man? It makes me proud to be a Labour Party member – at last’

    And if Lawrence of Arabia wants a screendump happy to provide it…..

  11. Frederick:

    “Saving is not the opposite of lending. Repaying a loan is the opposite of lending.”

    Incredible that this has to be pointed out to an alleged “economist” and “expert”.

    As for his “savings destroy money” argument, completely deranged.

  12. Oh look, DBC’s turned up to tell us all about how it’s ‘the jooz’ again.

    Which is of course also what Ritchie’s up to here. This is not a misunderstanding at all, it’s a deliberate attempt to ramp up the amount of the fruit of the magic money tree that’s currently stolen by the jooz.

  13. “That is because money is only created be lending”-under a fiat money fractional reserve system.
    This is a very bad system for ordinary people in productive work.
    But a great system for statists.

  14. @V_P,
    Hadn’t mentioned the BoE paper or Carol Wilcox whom you are now abusing for being a regular Labour party member, not a 1930’s Communist calling for the extermination of class enemies as you made out.
    You are making a fool of yourself.
    And what’s all this crap about “the jooz”?
    Used to troll this site because you got a higher class of debate that put Lefties on their mettle. Now its all a bit pathetic.Pull yourselves together chaps and do some homework on monetary systems etc.Or pack it in.

  15. DBC>

    Are you pretending you’re not well aware that the claptrap you’re spouting is merely a tired old antisemitic conspiracy theory?

  16. “Saving takes money out of circulation in our economy”

    Eh?

    And there was me thinking that when I save money in the bank (as if I would!), they lend it out to someone else to do something useful with. Isn’t that how they can afford to pay me interest?

  17. Obviously he meant saving as in digging a hole in the ground and burying it, and candidly if you cannot see that then I will not debate with you any further and any further attempts to troll will be deleted.

  18. @D
    The claptrap I’m spouting , not that it gets any applause, is straight out of the 2014 BoE Bulletin “Money creation in the Modern Economy” reinforced by recent-ish Martin Wolf arguments in the FE.( I don’t suppose he is anti-Semitic, or the BoE.)

  19. DBCReed

    Joined up thinking

    2:04pm

    ‘Hadn’t mentioned the BoE paper’

    3:36pm

    ‘The claptrap I’m spouting , not that it gets any applause, is straight out of the 2014 BoE Bulletin “Money creation in the Modern Economy”’

    Wondrous stuff….

  20. Bloke in Costa Rica

    I freely admit I am not an economist. I am not an accountant. I know very little of the technical side of any of this. But please explain how, exactly (using small words because I am a bear of very little brain) saving destroys money? Even if we ignore the lending-out-other-people’s-savings aspect I don’t see what the word ‘destroyed’ is doing there. Do people stuff it under their mattresses until it gets all lumpy and then burn it? Or is saving simply shifting the point at which the vouchers are redeemed for cool stuff from right now to some point in the future? So it’s not being destroyed at all, merely released later rather than sooner? I can see if everyone hoards their money and doesn’t spend it there will be adverse effects and maybe the pot of wealth will be slightly less full than it might otherwise have been, but where is the ‘destruction’ coming in? Isn’t the real destruction of money in debasing the currency so that those vouchers buy less cool stuff later rather than right now? And isn’t that what increasing the number of vouchers without increasing the amount of stuff being produced does? And isn’t that what PQE does?

    Are all the real experts now falling about clutching their sides at my naivety?

  21. V_P Fair cop. But I hadn’t mentioned it while debating with you which is rather the point.
    @D What flat out lies?It is normal when libelling somebody to give some grounds.

  22. DBC>

    It’s not in any way defamatory, let alone libellous, to point out that you first came out with a tired old antisemitic conspiracy theory, and then blatantly lied about being supported by a source that says nothing even close to what you claimed.

    And it’s simply another example of your flagrant mendacity that you’ve pretended there was the slightest ambiguity in what I said before, as if there was more than one point made in the post I replied to.

