Michael D. Greaney, Center for Economic and Social Justice (www.cesj.org) Comments:

Why Modern Monetary Theory is Illogical

“Modern Monetary Theory” or “MMT” is the theoretical framework for virtually all monetary policy in the world today. Even those who reject MMT do so within the context of the very system they reject.

If that sounds paradoxical, it’s because it is. The paradox can be traced directly to the most fundamental principle of modern monetary theory (note the absence of capitals; we do not mean Modern Monetary Theory, but monetary theory in modern times) is the “Quantity Theory of Money” equation,

M x V = P x Q

This equation, first formulated by Irving Fisher (1867-1947) using concepts that appear to have been suggested first by Sir William Petty (1623-1687), states the relationship between the variables involved in the interactions of economic activity. The usual interpretation of the theory is that the money supply and the price level in an economy are in direct proportion to one another. When there is a change in the supply of money, there is a proportional change in the price level and vice versa.

To understand why the usual interpretation is half-wrong (which is far more damaging than being completely wrong), we first have to understand the equation. It is straightforward algebra:

·      M = the quantity of money in the economy,

·      V = the velocity of money,

·      P = the price level, and

·      Q = the number of transactions in the economy.

As for what this special language means, M is the quantity of things recognized as “money” in an economy. V is the average number of times each unit of money is spent during a period. P is the total amount spent in an economy divided by the number of transactions. Q is just what it says, the total number of transactions in the economy.

Now here is where things get interesting. There are two ways of looking at the Quantity Theory of Money equation. One is called the Banking Principle, and the other is called the Currency Principle.

Both principles are slightly misnamed. This is because the Banking Principle doesn’t necessarily involve banks but describes the banking function, a minor semantic issue. The Currency Principle does involve currency but limits the definition of money to currency and currency substitutes — and that leads to some serious problems.

Despite modern commentators who insist on misstating the Banking Principle in terms of the opposing Currency Principle (we did mention that this gets interesting, didn’t we?), both principles can be stated and understood very easily, given the Quantity Theory of Money equation:

·      Banking Principle: The number of transactions, the price level, and the velocity of money determine the amount of money in an economy.

·      Currency Principle: The amount of money determines the number of transaction, the price level, and the velocity of money in an economy.

Anyone who remembers anything at all of high school algebra should now already see the fundamental serious problem with the Currency Principle. Should, of course, but probably won’t. It’s human nature not to see something so obviously wrong. Besides, no teacher would ever dare put this question on a test for fear of getting run out of the classroom with an angry mob of students hot on his or her trail because it is so obvious it turns into a “trick question.”

Here is the problem, and it’s a doozy.

There is one equation with four variables. One of the first things people learn in algebra is that you cannot have more than one unknown or “dependent” variable per equation, or the equation cannot be solved in one dimension, and one dimension is the only thing that makes sense in monetary theory.

Of course, if you have one equation and two dependent variables you can get a range of possible answers in two dimensions, and with one equation and three dependent variables you can get a range of possible answers in three dimensions, and so on . . . but what good does that do anyone? Monetary policy needs to answer only one question in one dimension: How much money is needed in the economy?

The Banking Principle answers that question very readily, and then moves on to other questions, such as how best to ensure that the amount of money in the economy is uniform, stable, “elastic”* and asset-backed. These are all essential characteristics of money, regardless how much there is or what form it takes.

*”Elastic” in monetary theory refers to a money supply that expands and contracts directly with the needs of the economy, so that there is neither inflation nor deflation. If prices change, it is because of changes in supply and demand, not because someone changed the unit of measurement.

As far as the Banking Principle is concerned, the question “How much money is needed in the economy?” actually answers itself. Assuming the system has been properly designed and is operating within established parameters, exactly enough money will be created as is needed. Under the Banking Principle, “money” — the medium of exchange — is created when people enter into agreements to exchange goods and services and is cancelled when the goods and services are delivered.

Thus, looking at the Quantity Theory of Money equation from the perspective of the Banking Principle, there is only one dependent variable in the equation, and it is one that takes care of itself. How much money does there need to be? As much as is needed, of course, and given that money is only created by entering into actual transactions and only cancelled when the transaction is completed, there is always exactly enough money in the economy to do the job.

