Modern Money (pt 2)

Political madness sweeps Washington

As of mid-July, the U.S. media and bourgeois politics appear to be swept by a wave of political madness, both on the side of supporters of President Trump and his “liberal-establishment” opponents. Trump calls the “mainstream” organs of the U.S. media such as The New York Times and Washington Post enemies of the people. This heated rhetoric is more reminiscent of the “reigns of terror” associated with certain stages of the French and Russian revolutions than the more normal polite discourse of U.S. Democratic and Republican Party politicians.

The “establishment media” counter Trump’s charge by claiming that Trump is working for “team Russia” rather than “team USA.” The Democrats are now engaged in a debate whether they should charge the president with “treason” because he failed to denounce President Putin at the mid-July summit meeting in Helsinki, Finland, for “Russian intervention” in the 2016 election.

The problem for the Democrats is that if Trump is actually guilty of treason, they – being the great patriots they are – should move to impeach him in the House of Representatives. Treason, after all, is an impeachable offense. However, up to now the Democratic leadership, both in the House and the Senate, opposes impeachment.

Behind the heated rhetoric – false and demagogic on both sides – is a growing conflict. That is the conflict between the need for the further development of a society where production is carried out by the socialized labor of the workers of the entire world, on one side, and the continued rule of capital over production and the nation state, on the other.

Trump and his supporters in the ruling class believe that U.S. imperialism can no longer afford the costs of the U.S. empire in its current form. They demand a major re-division of the markets of the world in favor of U.S. capitalists at the expense of capitalists of U.S. “allies” in Europe and Asia, as well as the People’s Republic of China. If this is not achieved in the near future, the Trumpists believe, the U.S. world empire will crumble.

Under current arrangements, the U.S. guarantees the European imperialists – above all, Germany (1) – access to world markets and raw materials. Meanwhile, the Trumpists complain, Germany and other European imperialist powers are “freeloading” on the costs of the “defense” of the U.S. empire, which as a result fall disproportionately on the U.S.

Trump therefore wants to restructure the empire so that the European and Japanese satellites of the U.S. get a smaller share of the global market while paying more for the empire’s defense against the exploited and oppressed peoples of the world. And he wants this achieved now! Not surprisingly, German Chancellor Angela Merkel prefers the status quo, which indeed has turned out quite nicely for the German capitalists that Merkel serves.

The Chinese leaders, in order achieve their goal of a moderately developed China by mid-century, need a much larger share of the world market than China has at present. To put things in perspective, Germany with a population of a little more than 80 million, has about the same share of world trade as China with a population of over 1 billion. If Trump achieves his goal, China will be locked into a situation of permanent underdevelopment.

It is important to realize that the fight between Trump’s imperialist supporters and his equally imperialist opponents within the U.S. capitalist class is not our fight! Instead, it is a fight among our capitalist class enemies.

However, the fight against Trump’s economic and political nationalism and the racism that is the inevitable companion of imperialistic nationalism is our fight. We must wage this struggle independently of unreliable capitalist “allies” who oppose only certain aspects and excesses of Trump’s policies. Under no circumstances can we accept the leadership of the pro-status quo “establishment” that wants to keep in place the current structure of the U.S. empire – the biggest machine of class, national and racial oppression the world has ever seen.

Behind the current fight within the ruling class is the fact that expansion of the productive forces in the age of the Internet and the smart phone and the crisis of global warming have entered into a qualitatively sharper conflict with the nation-state than was the case in the pre-Volcker shock era. As we saw in our review of the important work of British Marxist John Smith [link], capital driven by its inner laws that govern its long-term development – analyzed by Marx in “Capital” – has been forced to transfer much of its industrial production from imperialist countries to oppressed countries.

This contradiction is especially sharp with the People’s Republic China, whose leaders since the victory of the great Chinese Revolution in 1949 have built a strong nation-state. Yet increasingly, global capital is carrying out its industrial production – and even more so, as John Smith has shown, its production of surplus value – in China.

Global capitalist state?

This has created an explosive contradiction between the growing dependence of imperialism based in the U.S., Europe and Japan on workers located outside the imperialist countries – especially but by no means only in China. This contradiction can only be resolved under capitalism by creating a global capitalist state that would politically rule the U.S., Europe and China, as well as the rest of the world.

Unlike the present-day U.S. world empire, such a global capitalist state would have to do away with the nation-state entirely. Such a state would have a single currency and no tariffs or “capital controls” that limit the flow of capital between nations. However, there is no way such a global capitalist state can be established by peaceful means.

A global capitalist state, once it is established, would do away with wars between nations. However, such a state would not do away with the contradiction between the social nature of production and the private appropriation of the product. Instead, it would push capitalist production to the limits that are allowed by capitalist relations of production.

Such a completely globalized capitalism would experience crises of overproduction of an intensity beyond that which is possible under the current system of separate nation-states. And it would mean that the working class would have to overthrow only a single state rather than many separate states in order to realize the world socialist revolution.

Is the achievement of a global capitalist state the next step in the evolution of human society on the way to socialism? The insurmountable problem with this perspective is that to establish such a state, a series of brutal world wars would be necessary that, given the power of today’s means of destruction, would end with the destruction of civilization.