  23. “But please explain how, exactly (using small words because I am a bear of very little brain) saving destroys money?”

    It doesn’t. Saving is a form of borrowing with customer and bank exchanged. The bank effectively borrows from the customer (receives cash in return for an obligation to repay it) and borrowing creates money.

    ‘Money’ is just a credible, enforceable promise to pay value at some future date. (As the promise written on a banknote makes clear). When you go to a bank and borrow money, you give them a signed contract promising to repay it. Signing the loan agreement is what creates money – all the bank does is exchange this newly created money for an equivalent amount in a more liquid form. Because the bank gives as much as it gets (minus a small percentage to pay the admin costs) it’s not the bank creating money.

    However, when the customer deposits money in the bank, in exchange for the bank’s promise to repay it when the customer asks, it is the bank that creates the money (promise to repay) and the customer who finishes with as much as he started – cash is being exchanged for a bank account in credit – the same money in a less liquid form.

    Money is destroyed when the debt is repaid. When you pay off your bank loan, the signed loan contract in the bank’s vault is worth that much less. When you withdraw your money from the bank, the bank’s promise is worth less, as there is less in your bank account.

    It’s not particularly complicated – but it’s an unfamiliar way of thinking about it to most people. Just think – “where’s the promise to repay?”

    Were the words short enough?

  24. “McDonnell said he had changed his mind on the charter as a result of receiving “professional advice” …”

    Oh dear Christ, who can he have in mind?

  25. “you first came out with a tired old antisemitic conspiracy theory”: typical of Lefties- they can’t even come up with a vibrant new antisemitic conspiracy theory.

  26. People are confusing money with money. The money we use is mostly just promisory notes for payment of money at a future date, said money also being promisory notes for money, which is also promisory notes for… well you get the idea.

    This is why it’s almost impossible to understand money. Most libertarians think that the problem is “fiat” money. It isn’t; the problems start the day you issue your first gold certificate and its holder says to someone, “look, I’ve got this gold in the bank, here’s the proof. Can I pay you with this certificate instead of going and getting the actual gold?”. Fiat is just the ultimate stage of promisory note decadence.

    Once you’ve got a few billion people doing that, heads start to spin and, eventually, roll.

    I see that to keep the system cranking around, they’re now talking about abolishing note and coin altogether. Hmmm.

  27. NiV has DBCR ever popped up to explain where you are wrong? I thought not. He is too busy supervising schoolchildren in Switzerland playing with money…..or something.

  28. @Dave
    You persist in describing ideas from the BoE and Martin Wolf(!) as tired old anti-Semitic conspiracy theory.The ViPer on the other hand lambasts me for relying too much on the tired old BoE bulletin (from 2014!) You can’t both be right. But you can both be wrong, which you are in spades.
    Dave is also wrong if he believes he did not seek to libel me by calling me an antisemite; ViP is also wrong if he believes he did not libel Carol Wilcox with wild ad hominem accusations of her support for Stalinist purges etc .
    Calm down chaps: it is your side that is supposed to show moderation and act like gentlemen.

  29. @barrel dweller
    I do not need to explain the money creation process that NiV makes the usual obscurantist mess of elucidating: the Bank of England has done it in simple language for the general good in “Money Creation in the Modern Economy” on Net with supporting videos etc.They were obviously trying to stop the kind of crap that is passed off on here as fact.But some people are too up themselves to wonder what is really going on.PS I am fairly sure that the bulletin’s authors are not perpetuating a vicious racial slur.

  30. Banks do not create money.

    I am of course aware that they do a thing that is generally referred to — including, foolishly, by themselves — as “money creation”. But they really need to come up with a better technical term, because that word “create” encourages ignorance and plays right into the hands of people who hate banks.

    Creating is what God did with the world. When people talk about the banks “creating” money, that’s the conclusion all too many reach: that banks take nothing and turn it into something. But if this were true, it would be completely impossible for any bank ever to run out of money. Runs on banks wouldn’t matter. It’s obvious bollocks.

