Where Does Money Come From

 MS Copilot provides the answer, which is correct. This is not "Modern Monetary "THEORY". It's a factual description of how things work. MMT "theory" is like evolutionary "theory" - just a factual but perhaps counter-intuitive description of reality.

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**1. Central Banks and Money Creation:**

Central banks, like the Bank of Canada, play a crucial role in creating money. They do this primarily through two mechanisms:

   **a. Printing Currency:** Central banks print physical money (banknotes and coins), distributed through commercial banks. This is the most tangible form of money creation.

   **b. Digital Money Creation:** Central banks also create money digitally. They do this by purchasing government securities or other financial assets. When the central bank buys these assets, it credits the sellers' accounts with new money, increasing the money supply.

**2. Commercial Banks and Fractional Reserve Banking:**

Commercial banks create money through a process called fractional reserve banking. Here’s how it works:

   **a. Deposits:** When you deposit money into a bank, the bank is required to keep a fraction of it as reserves (let’s say 10%) and can lend out the remaining 90%.

   **b. Loans:** The money lent out is deposited into other bank accounts, which then become new deposits. These new deposits allow banks to create even more loans, and the cycle continues. This process multiplies the amount of money in the economy beyond the initial physical currency.

**3. Government Borrowing:**

Governments can also create money by borrowing from the central bank. When a government issues bonds, the central bank can buy these bonds, effectively creating new money that the government can then spend on public projects and services.

**4. Quantitative Easing:**

This is a more recent and unconventional method of money creation used by central banks during economic crises. The central bank buys financial assets from commercial banks and other institutions, injecting much money into the economy to stimulate economic activity.

In essence, money creation involves a combination of actions by central banks, commercial banks, and government policies. It's a complex process beyond just printing cash, involving digital transactions and financial instruments to ensure the economy has enough money to function and grow.

Reducing government spending by $1 trillion per year would have a significant impact on the economy. Here are some potential effects:

1. **Decrease in Aggregate Demand**: Government spending is a component of aggregate demand (AD). Reducing spending would likely lead to decreased AD, resulting in lower economic growth and potentially higher unemployment.

2. **Impact on GDP**: The immediate effect would likely be a reduction in GDP growth. The extent of this impact would depend on the state of the economy. If the economy is already weak, the reduction in spending could exacerbate the downturn.

3. **Inflation**: A decrease in government spending could lead to lower inflation rates, as less money would be circulating in the economy.

4. **Long-term Effects**: Over the long term, reducing government spending could help decrease the national debt and potentially lead to lower interest rates, which could stimulate private investment.

5. **Sector-Specific Impacts**: Certain sectors that rely heavily on government contracts and funding, such as defence and infrastructure, could be particularly hard hit.

Making America Small Again

While the world is transfixed by Trump's banning of plastic straws, Elon Musk continues to kick the stilts out of the US economy, threatening US economic emergency. Precedents include the 2008 banking crash and the great depression. 

From MS Copilot in "Think deep" mode:

 Slashing government spending is like removing beams from a building's foundation—take away too much, and the entire structure risks collapse. When a department like the Department of Government Efficiency (DOGE) enacts aggressive cost-cutting measures, the immediate impact often manifests as a surge in unemployment, setting off a chain reaction throughout the economy.

**Direct Job Losses**: Government cuts typically lead to layoffs of public sector employees—teachers, healthcare workers, infrastructure planners, and countless others who provide essential services. These individuals lose not just their incomes but also their purchasing power, which directly affects consumer spending.

**Decreased Consumer Spending**: With more people unemployed, there's less money circulating in the economy. Households tighten their belts, opting to save rather than spend. This reduction in consumer demand hits businesses hard, especially small and local enterprises that rely on steady patronage.

**Business Retrenchment**: As consumer demand dwindles, businesses face shrinking revenues. To stay afloat, they may freeze hiring, reduce employee hours, or lay off staff—spreading unemployment further into the private sector. It's a domino effect where one fallen piece topples the next.

