Systems of Money; Where is the flywheel?

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Jim H's picture
Jim H
Status: Diamond Member (Offline)
Joined: Jun 8 2009
Posts: 2391
Systems of Money; Where is the flywheel?

As I ponder money, my own view of it has evolved into a pretty complex chart that compares many important characteristics;  Ease of use, tendency toward inflation or deflation, counterparty risk... but the most important characteristic of all I believe is this simple question:  How is this money created.. and what is the resulting scarcity integrity?  Or, as Jesse puts it below in his discussion of the MMT'ers (or Platinum coiners, or whatever you want to call them), "where is the flywheel?".  My own conclusion is that my fellow man cannot be trusted to make the money... it always will end in failure.  Debt. based money has the veneer of being market-based (based on demand for debt)... but we know that can and is being gamed.  I therefore vote with my preferences by putting my savings into Gold and Silver, along with my newfound but as yet unconsummated interest in Bitcoin. I think this is worth a read;

Now I turn to the curious situation of the Modern Monetary Theorists.

Let me state, unequivocally, that there is nothing new to be seen here. There are no new discoveries, there are no new wonderful theories that make things possible that were not possible before, in the manner of an invention like the transistor, atomic fission, or flight.

What is presented as 'new' is the notion that the state can simply print and distribute its own funds as needed, determined by it.  And in doing so there will be no serious consequences.

I am willing to suspend all other discussion and objections, and bring this down to the absolutely critical point in any monetary system. And that is, 'where is the flywheel?' Or for the less mechanically inclined, where is the constraint, the restraint, the governing factor, on expanding the money supply?

In the case of an external physical standard, like gold and silver, or a hard peg to another currency, that constraint is easily seen. The 'flywheel' that governs how fast the printing presses may go is the amount of gold and silver one can obtain, or the level of value of some other currency, that is hopefully stable but may not be.

One can expand the money supply beyond the metal supply, but only with a conscious and obvious devaluation of the units which each ounce of gold and silver represents.  Or one can cheat and lie, but that is another matter, and a facet of all human systems which lack transparency.

In the case of a debt based market system, the flywheel is the willingness of the market to take the government debt at some value which 'works' for the monetary authority's purposes.

It is undeniably true that Bernanke is gaming this mechanism in what is purported to be the short term by buying that debt, the government bonds, at non-market, artificial prices. And it shows up in the Fed's balance sheet, for all to see.

As I have pointed out at some length before, as long as the Fed has at least one Primary Dealer in on the scheme, the money machine can keep turning until the market is revulsed by the stated valuations, and the machine breaks down.

And this is by design.  It is the principle of 'lender of last resort.'  And it is supposedly what provides the Federal Reserve System more flexibility to address currency shocks than a hard external system.  That the Fed has caused those currency shocks by its own policy errors at times is another matter.

But at least I understand why the Fed and the board of governors are doing what they are doing now, and it is obvious what they are doing despite the enormous lengths to which some may go to say otherwise.  And since it requires the agreement of a number of different, somewhat independent parties, it may very well stop before it goes too far. 

So I would ask, where is the flywheel in Modern Monetary Theory, in which the government spends at much as it wishes, and simply issues the currency to 'cover' its expenditures?

And if the answer is the checks and balances of the Congressional appropriations process and the policy of the Treasury Department, you will understand if the general public runs screaming towards the exits, given our recent experience with the budgeting and spending levels.  Or if the answer is that it is 'in the cloud' and that a restraint is an old-fashioned concept that is no longer applicable, then we will know that as it stands it is another new era idea like efficient market theory.

So, with regard to Modern Monetary Theory, what acts as the restraining factor on the expansion of the money supply? Where is the flywheel?

Answer that honestly and straightforwardly in less than two paragraphs,  and it might be said that MMT at least has a system.  And if not, it is something that needs to be done to take it from sophistry, which dodges and changes as required by the turn of the debate, into the realm of a real system that can be examined and critiqued.

darbikrash's picture
Status: Platinum Member (Offline)
Joined: Aug 25 2009
Posts: 573
Aggregate demand

Well, the answer to the question “Where is the flywheel” can be stated in two words, Aggregate Demand.