    What banks actually do is they produce money. And the thing about production is that you produce stuff out of other stuff. That last bit completely answers stupid shite like this:

    > Oh dear the walking corpses are back denying that banks create money and the government has to pay to “borrow” off them when it could just create the money itself.

    > sneery remarks about the money tree which is a dead giveaway of the ” nobody can create money” heresy.

    > There are numerous money trees and they are controlled by the banks.

    There’s nothing wrong with money trees. I used to know a forester, who was rightly contemptuous of the idea that trees are an easy crop to grow and harvest. The problem is people who believe in magic money trees.

    There’s something about antisemitic conspiracy theories. They insinuate themselves into people’s thinking. Lots of people who I know are not actually antisemitic still swallow the theories, as long as the word “Jews” is removed. Which is why it’s always worth putting it back in, to try and help such people realise what they’re doing.

    So, DBC, assuming you really don’t know, this bit is the old antisemitic conspiracy theory, and it’s certainly not in the BoE’s report:

    > the government has to pay to “borrow” off them when it could just create the money itself.

  31. @S2
    The “conspiracy theory” about banks creating money is not merely insidious ,it can also be sudden-onset. Take our genial host TW .In July 2012 he is staunchly sticking to the line “No banks don’t create money” on this blog then, after the publication of the BoE bulletin, he has been brainwashed into saying “The short explanation is that banks do indeed just create money out of thin air” (19.Mar .2014) . A tragic loss to right-wing pseudo-intellectual nitwittery.

  32. “I do not need to explain the money creation process that NiV makes the usual obscurantist mess of elucidating”

    Translation: “I can’t understand what you just said and that’s your fault.”

  33. “Creating is what God did with the world. When people talk about the banks “creating” money, that’s the conclusion all too many reach: that banks take nothing and turn it into something. But if this were true, it would be completely impossible for any bank ever to run out of money. Runs on banks wouldn’t matter. It’s obvious bollocks.”

    Money is a credible and enforceable promise to pay something of real value at a later date.

    Anyone can “make” a promise. And when they do, the obligation is “created” out of nothing. But there’s an obvious limit to how much you can create – you have to pay something of *real* value later to cancel it out. You can only promise as much as other people believe you can deliver. The ‘value’ of the newly created money is being backed by the value of all your years of work paying the loan off, so you can never create more than people believe you can do. And a bank can never issue more money than its borrowers can supply.

    Bank runs are something else entirely. Banks sell liquidity, and liquidity has a price. (You have to pay people interest if you want them to give you liquid assets in exchange for illiquid ones.) If there’s a sudden rise in demand for liquid funds, you may need to sell some of your less liquid assets to meet it, and if the price is higher than you bargained on, you’ll probably make a loss on the deal. That can bankrupt you if it goes on for too long. The same applies to any business selling a product for a pre-agreed price – if demand spikes and its price elsewhere on the market goes up, you can wind up being obliged to deliver more than you can afford.

    But you’ll note, when there’s a bank run people worry about the value of their savings accounts – they *don’t* worry about the value of the money created by that bank’s loans now circulating in the economy. If people doubted the soundness of the financial basis on which that money was created, they would.

  34. > Anyone can “make” a promise. And when they do, the obligation is “created” out of nothing. But there’s an obvious limit to how much you can create – you have to pay something of *real* value later to cancel it out. You can only promise as much as other people believe you can deliver.

    This is a rewording of what I said: there is a limit to the “creation”, because it’s not created out of nothing; there is a raw material. So “produce” is a better and less prejudicious word.

  35. Certainly there’s a raw material. But it’s a raw material that doesn’t come into existence until a later time. (i.e. the work you do to pay the loan off.)

    But if you’d be satisfied by substituting the word ‘produced’ then fine. I’ve got no objection to that.

  36. SQ2 &NiV.
    Rather than the pretentious, nay precious, wonderland you depict where all money is iou’s ( that reminds me I must go round and collect on the IOU the newsagent gave me instead of a ten-pound note then I’ll go to the bank and get them” to pay the bearer on demand”) perhaps you should give your sources as I have: independent, third-party authorities .If possible avoid authorities tainted with anti-Semitism,(snigger).