Behind the current convulsions, neither Trump and his nationalist/racist supporters nor the traditional Democratic-Republican “party of order” has – or can have – a realistic program to achieve the needed world capitalist state. The only way to resolve the conflict between the needs of production and the continued existence of the nation-state, then, is through a world socialist revolution that also abolishes the conflict between the rule of capital and socialized production. Through a series of transitional stages that above all liquidate all traces of the oppression of one nation by another, we will finally end the division of humanity into separate nations.

This brutal reality – and it is brutal – does not prevent well-meaning people (2) from searching for a third way between the madness of Trumpism and the Democratic-Republican “party of the current world order,” on one side, and the objective need for a global workers’ revolution, on the other. After decades of counterrevolution and political reaction, the goal of a world workers’ revolution seems to most workers and progressive people to be completely unrealistic.

Like their 19th-century predecessors, many progressive people seek a path out of the current impasse confronting our species through the reform of the monetary system. The most significant group of progressive monetary reformers active today call for reforms based on their Modern Monetary Theory, or MMT for short. Among the best-known supporters of MMT today are economists James Galbraith, the son of the well-known 20th-century economist John Kenneth Galbraith, and the progressive Australian economist Steve Keen.

This month I will examine the basics of MMT under the assumption that the world is organized as a single capitalist state, even though in reality it is not. Next month, I will examine MMT from the viewpoint of our current world, where the world market is divided into nation-states and national markets.

The ‘chartalist’ theory of money, also known as Modern Monetary Theory

The term ‘Chartalism’ was first used by German economist Georg Friedrich Knapp (1842-1926) in his book entitled “State Theory of Money,” first published in German in 1905. Chartalism comes from a Latin word meaning token. Chartalism, as the title of Knapp’s book suggests, holds that money arises not from the exchange of commodities, as believed by most economists, but directly from the state power.

Knapp contrasted his chartalist theory of money to “metalism,” by which he meant the theory that money must be a commodity – in practice a precious metal. The chartalist theory of money has evolved into today’s Modern Money Theory. Supporters of MMT base themselves not only on Knapp’s work but on the writings of many later 20th-century economists, above all but not only John Maynard Keynes, who himself was sympathetic to chartalism. (3)

The basic macro-economic accounting equation of Modern Monetary Theory

The basic equation of macro-economic accounting, according to MMT, is Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0. Since we are ignoring the division of the world into nation states this month, we will simplify the equation to Private Balance + Government Balance = 0.

There is a general belief among both the lay public and professional economists that, all things remaining equal, a central government deficit is a bad thing. Such a deficit means that the central government takes in less in taxes and other revenues than it spends in a given fiscal year. A surplus means that during a given fiscal year the central government raises more in taxes and other revenues than it spends. If the government revenue exactly matches its spending during an accounting year, the budget is said to be in balance.

It is well known among both professional economists and the educated lay public that traditional Keynesians advocate that the central government run a deficit during periods of recession and high unemployment to increase demand. However, they hold that these deficits should be offset by surpluses in central government accounts during periods of prosperity.

MMT, in contrast, holds that unless there is serious inflation the central government should always run a deficit, never a surplus. In practice, the U.S. government since 1969 has run continuous deficits except briefly during the Clinton boom in the late 1990s. While mainstream Keynesian and other economists see these chronic deficits as unfortunate, supporters of MMT view chronic deficits as a positive good, and even a vital necessity.

The real mistake, according to MMT supporters, that has been made in U.S. fiscal policy since 1969 is that the deficits have not been large enough. This is the most important difference between MMT supporters and mainstream and orthodox Keynesians when it comes to policy recommendations. The biggest blunder in economic policy made by the U.S. government since 1969 and the present, according to MMT supporters, was Clinton’s late 1990s balanced budget. (4) Clinton’s balanced budget, according to them, ultimately lead to the Great Recession.

Modern Monetary Theory in a nutshell holds that anything the central government accepts for payment of taxes is money. MMT has the merit of being the most coherent and consistent alternative to Marx’s theory of money. Indeed, in terms of a coherent and logical theory of money, there are really only two, Modern Monetary Theory, on one side, and the theory of money developed by Marx as part of his theory of (labor) value, on the other. All other theories of money, whether advanced by mainstream bourgeois economists or Marxists who believe we are living in an era of “non-commodity money,” are simply eclectic mixes of the two fundamental theories of money.

A brief review of Marx’s theory of money

First, let’s repeat some of the highlights of Marx’s theory of money. For those who want to examine Marx’s theory in depth, the best thing to read is the first three chapters of “Capital,” Volume I, though it is not an easy read. On the MMT side, Professor L. Randall Wray’s book “Modern Money Theory,” is a good place start. While Professor Wray is a professional economist, his book is written to be intelligible to the interested layperson. There are also many web videos – some with Professor Wray – that discuss MMT and its practical application.

Marx began his analysis of money with its role as the universal measure of the value of commodities. Though value, according to Marx, is in essence embodied abstract human labor, it must always take the form of exchange value, where the value of one commodity is measured in the use value of another commodity. The value of the commodity that is being measured is called by Marx the relative form of value, while the commodity that does the measuring is the equivalent form of value.

This means that in a simple barter exchange, the commodity you produce is equated to the commodity you exchange it for. If, for example, you produce a chair and exchange it for a pair of shoes, the value of the chair is measured in terms of the use value of the pair of shoes, the equivalent exchange value of your chair.