If your belief system is the Ptolemaic view that money is printed and dropped into the economy via helicopter, or whatever the current “printing press” vernacular consists of, then perhaps the restraints on value elude.


If you subscribe to the heliocentric view that monetary demand is endogenous, then things get much simpler.


MMT, and its associated chartalism,  is a conflicting viewpoint which suggests that the source of monetization in the economy is primarily government spending and the resulting tax revenue recognized as income. I do not think this is a reasonable model, so the purpose of debating it seems dubious to me.


Endogenous monetary demand says that there is no limit to how much (debt) money the economy can absorb without debasement, as long as the debt is used to finance productive capital. In other words, whatever you borrow is used to invest in goods and services that return a higher rate of return than the interest payments. It says that loans create deposits, not the other way ‘round. When banks make loans approaching the reserve limits, they attract bank deposits (by offering attractive depositor interest rates) to rectify the situation. The Federal Reserve backstops the banks as the lender of last resort.


So the modulation of the amount of money in the economy (not the amount of money in the Federal Reserve system) is governed by demand- by capitalists (and consumers) taking out loans. As long as these loans are not speculative, or Ponzi based, than the system self modulates. When the proportion of loans taken cannot provide returns in excess of interest payments and operations, as well as surplus profit, the system breaks down.


It breaks down in two critical ways, a.) If the expected profit margins are declining, or not interesting (read insufficient risk/reward) to the capitalist, the capitalist will not borrow the money, and b.) when the returns on loan investments cannot cover the interest and operating costs, due to speculative ventures OR insufficient consumer demand- or both.


However this is sliced, it still comes down to humans dictating the monetization of the economy. It is not governed now, and never can be governed, by the speed at which you dig a mineral out of the ground. This is a feeble attempt to modulate the money supply by some means ostensibly out of control of human intervention, e.g. the gold standard. Most historians and economists will tell you the gold standard and the resulting liquidity trap of the Great Depression in 1929 had a large influence on how deep and long the Depression lasted.


The population is always growing, there are always new businesses that need capital, and there is an upward, non linear need for currency to be added to the economy in support of this growth- whether we want growth or not. A capitalist economy modulates this currency requirement by aggregate demand.

Jim H's picture
Jim H
Status: Diamond Member (Offline)
Joined: Jun 8 2009
Posts: 2391

Thank you for starting out with something we can agree on.. namely that chartalism is not worth debating.  I posted Jesse's work not so much because I think chartalism is just dumb (I do) but because it helps us to flex that the mental muscle that allows us to answer the question;  what is the mechanism of money creation in this system, and the nature of the restraint (if any)?  

With regard to the rest of your commentary.. I don't argue that aggregate demand is not a real force in an economy.. no doubt it is.. but I would suggest that your belief system is deep in the maw of the banker's propaganda.. and that you don't even know it.  There are two competing mechanisms in money.. and you can equilibrate the system using one, or the other, or a combination of the two;

1)  Increasing Money supply

2)  Price level (at constant money supply)

You seem to think that increasing money supply is the only answer.  You are a banker's best friend!  Of course.. we need more money!  No, wrong... you don't need more money necessarily.. you just need the  money that already exists to be able to buy more.  But this would suck for the bankers.. because this is deflation.. and they have quite a bit more trouble keeping their businesses going in deflation.  On the other hand, this works great for savers.. but we can't have that.. savers over bankers?  Never.  You might ask, why do we really need bankers then?  Why don't we just have aggregations of savers who pool their money and loan it out with the hope of a positive return?  Hmmm..     

So, what is the problem really?  Would it really be so bad if we had money that increased in buying power in order to account for increasing population, and endogenous (read: good) growth?  A piece of Gold or Silver is nearly infinitely divisible... Yeah.. it's hard to see 0.001 grams of Silver.. but that could be dealt with I am sure.

I look forward to your rebuttal. 



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