And the Currency Principle? As both Aristotle and Aquinas agreed, a small error in the beginning can lead to great errors in the end. This is not, however, a small error that leads to great errors. It is a great error that leads to cosmically huge errors.

Under the Currency Principle, which is the theoretical basis of Modern Monetary Theory, the question “How much money is needed in the economy” is answered by saying, “Gee, I dunno. Let’s make a guess, fiddle with things, hold our breaths, and hope it comes out right.”

This is because under the Currency Principle, instead of having one dependent and three independent variables that you have for the Quantity Theory of Money equation under the Banking Principle, you have one independent and three dependent variables.

One equation and three dependent variables? Check your high school algebra textbook — you cannot solve that equation in one dimension. You can only solve it for a range of answers in three dimensions . . . and even then, only if you know how the different variables relate to one another within the equation itself.

And that’s another problem. The so-called Keynesian Money Multiplier claims (based on some very flawed assumptions, by the way) that increasing or decreasing the amount of money in the economy will affect V, P, and Q in some mysterious way that has more exceptions than you can shake a stick at. Does doubling M mean doubling T? Or does it double P, cut V in half, or some combination thereof? Cross your fingers and hope for the best.

To try and make the equation work, different definitions of M have to be tried, different relationships between the variables assumed, and the characteristics of money manipulated, e.g., should the money supply be asset-backed or debt-backed? Privately issued or government issued? Gold, silver, dirt, or political whim? Elastic or inelastic? Stable or constantly changing? Uniform or variable?And so on, ad infinitum . . . and all to try and answer a question that the Banking Principle answers automatically.

Ironically, all the gyrations people have been going through for almost two centuries trying to come up with the magical incantation that will make the Quantity Theory of Money equation work under the Currency Principle could have been seen as completely unnecessary by any high school student who has taken algebra. And why?

Like, fer shure, Dude, you can’t, like, you know, have more than, like, one dependent variable in an equation and hope to make, like, sense, you know?

Given that rather enormous problem with Modern Monetary Theory, you can argue all you like about interest rates, inflation, deflation, trade imbalances, reserve ratios, fractional reserve banking (which doesn’t mean what most people think, anyway), sterilization of exogenous money (no, we didn’t make that one up), and so on, so forth . . . but it doesn’t mean a thing because MMT is based on a flawed assumption to begin with. Yes, people might by chance manage to create the right amount of money for an economy without causing too much damage (although don’t hold your breath), but that’s the point — it would be completely by chance!

Can the world today really risk its economic wellbeing on the chance that the politicians people curse for their stupidity and the bankers they excoriate for their villainy are going to make a good guess about something for which they cannot even state the basic principle?

Or is there a better way?

Reference another Michael D. Greaney Comment:

Legal Counterfeiting

The late Paul Samuelson once quoted the late Irving Fisher regarding the monetary policies of the late John Maynard Keynes to the effect that what developed into Keynesian “Modern Monetary Theory” is, in reality, nothing more than “legal counterfeiting.” While it is unusual to find so many defunct economists in agreement on this point, there is another that is even more remarkable:

They all thought it was a good thing. Of course, it seems that all three had somewhat interested motives for advocating “legal counterfeiting.”  Fisher, for example, lost a ton of money in the 1929 Crash, and had to be bailed out by Yale University. By “reflating” the currency, Fisher figured the stock market would go up, and he would recoup all his losses, gaining back all that lovely money. Keynes realized that his monetary theories could not be implemented without the government having total control of the economy, and total control of the economy could not be achieved except by allowing the government to control all economic life through the creation of money and credit, thereby permanently attaching Academia and most of the people in the world to the government spigot that was now the source of all that lovely money for him and his academic buddies.

Samuelson built his reputation and won a Nobel Prize for supporting Keynesian economics. He wrote what was the most widely used and bestselling economics textbook ever. Had he not backed Keynesian monetary theory to the hilt, he would have lost his Great Reputation and, worse, all that lovely money.

Fisher, Keynes, and Samuelson all have something else in common, too, something they share with virtually every major economist since David Ricardo. It’s acceptance of something called “the Currency Principle.”