  37. DBC

    “again ridiculing the notion of IOU’s”

    LE said above that banks create broad money (M4), and that central banks create narrow money (M0).

    The amount of coins and notes (M0) in existence are relatively minimal in the context of value of total balances that exist. The rest is all electronic, ie, for every lender there is a borrower.

    you should give your sources as I have: independent, third-party authorities

    Is the ONS good enough for you (page 11)?

    http://www.ons.gov.uk/ons/dcp171778_386098.pdf

    or this gives the full excel analysis linking to total UK net worth (look at Table C):

    http://www.ons.gov.uk/ons/rel/cap-stock/the-national-balance-sheet/2014-estimates/rft-national-balance-sheet–2014-estimates.xls

    Page 11 of the first report is the same as the “financial assets” part of Table C of the second. Ie, it all links in to total UK wealth. See how small the “net” balance is that comes from page 11 (or Table C – financial). btw you are right, houses are the big ponzi (planning chitties versus “demand over supply” but that’s a different issue).

    And at that point, what actually do we think that all that lending = borrowing comprises, in all of its different forms, liquid and illiquid? Ie, bank lends large sum to me (their asset) / my loan secured on a house (my liability); my current account / banks owes me; my investment in a company / a company’s share capital; bank lends to government / gilts issued; etc, etc..

    If these are not all different forms of IOU (as in the “borrower” owes the “lender”), then what are they? Genuinely, I am interested?

    btw, when you dismiss with “people think that savings are required before the bank can lend that money back out”, consider that when you deposit some savings / money into a bank, electronically, where did that money just come from? Did another person pay it into your account, electronically? In other words as one account goes up, another account somewhere else in the system went down “at the same time”, and that all has to be matched off / balanced with intra bank clearing etc.

    So, sure savings do not need to “precede” a bank making a loan. But when the bank lends and that person then “spends” that money, that that transfer of funds elsewhere comprises the new savings in some other person’s bank account and which then all has to match out.

  38. “perhaps you should give your sources as I have: independent, third-party authorities”

    ‘Argument from Authority’ is a logical fallacy.

    But since you probably won’t accept that on the basis of logic, here’s an authority for you…

    “In questions of science, the authority of a thousand is not worth the humble reasoning of a single individual.”
    Galileo.

    Happy? 🙂

  39. PF So every time you go to your bank, you are told you can’t have any money because its nearly all lent out? Fractional reserve banking only keeps a small percentage in reserve-hence the name.Read Murray Rothbard ,Austrian school tough guy, on FRB: he is much worse /better than me; he calls it a swindle.
    NiV: Pathetic.

  40. “So every time you go to your bank, you are told you can’t have any money because its nearly all lent out?”

    No, because your promise to repay isn’t credible.

    “Read Murray Rothbard ,Austrian school tough guy”

    Argument from Authority.

    Again.

    “NiV: Pathetic.”

    Brill! I do love a graceful loser!

  41. > If possible avoid authorities tainted with anti-Semitism,(snigger).

    See, there are two responses to having the anti-Semitism you’re (perhaps unwittingly) propagating pointed out: giving or not giving a fuck. You’ve opted for the latter, with extra sniggering no less, so I’ll withdraw my benefit of the doubt.

  42. DBC

    “So every time you go to your bank, you are told you can’t have any money because its nearly all lent out?”

    I’m not sure I’m following you at all. I don’t think I that implied that?

    “Fractional reserve banking only keeps a small percentage in reserve-hence the name.”

    And I’m also not quite sure how the reserve bit contradicts what I said. Table C (above) demonstrated that we haven’t violated the 1st Law of Bean Counting – in that, in this case, gross financial assets tallied with gross financial liabilities, hence, if someone borrowed, then someone lent? The reserve bit you talk about is ensuring that the bank is not too highly geared (relative to its capital base) in relation to its total of gross financial assets and liabilities.