As production for exchange – as opposed to production for use – expands, a single commodity emerges that acts as the general equivalent of all other commodities. That means that the value of all commodities – except of course for the commodity that acts as the general equivalent – are measured in terms of the use value of the commodity that serves as the general equivalent. The use value of this commodity is measured in terms of a unit that is appropriate to its use value – for example, heads of cattle.

At first, the commodity that functions as the general equivalent is the commodity whose use value is most important for that particular society. For example, heads of cattle are used as the measure of value in Homer’s “Iliad.” In the society portrayed by Homer, cattle were the chief form of wealth.

As commodity production and exchange develop, a commodity emerges whose use value serves as the measure of value whose use value is trivial outside its role as the universal measure of value. Historically, this has been the precious metals, silver and then gold bullion. The use values of both silver and gold bullion are measured in terms of some unit of weight. The general equivalent has become the universal equivalent – money.

Finally, under capitalism where commodity relations have become generalized and labor power itself has become a commodity, money becomes the measure of all things. A fundamental conclusion of Marx’s entire theory of value is that in its role as the measure of value money must always be itself a commodity. The concept of MELT – the Monetary Equivalent of Labor Time, supported by most but not all academic Marxists, where paper tokens issued by the state can replace commodity money as the measure of value by somehow directly measuring the value of commodities – it is not explained exactly how – is in fundamental conflict with Marx’s theory of exchange value as the form of value.

Money and the currency of money

Marx noted that the English language distinguishes between money proper and the currency of money. Currency is the representative of money in circulation. Money and the currency of money are not the same thing even if they are often used interchangeability in common speech. Currency may or may not be made of the same material as money itself.

Full-weight gold coins are an example of currency that is made of actual money material. However, to use money material as currency makes for a clumsy currency system. In a gold coin currency system, the mint must be careful to remove coins that have become light through wear and tear – or been clipped – from circulation. In the days before 1914 when gold sovereigns actually circulated in Britain as part of the currency system, if a particular gold sovereign fell below a certain weight, it ceased to be legal tender and was withdrawn from circulation.

Let’s assume that a one-ounce gold coin turns over a hundred times in a given year. This coin in circulation will represent over the year not one ounce of gold but a hundred ounces of gold. In addition, gold coins in circulation lose weight. However, as long as the amount of gold coins, whether “light” or “full weight,” in circulation do not increase relative to the amount of gold bullion in the country, the market price of gold bullion in terms of the gold coins will not rise.

Therefore, in circulation money becomes a symbol of itself. This shows the possibility of replacing money in circulation by tokens made of cheap materials – base metals and later paper and ink, and today in some countries plastic. A great advantage of a system of token money is that wear and tear of the tokens does not threaten the devaluation of currency even if the mint does not withdraw “light” coins from circulation. In addition, the making of currency tokens out of cheap materials eliminates the incentive to “clip” the coins.

In the past, government-issued tokens, whether coins made of base metal or paper notes, were claimed to represent a definite quantity of precious metal. Government mints sometimes charged a fee when presented with bullion for coining. For example, the mint might return only 99 British pounds in gold sovereigns for every 100 British pounds’ worth of bullion presented to it. These charges were designed to cover the cost of minting the bullion.

The charge for coining bullion is called seigniorage. The seigniorage on such coins is measured by the difference between the value of the coin in terms of the “free market” price of bullion in terms of the coins and the uncoined bullion. The seigniorage on gold coins that a mint produces for the bullion owner is generally quite slight and can be generally ignored as far as economic theory is concerned.

However, the “seigniorage” on paper and ink currency in terms of the actual value of the paper and ink that make up the notes in relation to its buying power can be immense. In reality, the seigniorage on freely minted gold (or silver) coins and the “seigniorage” on paper money are completely different economic phenomenon. The economists – and our “modern” Marxists who believe in “non-commodity money” – reveal their total helplessness when attempting to explain the “seigniorage” on the paper and ink used to produce paper money.

In the early days of capitalism – the period between the 16th century and the industrial revolution, which began in the late 18th century – the government defined the official currency as a certain quantity of silver or gold bullion measured in terms of weight. The government often changed the quantity of gold or silver bullion that constituted the official currency. Only with the coming of economic liberalism that accompanied the industrial revolution was the legal definition of the currency units such as pounds, dollars, marks, and so on in terms of a specific weight of precious metal more or less stabilized.

Each inconvertible paper note, therefore, represented an official amount of gold and silver, even though the note could not be redeemed in precious metal. Legal traces of this remain with us today. The extent to which the coin or note actually represents its nominal value or is depreciated is determined by the price of bullion in terms of the coin or note on the open market.

For example, the U.S. Treasury and the International Monetary Fund value their gold reserves – and the Federal Reserve Banks that make up the Federal Reserve System value their gold certificates – at the official “price of gold,” which is $42.22 per ounce. In the legal sense, when a Federal Reserve Note claims to represent a “dollar,” it is claiming to represent 1/42.22 of a troy ounce of gold. This more or less corresponded to reality in the early 1970s when the current official dollar price of gold was established.

