Martin Wolf on Creating Funny Money


With his latest column on the nature of money and credit in the modern monetary system, the FT’s Martin Wolf delves deeper into the dark depths of the ‘what is money’ debate.

Anyone who has speculated on the importance and effects of QE over the past five years should probably have a read.

In the article, Wolf comes out in favor of the endogenous theory of money supply and explains why banks, through their power to issue private money directly, influence the economy in a very different way than it is. traditionally accepted.

The bottom line is that banks can, if they wish, lend first and then finance. And because they can, their liabilities (whether backed by proven assets or not) look like a type of equity that mimics the currency units of the state rather than directly representing them. This challenges the established theory that deposits are not money but private transferable debt.

If Wolf is right, then financial instability is most likely the product of the system’s tendency to take for granted the private money-issuing power of banks. In reality, this power is imposed on banks by participants in the system and can be easily compromised if these institutions prove to be unreliable in matching trusted liabilities with projected assets that do not yet exist.

Much of the instability is therefore linked to the public’s misunderstanding of what bank money really is, namely the imitation of electronic money which imitates government money well, the only safe source. purchasing power in a developed economy with a competent central bank. As FT Alphaville has previously stated, this means that unproven private liabilities intermingle with sovereign liabilities, making them impossible to differentiate or measure on individual conditions, a fact that ultimately leaves the state on the hook for guarantee them even if it was not the state that was responsible for creating them.

The problem of financial stability arises if, when the private issuing power of banks fails, there is no more reliable authority that can intervene to directly guarantee these liabilities – and likewise, if there is such a authority but that they do not want to assume these private commitments because of fears related to price stability.

All of this technically shifts the debate over financial stability to why these private liabilities may have failed in the first place.

If this is because sovereign liquidity has not grown fast enough to allow bank asset quality projections to materialize – as a deflationary shock would indicate – then the fault does not necessarily even lie with the banks, but rather to a central bank which acted in a way too conservative at the start. In this scenario, the best thing a central bank can do is rapidly expand sovereign money, a process that ultimately substitutes failing private liabilities (defending the assets that forged them) for public liabilities.

If, on the other hand, these assets failed because there was too much sovereign liquidity competing with private money – as an inflationary shock would indicate – then the fault could still lie with the central bank, but for too many political reasons to start with. The correct course of action in this case is to drain the state’s money supply to restore balance.

None of these thoughts, of course, are new.

Wolf’s article, for example, borrows heavily from recent findings presented by the Bank of England in its Quarterly Bulletin.

The BoE report, in turn, borrows heavily from a new school of monetary thought that rose to prominence just after the onset of the 2008 crisis. In the UK, this is characterized by the opinions expressed by institutions like the New Economics Foundation NEF (which has been in existence since 1986), themselves influenced by the work of more established economists like Wicksell, Keynes and Fisher.

As NEF’s Josh Ryan-Collins tells FT Alphaville, the theory is not inconsistent with what John Maynard Keynes said in his 1930 Money Treatise and Schumpeter in his Theory of Economic Development (1934). And these authors themselves took inspiration from Henry Dunning Macleod’s work, The Theory of Credit, written in 1889. Macleod’s work was developed by Alfred Mitchell-Innes in his articles What is Money? (1913) and The Credit Theory of Money (1914) where he opposed the then conventional view of money arising as a means of improving the medium of exchange – then known as “metallism”

In the United States, meanwhile, the School of Modern Monetary Theory (MMT) made additional observations, albeit focusing on the importance of the state as the ultimate provider of secure money through its ability to tax the income of the population.

Which makes you wonder why all of this should be seen as a provocative thought? A more relevant question is perhaps what led the economics profession to deliberately forget endogenous monetary theory in the first place, and to roll it back in time to the more orthodox monetary thought of the classical era.

Of course, there will always be schools of thought that do not agree with the above. But for now at least, there seems to be a Keynesian revival in established economic circles, centered on the endogenous or creditor nature of money.

Where could such enlightenment ultimately lead us?

In Wolf’s view regarding the argument for the outright elimination of private money:

Our financial system is so unstable because the state first allowed it to create almost all of the money in the economy and then was forced to insure it when it performed this function. It is a giant hole in the heart of our market economies. It could be closed by separating the provision of money, rightly a function of the state, from the provision of finance, a function of the private sector.

In this case, this is where we respectfully agree but at the same time disagree with our esteemed colleague. But we’ll explain why in more detail in our next article.

Related links:
Stripping private banks of their money creation power – FT
Negative Interest Cash, or Farewell Bills – FT Alphaville
A digital solution for the repo squeeze? – FT Alphaville
The “overkill money” problem – FT Alphaville
Guest article: The case of digital legal tender – FT Alphaville


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