And what is “the Currency Principle” you ask?

Most simply put, the Currency Principle is that the money supply determines the rate at which money is spent (the “velocity” of money, a concept developed by Sir William Petty in the seventeenth century), the number of transactions, and the price level. As Irving Fisher expressed it when he put it into an equation,

M x V = P x Q

where M is the quantity of money, V is the velocity of money, P is the price level, and Q is the number of transactions (some people use “T” instead of “Q”).

In mathematical terms, the Currency Principle is that M (construed ONLY as currency and, sometimes, “currency substitutes”) is the independent variable in the equation, and V, P, and Q are the dependent variables. That means that as you change M (the amount of currency), the other variables, V, P, and Q, change in response.

There are two basic problems here. One, within the “Currency School,” M is limited to currency or its substitutes (hence “the Currency Principle,” obviously). It does not take into consideration any other form of money . . . and other forms of money in many economies far outweigh currency. This means that, within the Currency Principle framework, the basic assumption is already wrong because it simply ignores the bulk of the money supply! “Money” is not a medium of exchange as the Currency Principle people would have it, it is the medium of exchange.

Two (and you math majors probably spotted this already), you can’t have more than one dependent variable in an equation. Period. As interpreted by Fisher and every other Currency Principle economist who ever lived, the Quantity Theory of Money equation is utter nonsense. It doesn’t work because it can’t work.  All you get is mathematical gibberish.

To understand this, let’s contrast the Currency Principle with the “Banking Principle.” The Banking Principle uses exactly the same equation as the Currency Principle, but instead of starting with the gyrations of David Ricardo, it goes back to the beginning of time and the first principle of economics.

As Adam Smith (whom Ricardo claimed to be correcting) put it, the first principle of economics is —

Consumption is the sole end and purpose of all production.

There are two ways to have something to consume, aside from theft or gift. One, you produce what you want to consume. Two, you produce something to trade to someone else in exchange for something someone else produced that you want to consume.

“Money” is what the medium of exchange is called, the making and keeping of a contract, a promise. “Money” is therefore anything that can be used to settle a debt; “All things transferred in commerce.”

Most simply put, “money” is how I exchange what I produce for what you produce. Money is therefore not “A” medium of exchange, it is “THE” medium of exchange.

The key to understanding the Banking Principle is that, just as there can be no exchanges without something having been produced, there can be no money (at least, legitimate money) without something having been produced (take that, crypto currencies!). Thus, starting again with the Quantity Theory of Money Equation,

M x V = P x Q

we see that V, P, and Q do not depend on M as in the Currency Principle. Instead, M depends on V, P, and Q!

In mathematical terms, what we see is that there are now three independent variables instead of one, and one dependent variable instead of three.  Our math majors can now relax, because that makes sense! You don’t have to guess what is going to happen to V, P, and Q by changing M, you know what is going to happen to M by changing V, P, or Q.

And how do you do that?

In a properly run economy (meaning one in which actual people run things with the government limited to setting standards, enforcing contracts, and keeping people from killing each other when contracts aren’t kept), the amount of money will adjust automatically to the needs of the economy. That is, it will do so as long as everyone has the right to produce marketable goods and services and enter into contracts with each other to exchange those goods and services . . . which means, as long as everyone has the ability to, well, “create money.”

Dave Hamill, Center for Economic and Social Justice (www.cesj.org) Comments:

As my colleague and others at the Center for Economic and Social Justice (www.cesj.org) have stated previously, whatever powers banks have in controlling the U.S. currency would disappear if the Federal Reserve (and especially the New York Federal Reserve) was not handed these powers under the Federal Reserve Act of 1913, as it has been amended. Yes, as a matter of form, it is true that the Federal Government set up the Federal Reserve so that it would be “owned” by U.S. banks, and the larger banks are owned or controlled by powerful global bankers. However, the President and the Congress select the Chair of the Fed’s Board of Governors. And the Congress could amend the Federal Reserve Act so that each of the 12 regional Feds would be owned by the citizens of each region, treating the Fed as a sort of “fourth branch of the Federal Government” charged with monetizing private sector growth in industry, commerce and agriculture in each of the 12 regions, as expressed in Section 13(2) of the Federal Reserve Act of 1913, which states:

“Any Federal reserve bank may discount notes, drafts, and bills of exchange arising out of actual commercial transactions; that is, notes, drafts, and bills of exchange issued or drawn for agricultural, industrial, or commercial purposes, or the proceeds of which have been used, or are to be used, for such purposes, the Board of Governors of the Federal Reserve System to have the right to determine or define the character of the paper thus eligible for discount, within the meaning of this Act.”