    “Read Murray Rothbard ,Austrian school tough guy, on FRB: he is much worse /better than me; he calls it a swindle.”

    OK, I’ll do that. Mainly because I’m curious, I just can’t see yet what the apparent swindle is? I’ll let you know if I come round and agree that it is in fact all one big con / swindle..:)

    All I see is banks facilitating the borrowing / lending process, so that in any form of non basic economy Person 1 and Person 2 don’t have to have borrowing / lending balances with each other (IOU’s) to carry out a transaction.

    Instead they can do it through intermediaries, such as banks, which (for a fee to the borrower, ie interest) can mitigate the personal risk to the lender.

    Hence, very simplisticly, instead of Person 1 buying a product from Person 2 and having an IOU with Person 2 – Person 1 can instead (as a result of “paying” Person 2 through a bank) owe Bank 1 (loan, or a reduction in their savings); Bank 1 can owe Bank 2 (intra bank); and Bank 2 can owe Person 2 (current or savings account, or reduction in an existing loan). Multiplied billions of times over…

  43. PF and NiV

    great explanations of the process…just don’t expect someone like DBCR to be capable of understanding you. He has proved on innumerable occasions that he prefers to refer to arcane experiments involving schoolchildren in Switzerland or the musings of academic economists with no banking experience to any kind of real world knowledge.

  44. @D
    We now hear that the BoE has no banking experience or real world knowledge. Gawd almighty.
    NiV is arguing that only he understands the banking system and that all other authorities are wrong.Oh dear.
    The school children are continuing the work of Silvio Gesell favourably referenced by Frances Coppola recently and admired by Keynes though misapplied because Keynes didn’t stop “velocity money” being hedged into land as Gesell specified.
    PF How’s it going with Rothbard on FRB? A little clearer than some of the footlers on here, innit?

  45. DBC

    “PF How’s it going with Rothbard on FRB? A little clearer than some of the footlers on here, innit?”

    Yes, it’s interesting. But, to be honest, so far I can’t see which bit is supposed to be the “swindle”, to use the same term? Inherent inflation caused by increased credit, or the “property rights / claims” arguments, or combinations / other?

    I thought about some detailed response, but I’m not sure it would necessarily add value! Happy (later or whenever) to pitch in or respond (if I am able?) to any detailed or specific arguments as to why FRB is (or isn’t) supposed to be one big fraud, but perhaps easier to respond to specifics in that context? I’ll read further in any case.

    And also nothing there (yet) to convince me or help me understand why NiV’s use of the term IOU is flawed at all, or the lender / borrower terminology?

  46. and DBCR continues to appeal to schoolchildren, Liquidity is the word you need to learn. Consider its meanings.

  47. DBCR are you able to show us the charts of mo netary growth for the various aggregates over the last 10 years? With your sagacious conclusions thereon…without the assistance of the schoolchildren?

  48. “Never before seen Murray Rothbard on FRB described as not entirely clear!”

    DBC – what I think I indicated was that I couldn’t see which bit was supposed to be a “swindle”. Ie, “as I understand swindle” – which is perhaps subtly different, if that helps? And obviously, please do feel free to elaborate / offer your own interpretations?

    What I fully accept isn’t clear: I still can’t see how this is supposed to contradict in any way the substantive point I did make – which was about the current 21st century reality of lending / borrowing, and hence different forms of IOU (and as illustrated by parts of Table C from the ONS dataset)?

  49. “NiV is arguing that only he understands the banking system and that all other authorities are wrong.Oh dear.”

    I’m saying that if you want to persuade me I’m wrong then you have to provide an actual explanation or reason of how or why, not just cite an authority with no understanding of what they mean or why they say so. Authorities are often misunderstood, if things they say casually are repeated out of context by those who don’t understand the subtleties of the subject, and yes, sometimes authorities are wrong, even about subjects they’re supposed to know well.