Of course, with the dollar price of gold now quoted in four digits, the official price of gold is a mere legal fiction of interest only for the dollar valuation of government gold reserves and the gold certificates held by the U.S. Federal Reserve banks on the asset side of their balance sheets. However, the difference between the market price of a troy ounce of gold at the moment – around $1,200 – and $42.22 measures in legal terms the depreciation of the U.S. dollar.

In the past, unlike today, governments when they issued paper money aimed to keep the price of gold and/or silver bullion in terms of coins made of base metals and inconvertible paper notes somewhere in the neighborhood of their official values. But since the early 1970s, the U.S. Federal Reserve Notes and the fractional coinage of the U.S. – and its satellite currencies – has become so depreciated relative to the official price of gold of $42.22 that it has given rise to the illusion that “modern money” is not based on a specific money commodity – gold bullion – but represents the value of commodities directly without the mediation of the use value of an actual money commodity.

Token money versus credit money

Token money must not be confused with credit money – a common mistake. Credit money is a legal contract to pay the bearer on demand a certain sum of money – whether in actual gold money or legal-tender token money – that can be transfered to another person. Credit money can be used in place of real – that is commodity – money in circulation, but it can never replace real money as the measure of value.

A common error made by many of today’s Marxists is to confuse credit with money. For example, it is claimed that the expansion of markets, absolutely necessary for the continued existence of capitalist production, is based on the expansion of credit. This is based on the belief that credit and money are the same thing. However, if we follow Marx, credit, though based on money, is by no means equal to money – as we saw, for example, in 2008.

With the invention of paper, it became possible to increase the quantity of token money very rapidly. This created the possibility of governments dramatically increasing the quantity of coins relative to the quantity of bullion in the country. This made hyper-inflations in the modern sense possible. (5)

In order to establish a stable system of paper money, the state that issues the paper money must provide a mechanism not only for issuing the paper money but also withdrawing it from circulation. If the state purchases labor power and supplies its needs to operate with paper money and there is no mechanism to withdraw the paper money from circulation, the quantity of paper money relative to real money in the country – gold bullion – will explode, causing the paper money to lose its value and collapse. If the state purchases commodities (including labor power) with newly issued paper money, it must withdraw paper money through taxes. As long as the state maintains the a fixed ratio of paper money and bullion in the country, the paper money will not depreciate.

Therefore, when a government issues paper money, it must at the very least declare that it will accept the paper currency for purposes of payment of taxes. Sometimes the state goes further and declares the paper money legal tender payable for all debts both public and private. Marx was well aware of this, and some supporters of MMT use this to claim Marx as one of the forerunners of MMT.

The origins of money, commodities, markets and the state according to Modern Monetary Theory

Now let’s examine the Modern Monetary Theory of the origin of money.

Once upon a time, according to MMT supporters, production was carried out for use and not for exchange and money. Marx of course would agree. This is the paradise lost of MMT. However, at some point – why MMT supporters do not explain – state power developed. At the dawn of state power, it was often temple priests who were in control on the state. Anthropologists call these early priest-controlled states “temple states.” The ruling priesthoods in order to flaunt their power over society would demand that families present their first-born children to be sacrificed to the gods the priests claimed to represent. If, the priests warned, these human sacrifices were not made, the gods would destroy the community and everybody in it.

The Bible and Quran tell the story of a man named Abraham who became God’s personal friend. Though God was Abraham’s friend, He still demanded absolute obedience. In order to test his human friend’s absolute obedience, God demanded that Abraham kill his son as an offering to Him. With broken heart, Abraham was about to kill his son. Though Abraham was a righteous man who deeply loved his son, his obedience to God was boundless. But at the very last moment, God sent an angel to Abraham (in the Bible version) – or sheep magically appeared in place of Abraham’s son (in the Quran version) – to stop him from killing his son, thereby saving the child’s life. From then on, God in His infinite mercy was satisfied with animal sacrifices. The Muslim holiday of Eid Al Adha celebrates God’s replacement of human with animal sacrifices.

If any person today killed his child and claimed in his defense that God told him to do it as a sacrifice to Him, the person would be executed in countries like the U.S. that retain the death penalty; be imprisoned for life; or, at best, be committed to a mental hospital for the criminally insane. However, the ancient tale of God’s friend Abraham and his son, which sounds so barbaric today, reflects a very real transition away from human sacrifice towards animal sacrifice that occurred in ancient societies.

By demanding that families sacrifice their first-born child – in the emerging patriarchy, the first-born son – the ancient priesthood that was living off the surplus product produced by those who had to work by the sweat of their brows was showing how far they would go to break any resistance to their exploitative rule. Today, the modern-day successors of these ancient priests, the capitalists, though their methods may be different, are just as determined to defend their exploitative rule.

Assume that the head of one family who had already satisfied his obligation to the ruling temple priesthood by killing his first child desired to obtain some cattle in the hands of a second family. The man who headed the first family might kill a slave child he didn’t really need. The head of the first family could then exchange the dead slave for some cattle possessed by the second family. The man who headed the second family could then present the dead slave child to the temple priests panning off the dead child as his own first-born child. At the cost of some cattle, the head of the second family would save the life of his first-born child.