**Ripple Through Supply Chains**: Suppliers and manufacturers feel the pinch as orders decrease. This slowdown propagates upstream, affecting industries that might seem disconnected from government spending at first glance. For example, reduced infrastructure projects mean less demand for raw materials like steel and concrete, impacting those industries and their workers.

**Psychological Impact**: Rising unemployment fosters uncertainty and fear. Even those still employed might curb their spending in anticipation of hard times ahead. This collective anxiety can exacerbate economic contraction, making recovery more challenging.

**Strained Social Services**: Ironically, cuts intended to save money can lead to increased spending elsewhere. Higher unemployment boosts demand for social safety nets—unemployment benefits, food assistance, and healthcare services—all of which require government funding.

**Historical Precedents**:

- **The Great Depression**: In the 1930s, austerity measures deepened the economic crisis. It wasn't until government spending increased through programs like the New Deal that the economy began to recover.

  

- **European Austerity Post-2008**: Countries like Greece and Spain imposed strict spending cuts after the financial crisis. Unemployment rates soared—Greece's unemployment exceeded 27%, with youth unemployment even higher. The social and economic fabric of these nations suffered immensely, leading to prolonged recessions.

**Long-Term Consequences**:

- **Skill Erosion**: Prolonged unemployment can lead to a decline in workers' skills, making it harder for them to re-enter the workforce later.

  

- **Income Inequality**: Job losses often hit lower-income workers hardest, widening the gap between the rich and the poor.

  

- **Reduced Tax Revenue**: Fewer employed individuals mean less income tax revenue, which can worsen budget deficits and undermine the initial goal of the cuts.

**Metaphorical Insight**: Think of the economy as a living organism. Government spending is the blood flow that nourishes various parts. Sudden cuts are like constricting arteries—organs begin to fail, and the health of the entire body declines.

**Balancing Act**:

- **Targeted Efficiency**: Instead of broad cuts, focusing on reducing waste and improving efficiency can save money without massive job losses.

  

- **Invest in Growth**: Allocating funds to sectors with high growth potential—like renewable energy or technology—can create new jobs and stimulate the economy.

  

- **Social Programs**: Investing in education and retraining programs helps unemployed workers adapt to changing job markets, reducing long-term unemployment.

**Global Examples**:

- **Post-WWII Recovery**: The Marshall Plan injected significant funds into war-torn European economies, leading to rapid recovery and growth rather than collapse.

  

- **Japan's Lost Decade**: In the 1990s, Japan's efforts to cut spending during a recession led to stagnation. It wasn't until expansive fiscal policies were reintroduced that the economy showed signs of recovery.

Understanding the delicate interplay between government spending and employment is crucial. Aggressive cuts might seem fiscally responsible on the surface, but without careful implementation, they can trigger unemployment spikes and economic downturns that negate any short-term savings.

**Looking Ahead**: It's worth exploring how monetary policy can counteract these negative effects. Central banks might adjust interest rates or implement quantitative easing to stimulate the economy. Additionally, discussing how public-private partnerships could maintain essential services while relieving government budgets might provide a balanced path forward.

Magic Money Tree (MMT) - Have I Got This Right?

Modern Monetary Theory (MMT or Magic Monetary Tree) is all in the air. I have spent a good amount of time understanding the idea. I think I get it.

• MMT advocates are solely on the "left," claiming that there is more "policy space" than traditional accounting methods show and that MMT provides the "space" for more spending on social problems, such as the Green New Deal.
• I find no inherent connection between the expansion of "policy space" and the use of this space to expand spending on social programs. Ronald Reagan expanded the "policy space" to vastly increase military spending along with a jaw-dropping deficit.
• The above observation leads me to see MMT as "motivated reasoning."
• Advocates of MMT obviously assume that they will also be in political power to institute "reforms" in, for example, the Federal Reserve and to spend the funds on programs advocated by the "left." I don't see why a Tea Party government could not use the same logic to eliminate taxes entirely. The deficit doesn't matter, right? Or do we assume that the "left" will somehow be permanently in power? Hmmm...