    Authorities/experts are only of value to the extent that they can provide concise and definitive explanations, summarizing all the arguments for and against a standard position. It’s the explanation that you have to understand and judge. Or how can you decide who is a genuine authority? Go to an authority on authorities, perhaps?

    The issue isn’t really very complicated. The trading of debt instruments on the bond market is standard practice, and well-understood. Bonds, promissory notes, and commercial paper are widely interpreted as forms of ‘money’ (and are counted in the M4 definition of money supply). A debt instrument such as a loan agreement is therefore a form of money. It is created by the borrower, and its value backed by their future repayments. The parallels between a loan agreement and other more easily recognisable varieties – such as cheques and banknotes with their promise to pay the bearer on demand… – can be easily seen and understood.

    And once you include the loan agreement itself as a monetary asset being traded in the process of taking out a loan, it’s not hard to see that the money the bank gives out is backed by the money it has just been given by the borrower.

    Depositors funds are just used to grant liquidity. A bank would not normally run out of depositors’ cash and be forced to stop granting loans because liquidity is an asset that can be bought. The bank simply sells some of those loan agreements to another bank in return for cash. Or if it has too much on deposit compared to the amount it is loaning, sells the excess to other banks in exchange for more debt instruments. Under normal circumstances a bank will never run short of funds for making loans or repaying depositors – it simply buys and sells the required liquidity, the average risks and losses from fluctuations in the price are simply added to the interest rate. Problems only arise when the market price of liquidity rises higher than was anticipated or allowed for.

    The concept of debt instruments as a form of money is straightforward. The concept of liquidity less so. But none of this will be unfamiliar to financiers on the bond markets. I’m not sure who wrote the BoE paper, but I’ve seen a number of documents like it that turned out to have been written by the marketing and PR departments, often by very junior staff. I doubt they’d have their top bond traders writing noddy pieces explaining basic economics to journalists and the general public.

    “How’s it going with Rothbard on FRB? A little clearer than some of the footlers on here, innit?”

    Rothbard regarded money as a representative of a concrete commodity, able to act as a medium of exchange in a barter system. If you’ve got some fish, you can sell them in exchange for a fishing boat. What you can’t do is to sell the fish you’re planning to catch tomorrow for a fishing boat today, because at the moment you don’t own the fish. You’re trying to sell something you don’t actually currently possess, and that might not even be real. (What if you get out there and find the lake has been fished out?)

    To sell fish you don’t have for a real fishing boat, or a set of chairs you don’t have in exchange for a set of carpenter’s tools, is what Rothbard is counting as ‘fraud’, and a ‘Ponzi scheme’. Trade is still barter, according to Rothbard, and barter is a direct exchange of ownership completed in an instant of time. The idea of incurring debts you can’t currently meet, and relying on the fact you won’t have to repay it until later when hopefully you will have something to exchange is how a Ponzi scheme works – using the income from later investors to pay off the early investors. Such schemes seem to create money out of nowhere, and always collapse when the ever-rising demand for more suckers to buy into it exceeds the supply.

    However, this reasoning is incorrect. It clearly *is* possible to promise fish tomorrow in exchange for a boat, go out fishing in it, and with very high confidence catch enough fish to make good on the promise. Unlike a Ponzi scheme, something of real value is delivered. And the higher probability of default when dealing with goods that don’t yet exist is naturally compensated for by the interest on the loan.

    Or to put it another way, while “jam tomorrow” does not exist and therefore can have no value today, the credible and enforceable promise of jam tomorrow is a thing that exists today. Contracts are reified as commodities.

    Rothbard I think had other reasons for wanting to stick to the purity and certainty of a concrete commodity-based barter system. Trading in abstract concepts makes it easier for governments to pull the wool over people’s eyes, and run up debts on the taxpayer’s account that cannot be repaid. But I don’t think he was right about this particular point. There’s nothing fraudulent about fractional reserve banking, so long as depositors are aware that the interest they’re paid is partially to offset the risk they’re taking of losing their money. Sadly, a lot of depositors aren’t.

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