According to Modern Monetary Theory, the dead slave child is a form of money because dead children are the media in which taxes – or tithes in early temple states – were paid. Eventually, the temple priests relented, as reflected in the story of Abraham and his son, and settled for forms of wealth such as cattle and grain. But the sellers are willing to accept cattle, grain, and other forms of wealth because they need the cattle or grain to pay their tithes to the ruling priesthood – members of the early ruling class – who would otherwise kill them and their families.

Production for use gave way to production for exchange, and money and markets were born. Over thousands of years, this developed into the complex system of markets that today we call capitalism. Therefore, according to MMT supporters, commodities, markets, and ultimately capitalism issue from the state power.

Today, under the present international monetary system centered on the U.S. dollar, MMT supporters ask: How do we know when we go the supermarket, the clothing store, the shoe store, the grocery store, or other retail outlet that our dollar-denominated Federal Reserve Notes or the U.S. dollar’s local satellite currency will be accepted? If we MMT supporters had any reason to doubt the Federal Reserve Notes would be accepted, why would we agree to sell our labor (power) to our boss in exchange for Federal Reserve Notes – or a paycheck that is simply a promise by our boss’s bank to pay a certain quantity of dollar-denominated Federal Reserve Notes?

MMT claims – and this is the nub of their theory of money, commodities and capitalism – that you as an owner of a Federal Reserve Note – aka a dollar bill – are a creditor of the U.S. federal government, or the central government of some other country that issues it own currency. But – and this takes some mental effort to get your head around – what exactly, MMT asks, does the government owe you as an owner of a Federal Reserve Note?

Once upon a time, a Federal Reserve Note had a sentence printed on it that the Federal Reserve Bank that issued the note would pay to the bearer on demand a sum of “lawful money” to the amount of the note. Legal money was understood to mean a gold coin of a certain legally defined weight. But what about today when Federal Reserve Notes cannot be redeemed in gold or anything else, either at the U.S. Treasury, which printed the note, or the Federal Reserve Bank, which issued the note?

True, if you have enough Federal Reserve Notes you can purchase virtually any commodity produced anywhere in the world, including the labor power of workers as well as the services of politicians and corrupt officials. But you cannot obtain these things from either the U.S. Treasury or the Federal Reserve Bank that issued the note.

Instead, you must find on the market a person – remember, under U.S. laws corporations are considered persons, so a person here could be a corporation – who possesses the commodity whose use value you desire. However – and this is important to grasp – MMT insists Federal Reserve Notes are money not because “the market” owes you something but because the U.S. federal government owes you something. But, again, what is it the federal government owes you?

MMT answers that the government owes you what God owed Abraham when He demanded Abraham’s son as a sacrifice to Him. That is, the government agrees that it won’t do something very, very bad to you that it could do if it chose to. It is, according to MMT, in that sense – and only in that sense – that you as an owner of a Federal Reserve Note are a creditor of the U.S. government. The government when it does not do the bad thing it could do to you redeems the debt it owes you. Or as MMT supporters like to put it, Federal Reserve Notes are quite literally keep out of jail cards. Therefore, according to MMT, the monetary system from its origin 4,000 or more years ago to the present has always been and will remain in the future nothing but a government-run gigantic protection racket.

The ‘modern’ in Modern Monetary Theory

It seems most Marxists these days believe that the nature of money underwent a fundamental transformation during either the Roosevelt or Nixon administrations when the commodity money described by Marx in “Capital” and other works was transformed into “non-commodity” money. Under the alleged system of “non-commodity” money, pieces of paper issued by the state gained the ability to represent value (abstract labor) directly without a commodity intermediary. Hence, the argument goes, “modern money” was born. Money, according to this view, was one thing for most of the last four thousand years, but sometime between 1933 and 1971 became something quite different. This is not what MMT is saying.

Modern Money Theory rejects the claim that the nature of money underwent any fundamental transformation with the end of the international gold standard. The only reason, according to MMT, that gold was money was that gold was accepted by the government for payment of taxes. If the government had not accepted gold for payment of taxes, MMT holds, gold would not have been money. In Modern Money Theory, according to its supporters, it is the theory of money and not the money that is modern. This view is wrong, in my opinion, but it is, in contrast to most present-day Marxists, at least consistent.

The crucial difference between Marxism and Modern Monetary Theory

According to Marx’s theory of historical materialism, at a certain point in society’s development the needs of production required that society be divided between a class of non-workers who appropriate a portion of the product – called by Marx the surplus product – and the direct producers. The class(es) that appropriate the surplus product are freed of the need to work, while the direct producers are obligated to work.

In order to defend this division of society, an organization was developed of armed men – today some armed women as well – equipped with the necessary material means to repress rebellions of members of the exploited class(es). This organization, whether controlled by the temple priests, as was the case four thousand years ago, or presidents or prime ministers and parliaments today, is called the state. The origin of the state, however, is not the origin of money.

MMT supporters point to the case when modern capitalist colonial powers in order to force the natives to become wage workers required them to pay taxes in money. But this occurred only once the commodity money relation had achieved a high degree of development in the form of modern capitalist colonialism. It is not, however, the origin of money – or markets and commodities.

MMT supporters believe that now that the real nature of money has finally been figured out by a few professional economists, money under modern conditions is created by the government by simply crediting the bank accounts of its employees and suppliers. The money created through these credits is then accepted by the government as payment for taxes.