This Section 13(2) power still exists. It has not been used since the U.S. went into the First World War and switched from what would have been asset-backed money to debt-backed money––a switch to government debt to cover government deficits. The power to create asset-backed money could be revived and used to democratize equal opportunity for every child, woman and man to have access to whatever capital credit is extended to finance growth of the private sector with interest-free money. The capital credit  loans would be repaid with pretax dollars, as proposed by binary economist, corporate tax lawyer, investment banker and author Louis O. Kelso as early as 1958. Then the poorest person in the region would get the same amount of interest-free capital credit each year as someone as rich as Bill Gates or Warren Buffett. In other words, as with leveraged Employee Stock Ownership Plans (ESOPs) invented and applied by Kelso under present laws for private sector workers, propertyless citizens would no longer depend on the enormous accumulated savings of the rich to get loans to become owners and growing new jobs in the productive private sector in any region of the country. Then, the logic of corporate finance–to invest in productive capital only when those assets are expected to pay for themselves out of expected future profits–would be available to enable every worker to become a capital owner. As with ESOP, the loans for buying shares pay off the principal and other costs of the loan with untaxed future profits of the company issuing those shares. Then those without “past savings” can and have become owners out of “future savings.”

The problem is if you assume that the money supply, and thus the source of financing for new capital projects, can only be backed by government debt, that, in effect, creates a Catch-22 situation. You can’t have growth unless you burden yourself with debt that you are already unable to repay (now at over $22 trillion). If you grow economically, you assume more debt you can’t repay, and if you repay debt (or try to) you won’t be able to grow to finance the debt repayment.

The problems the world’s central banks try to solve by artificially manipulating currencies would solve themselves by making monetary and fiscal policy consistent with the original purpose of commercial and central banking. That is to create money for private sector investment by purchasing mortgages and discounting and rediscounting bills of exchange based on the present value of existing and future marketable goods and services, respectively.

By creating money in ways that finance widespread capital ownership by people who, consistent with Adam Smith’s dictum that the purpose of production is consumption, will spend their dividends rather than reinvest them, consumption power can be sustained naturally, rather than artificially induced through inflationary government stimulus.

The fact of the matter is that the problem of financing growth can be solved with ease, and in a way that not only doesn’t require additional government debt, it can lead to paying down the debt that is already outstanding. The only thing that absolutely must be done is to start using the banking system — the commercial banks backed up with the central bank, the Federal Reserve — the way it was intended to be used: to finance private sector development, not to monetize government deficits.

Central banks were not invented to finance government operations, nor are commercial banks engaged in a criminal conspiracy against the people by creating money that only government has the right to create. The fact is that government doesn’t actually have a natural right to create money.

Only natural persons have natural rights, and a government is an artificial person, a “legal fiction” created by human beings who are natural persons. When we say a government has no natural right to create money, we mean that the nature of government is such that it does not as one of its natural functions create money.

That is not the same as saying that government does not have the right by nature to regulate the currency and enforce contracts. Money derives from production, however, and government by its nature is not a producer of marketable goods, products and services that require money to be exchanged. Government is a service for which the citizens pay a fee called “taxes” in order to receive the services. Allowing government to create money means that it is not accountable to that degree to the citizens — which means the government is in charge, not the citizens.

So what our country could do, and in fact should be doing, along with everybody else, is turning the value of existing inventories of goods into money for trade and commerce and turning the value of future productive capital into money for new productive capital formation. That is what commercial banks were invented to do in the first place, with central banks assisting to make it easier. All government has to do is set the value of the currency, and make certain all contracts are kept.