Therefore, the government, according to MMT, as long as it retains the sovereign power of issuing currency, can never run out money. This is the great discovery of MMT, which has the potential to completely revolutionize government finance and open up virtually endless possibilities for social reform under capitalism. Why it took four thousand years to make the great discovery that sovereign governments don’t have to worry about a shortage of money is not explained.

Today, MMT supporters complain that the great majority of economists, politicians and policymakers still don’t understand the real nature of money.. The big job of the few economists that now understand the real nature of money is exactly the same as that faced by Christ’s apostles in the Bible. Their job is to preach to the ends of the Earth the good news – that central governments can stop worrying about running out of money.

MMT is much like Christianity in the sense its good news is great if you can believe it. If Christians are right, we have eternal life if only we accept the Jesus Christ as our personal Lord and Saviour. In that case, we have little to fear from unemployment, poverty, nuclear war, and global warming because what are a few decades of misery in this “veil of tears” relative to everlasting bliss? However, unlike Christianity, a religion based on faith, economics is, at least potentially, a science and has the path not of faith but of science. Like in all the positive sciences, we must begin with the empirical evidence – the facts. So to begin at the beginning, how is money actually created?

How is money created?

MMT supporters believe that money arises purely from operations of the government. If this is true, the private sector, defined as private businesses, households, and state, provincial, and local governments that do not have authority to create their own currency – and as we will see next month – the governments of the countries that are members of the eurozone – cannot create net financial assets. True, banks under the fractional reserve system, as you learn from introductory economic textbooks, credit your bank account when they issue you a loan. However, what is an asset to you is a liability to the bank. Therefore, the total financial assets created by the private sector minus the total financial liabilities of the private sector always equals zero.

Therefore, MMT supporters believe to increase the net financial assets of the private sector – without which there can be no economic growth in a capitalist economy – the government sector must run a financial deficit.

The net financial assets the central government can create, MMT supporters believe, come in two forms. One is government notes and bonds. The other is nothing less than money itself. Given the nature of the current monetary system, this argument seems plausible at first glance. After all, aren’t those green dollar notes in your wallet or the small change in your pocket created by the federal government?

However, the claim that money is created only in the central government sector and not by private for-profit companies would have seemed strange if it had been made before World War I. And remember, MMT supporters believe that the nature of money has not changed in the last four thousand years.

In the years leading up to World War I, money was gold bullion and full-weight gold coins. Indeed, banknotes convertible into gold were considered to be “money substitutes” just as checking accounts were, as opposed to actual money.

Gold bullion was created, just like it is today, by the gold-mining and refining industry. Like all private industry under capitalism, this industry is obliged by the pressure of competition to make the greatest profit possible. The fact that profit was measured in terms of the use value of the commodity produced by the gold-mining and refining industry made no difference as far as profit being the sole goal of production was concerned.

Newly mined and refined gold bullion was sold to the various central banks and national mints for coining. In return for the newly mined bullion, the gold-mining and refining companies got a check from the central bank – or in the case of the U.S. the U.S. Treasury – that would be deposited in the commercial banking system. This was the way additional money came into the world.

The commercial banks would deposit the checks they received from the gold-mining and refining companies into their accounts with the central bank, swelling the reserves of the central bank and with it the central bank’s ability to issue additional banknotes that were convertible to the bearer on demand in gold coins – actual money. In this way, the net financial assets of the private sector expanded without any need for the central government to run a deficit. The problem that faced early chartalist theory was to explain how, contrary to appearances, money was being created by the government – and not the private for-profit gold-mining and refining companies.

Today, however, the creation of money appears to be completely different. I will examine how money is created under the current U.S. monetary system because under the dollar system the U.S. Federal Reserve System creates the dollar reserves that other central banks use to back their own currency issues. The dollar, therefore, represents “high-powered” money throughout the world. While the view of Modern Monetary Theory would seem to make no sense if you use the pre-1914 monetary system, it seems to correspond to the present monetary system.

Under the current system, bank reserves consist of legal-tender currency – vault cash – and promises by the central bank to pay the private bank on demand in legal-tender currency – either the U.S. dollar or one of its local satellite currencies – called by the economists central bank money. The size of the reserves the banking system creates limits the quantity of bank money – promises by the private banks to pay an owner on demand in legal-tender currency. These promises to pay can be transfered to another person either by traditional checks or electronically.

How is dollar-denominated central bank money, which forms the pivot of today’s dollar-centered international monetary system, created? Let’s look at how the U.S. Federal Reserve System creates and destroys bank reserves through the buying and selling of U.S. government securities.

When a U.S. Federal Reserve Bank purchases government bonds for its own account, it writes a check to the seller of the bond, who deposits the check in the commercial banking system. The Federal Reserve Bank does not deal directly with the commercial banks or the general public but rather with special dealers in U.S. government securities. The dealer that sells a government bond to a Federal Reserve Bank then deposits the check in its commercial bank. The commercial bank in turn deposits the check with one of the 12 regional Federal Reserve Banks.

But where does the central bank get the money to buy the bond from the dealer? If you open a modern economics textbook – the kind you use in high school or introductory college economic classes – it is explained that when the central bank writes a check to buy a government bond it is ”creating money out of thin air.” In this way, “high-powered” money is created that increases the lending power of the commercial banking system.

Unlike in the past, the U.S. Treasury does not issue paper money through the U.S. mint – an arm of the U.S. Treasury – that actually prints the money. In many other countries, currency is actually printed by private for-profit companies such as the American Banknote Company. The newly printed Federal Reserve Notes – unless they are stolen – are not yet money. The U.S. Treasury under current law is not allowed to buy anything or pay off any debts with its newly printed notes. Under the current U.S. domestic monetary system, the paper notes only become money when they are issued by one of the 12 Federal Reserve Banks.

In addition to the paper U.S. dollar Federal Reserve Notes, there is another type of currency called Treasury money. Treasury money consists of legal-tender coins. Leaving aside gold and silver bullion coins that are not designed to circulate, Treasury money consists of base metals. In the U.S., the denominations are currently one dollar, half dollar, one-quarter dollar and nickels or 1/20th of a dollar and pennies or 1/100th of a dollar. The various one-dollar coins issued by the U.S. Treasury have never caught on very much. Unlike the Federal Reserve Notes, coins as Treasury money are technically money from the moment they are coined.

In practice, the “small change” coined from base metals are economically no different than the Federal Reserve Notes. The U.S. Treasury is not very likely to use one-dollar coins, 50-cent pieces, quarters, nickels or pennies to purchase commodities and pay debts. The metals that make up fractional coins, whether in the United States or in other countries, are coined from base metals that are in no sense money before they are coined – unlike the gold bullion that is money both economically and, on an international basis, legally as well.

Retail merchants, though far less than in the past due to the rise of electronic payments – credit cards, debit cards, and smart phones – still need coins to make small change. As a result, retailers periodically withdraw money from their bank accounts in the form not only of Federal Reserve Notes – issued in denominations of $100, $50, $20, $2 and $1 but also fractional coins and a few unpopular one-dollar coins.

The commercial banks in order to satisfy their customers’ need for cash – keep on hand as vault cash not only Federal Reserve Notes but dollar coins, half-dollar pieces, quarters, dimes, and nickels and pennies as well. Therefore, when U.S. commercial banks withdraw money from their accounts with their regional Federal Reserve Bank, they withdraw a certain amount in the form of coins – Treasury money. The Federal Reserve Banks, in turn, in order to meet the demand for both Federal Reserve Notes and fractional coin, go to the U.S. Treasury mint, which both prints the Federal Reserve Notes and coins the base metals into fractional coin.

The mint in order to meet the demands of the Federal Reserve Banks must buy the base metals – and the special paper that goes into Federal Reserve Notes – from industrial capitalists that produce these commodities at the prevailing market prices.

Does the commercial banking system determine the size of its reserves?

The supporters of MMT believe that the commercial banking system determines the size of its reserves. The reason is that the Federal Reserve Open Market Committee targets the federal funds rate – the rate of interest on money commercial banks charge each other on overnight loans. (6)

If the commercial banking system desires more reserves, the supporters of MMT reason – due to a rising trend in business, for example – the federal funds rate will rise above the Federal Reserve’s target level. When the federal funds rate exceeds the Open Market Committee target rate, the Federal Reserve Bank of New York – the most important of the 12 Federal Reserve Banks that make up the Federal Reserve System – will buy additional government bonds from the authorized dealers, which increases bank reserves and again lowers the federal funds rate. When the federal fund rate falls below the target rate, the Federal Reserve Bank of New York will sell some its government securities to an authorized dealer, which reduces the reserves of the commercial banking system causing the federal funds rate to rise.

MMT supporters assume that if the commercial banks desire additional reserves, the federal funds rate will rise, forcing the Federal Reserve System acting through its Open Market Committee to create additional reserves in order to lower it again. If the commercial banking system has more reserves than it can use, the federal funds rate will fall below the target obliging the central bank through the Open Market Committee to reduce the size of the commercial bank reserves in order to raise the rate once again to the target.

However, the actual history of the federal funds rate over the last 40 years shows that in reality the Federal Reserve and its Open Market Committee can only tweak the rate. The fed funds rate target has ranged from a low of .25 percent – established in December 2008 to a high of 20 percent in January 1981. Such wild swings in the federal funds rate would not occur if the Open Market Committee could simply set any interest rate it chooses. And if the Open Market Committee cannot simply set the federal funds rate at will, MMT supporters’ claim that the commercial banking system can establish the size of its reserves collapses.

In reality, some tweaking aside, the federal funds rate simply reflects the general level of interest rates and the conditions of the money market that prevail at the moment. The approximate level of the federal funds rate – whether, for example, it is .25 or 20 percent – are therefore determined by the same economic laws that determine interest rates in general, which we have examined throughout this blog.

To review the results of our investigation, the rate of interest cannot in the long run be equal or higher than the rate of profit. If the rate of interest does rise to the level of the rate of profit, a portion of the industrial and commercial capitalists will transform themselves into money-lending capitalists, which will lower the rate of interest once again.

Within these limits, a situation where the quantity of commodities – measured in terms of their prices defined as quantities of gold bullion – is increasing faster than the quantity of gold bullion – money material – will mean a rising rate of interest. A situation where the quantity of commodities on the markets of the world is increasing more slowly than the quantity of gold bullion in the world, or is actually contracting like happens in a crisis, will mean a falling tendency in the rate of interest.