The norm should be everybody who consumes, produces, and everybody who produces, consumes. Then things would work a lot better in the world. When people cannot produce, something must be done to meet their consumption needs, or what was a simple economic problem (how people can consume) turns into a major political problem (how to keep order in society when people are deprived and starving). Thus, what should be the major, if not sole focus of government — how to assist people in becoming and remaining productive is ignored. Instead, government implements policies seeking to guarantee that most if not all people have sufficient effective demand to enable them to consume when they do not or cannot produce. This in turn requires ever-increasing levels of government interference not only in the economy, but in every aspect of life.

The conclusion is that, given financially feasible investments, i.e., investments that pay for themselves out of future profits and thereafter provide consumption income for the investor, there should never be a question of whether there’s enough savings accumulated in the economy to finance all the necessary new capital. Using future savings, there can always be enough money in the economy — and past savings can effectively be spent on consumption, which is their purpose, as they represent unconsumed production from the past.

And taxes should be the sole source of funding government, not false money creation with no tie to real economic value creation.

That is the short term solution. It gets any country out of the hole they’re in with respect to the presumed scarcity of money. The long term solution is to get everybody on board with the program by making it possible for everybody to purchase part (shares) of the new capital formation that would be financed. By everybody we mean starting at birth with EVERY child, woman and man. They can do this by purchasing newly issued shares that finance the new productive capital projects using insured, interest-free capital credit (new money), making dividends tax deductible at the corporate level, paying out all earnings as dividends, and repaying the credit extended to purchase shares out of the dividends on a tax-deferred basis.

Afterwards, the dividends can be taxed as personal income to the recipient and the balance used for consumption purposes. This would take a great burden off the government and increase tax revenues at the same time, allowing repayment of the outstanding debt without imposing austerity measures that only cripple growth.

Such a program is described in the Center for Economic and Social Justice’s (www.cesj.org) Capital Homesteading proposal. It’s something to think about. See the proposed Capital Homestead Act (aka Economic Democracy Act and Economic Empowerment Act) at http://www.cesj.org/learn/capital-homesteading/, http://www.cesj.org/learn/capital-homesteading/capital-homestead-act-a-plan-for-getting-ownership-income-and-power-to-every-citizen/, http://www.cesj.org/learn/capital-homesteading/capital-homestead-act-summary/ and http://www.cesj.org/learn/capital-homesteading/ch-vehicles/. And The Capital Homestead Act brochure, pdf print version at http://www.cesj.org/wp-content/uploads/2014/11/C-CHAflyer_1018101.pdf and Capital Homestead Accounts (CHAs) at http://www.cesj.org/learn/capital-homesteading/ch-vehicles/capital-homestead-accounts-chas/

When both the leadership of both political parties or third parties wake up, then the Federal Reserve would become a “social tool” owned by the people and the rich plutocrats could not stop this reform of the system. Nothing would be taken from them but the current monopoly over the creation of money, supported by politicians who promote this unjust monopoly over money.

See the Summary of the proposed Capital Homestead Act designed by our Center for Economic and Social Justice for the comprehensive set of reforms for restoring full economic power for every citizen. See the Capital Homestead Act at http://www.cesj.org/homestead/index.htm and http://www.cesj.org/homestead/summary-cha.htm. See the full Act at http://cesj.org/homestead/strategies/national/cha-full.pdf

The main reason the economic system, especially control over money and finance, produces unjust concentration of economic power and corruption of a market system is that most people have been mis-educated by academia on the nature of money and how it could serve to achieve truly full equality of opportunity to enable all citizens to become fully empowered productive capital owners with ever-growing capital incomes over the course of their lives. Educators teach people how to work (assuming jobs are not displaced by robots), but never teach them how to gain equal ownership opportunity over labor-displacing technology. When the American people wake up, the left and the right will come together to demand a JUST Third WAY beyond both monopoly capitalism and all forms of socialism and communism. Then Americans will have launched and achieved an economically classless society, a worthy result of a truly peaceful and just Second American Revolution. And no one will have lost anything except the power to dominate and enslave others, or the frustration of going through life feeling that change is impossible.

Those willing to work together to bring about a more just future for themselves and the rest of society should join the Coalition for Capital Homesteading at www.capitalhomestead.org. For those with time to read books and articles of the ideas behind Capital Homestead, the cesj.org Web site is a treasured resource.