Therefore, as a general rule – everything else remaining equal – a rising trend in gold production will cause interest rates to fall while declining gold production will lead to higher interest rates – or a crisis that will again lower the rate of interest as happened in 2008. Assuming the currency is stable – that is, its gold value is not expected to change in the near future, the changing relationship between the quantity of commodities – measured in terms of their prices – and the quantity of gold bullion determine the direction and rate of change of interest rates.

This brings us to the other major factor that determines the rate of interest. That is the stability of the currency in terms of the quantity of money material it represents in circulation. If the currency is expected to fall against gold, the rate of interest, all other things remaining equal, will rise. If the currency is expected to rise (strengthen) against gold – again all other things remaining equal – the rate of interest will fall.

This means that, contrary to MMT supporters or what many Marxists, non-MMT professional economists, and the lay public believe – the ability of the Federal Reserve System to tweak the fed funds rate or influence interest rates by other means is extremely limited. If the Federal Reserve System – or any other “monetary authority” attempts to drive down interest rates when market forces are pushing in the other direction, as occurred in the 1970s – the result will be a currency crisis that ends up raising interest rates. This explains why the federal funds rate target was 20 percent in January 1980.

In addition to open market operations, the Federal Reserve System has another method of tweaking interest rates called discounting – or re-discounting. During the short-lived period of balanced budgets that occurred under Bill Clinton, many economists – to be fair to them not the supporters of MMT – with their usual foresight predicted balanced budgets would continue. The technological revolution, according to these professional economic weather forecasters, represented by the Internet, was supposed to guarantee decades of prosperity as far as the eye could see. Things didn’t exactly turn out the way these economists predicted, but what would have happened to the present monetary system if they had?

If the federal government had continued with a balanced budget, the national debt would have been paid down and eventually would have disappeared. If there was no national debt, how would the Federal Reserve System have carried out open market operations? Economists – and not only MMT supporters – were concerned about this looming problem that of course never materialized.

The answer to this question is that the Federal Reserve System – and its satellite central banks – charge a (re)discount rate for loans to commercial banks – but little attention is paid to it as compared to the federal funds rate. If in the future the U.S. – or whatever country is the leading capitalist power at the time – actually paid down its debt, central banks would have to return to changes in the (re)discount rate as its chief weapon in tweaking interests rates.

Before the Depression when national debts were much smaller than they are now, the central banks relied on their purchases and sales of commercial paper to the commercial banks and on loans granted directly to commercial banks to tweak interest rates. In those days, nobody paid much attention to the rate of interest that commercial banks charged one another on overnight loans among themselves – except perhaps during extreme crises. Instead, the financial markets were concerned about the discount rate. Would the Bank of England raise or lower its discount rate? In the days of the classic gold standard, the Bank of England would raise the discount rate when gold was flowing out of its vaults and cut it when gold flowed in.

This brings us to the question of foreign trade, which will be the main subject of next month’s post.

To be continued.


1 Some years ago Ben Bernanke, former head of the Federal Reserve System and far from a Trumpist, complained that Germany’s trade surplus was getting out of hand. Bernanke was far from alone in this and was supported by many other establishment figures and economists. The difference between the “establishment” and the Trumpists is therefore a matter of degree. The U.S. capitalist establishment favors policies aimed at slowing down China’s development and reducing Germany’s share of the world market just like Trump does. But they fear that Trump’s heavy-handed policies will throw the world back into the kind of political and military anarchy that characterized the 1914-1945 era with the added danger that unlike then major powers have weapons that are capable of destroying civilization. (back)

2 In class terms, these people represent layers that are intermediate between the capitalists at one pole and the working class at the other pole. (back)

3 Mainstream Keynesian economists reject MMT, though Keynes himself was sympathetic to chartalism. Radical left-wing Keynesian economists or “post-Keynesian” economists tend to be supporters of MMT. (back)

4 The Clinton administration balanced the federal budget on the backs of the working class by “ending welfare as we know it” and declaring the end of the era of “big government” – that is, government that actually did something positive for the great majority of people. The counterrevolution that destroyed the Soviet Union also made it possible for the U.S. empire to reduce its military expenditures, since the Soviet Union had been the only military counter-balance to the U.S. Clinton also raised taxes somewhat after the huge tax cuts for the rich of the Reagan administration.

In addition, rising gold production that followed economic crises of the 1970s and early 1980s, combined with other cyclical forces, created a modest boom in the U.S. economy that increased federal revenues. This is in sharp contradiction to the situation today where despite the current economic boom caused again by rising gold production and other cyclical forces stemming from the 2007-08 crisis, the U.S. government is running huge deficits that most economists see as very dangerous, especially at this stage of the industrial cycle. However, in contrast to most economists, MMT supporters believe these deficits are a good thing and will help further reduce unemployment in coming years. (back)

5 Paper was invented in China and so was paper money. Not surprisingly, history’s first “runaway inflation” leading to collapse of the paper currency occurred in China. (back)

6 The Open Market Committee consists of the seven members of the Board of Governors of the Federal Reserve plus the president of the Federal Reserve Bank of New York plus four of presidents of the other 11 Federal Reserve Banks, who serve on a rotating bases for one-year terms. The chairperson of the Federal Reserve Board of Governors is currently Trump appointee and wealthy banker Jerome H. Powell, the leader of the Open Market Committee. (back)


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