It should be noted that "Keynsean" policies have been used in the past to produce full employment, specifically to hire any able-bodied' person for the military in World War II. This, not the "new deal," brought the American economy back to life. Price stability was another matter ...

MMT promises to achieve price stability despite full employment. We are currently seeing how the "tight" labor market is contributing to record inflation. So one must wonder exactly how MMT achieves price stability or is this just a goal? It must be said that price stability is a goal of any economic policy. It turns out to be tricky. 

"Price stability" is not up to the government. There is a real, chaotic world out there where the prices of the "stuff" that money can buy is strongly affected by the details of delivering the "stuff" to market. In the real world, there are things like pandemics, climate change, supply chains, and politics. 

It must also be mentioned that "modern" economic models don't assume perfect knowledge, perfect competition, or rational actors. All this went into the trash bin with the advent of computer models. Whatever you might say about MMT, it has the air of quaint philosophy -- more at home in 1922 than in 2022. As a philosophy, it is talk about talk, not talk about the real world.

MMT in a category of theories that aim to control the economy and, through that control, make the world a better place. The world is simply too complex for any theory - economic or not - to achieve "control."

Just as a reality check, this is what the current US debt looks like:

Advocates of MMT propose to massively increase the national debt. Debt "service" is already a huge expense, crowding out the ability to finance new programs. Some advocates claim that massive new programs can be somehow funded without debt (by an implausible modification of how money works in the US). Even if this is possible, we can see that existing debt competes with any new programming. 

Finally, we know that "printing money" is just as popular with the "right" as it is with the "left." All arguments for the "Green New Deal" are also arguments for massive tax cuts, reduced services, and more military spending.

------------------ BUT! ---------------- 

All this ignores the wealth of the USA pubic sector. This is not to be confused with the net financial position of the government, which is easily found. Ironically, the biggest financial asset of the US government is student debt!

US Government assets (not including land) are about 762,622,087,000,000 or, to save you counting commas, 763 trillion dollars as compared to the approximately 3 trillion shown above in debt.

"Not including land" is important since government land can easily be turned into rent (income).

 

It is also important to see that assets other than land require maintenance - they "depreciate." A very conservative estimate would be 10% per year - %76 trillion. This may be at the heart of "build back better" since public assets such as roads, bridges, and buildings are famously in need of maintenance and upgrade.

I suspect the figure doesn't include military assets, which cost about 3% of the US GDP of $20 trillion. What they are worth is almost a theological exercise, but the value at least involves the 38 military bases on US soil, each a small town its own right, sitting on square miles of valuable land.

And then we need to toss in the wealth of the individual states, counties and cities...

For all intents and purposes, the wealth of the US (and Canada for that matter) is infinite. Many zillions. It is this wealth that "backs up" what we borrow, not "GDP", which is vaguely related to what we can tax. If you want to assess personal debt, you compare it to assets (wealth). The ability to "service" the debt is related to income, which, in the case of a Nation State, is "revenue". MMT tosses both debt and revenue into a deep fog, but you may be able to arrive at the same conclusions (build back better) by another road entirely. It's about upgrading, maintaining and protecting our vast resources. MtMT can therefore be seen as an effort to justify the right program for wrong reasons. In the words of Keyes himself, we need a more plausible lie.

Bitcoin, Money and Value

 

In the course of my online discussions, I have been tempted to provide a treatment of Bitcoin and related subjects (Modern Monetary Theory, "Fiat" money), etc. But, on examination, I seem to have already written enough on the subject. Check here.

I have changed my opinion that crypto is a "zero-sum" game. The reason is that some players are happy to lose money, which changes the whole picture.

There are major players who are glad to lose money in this market. If you are a criminal enterprise or a terrorist organization wanting to launder millions of dollars, a "loss" of 10% is totally acceptable. Crypto is, in other words, a godsend for organized crime. Among other reasons, these are one reason that governments of the world will soon consign all this crypto-crap to the trash bin overnight. I note that crypto-nerds regard this as impossible with almost religious fanaticism, nor are they willing to even discuss the fact that "winners" in this marketplace are financing terrorism and organized crime.

Like all laundering schemes, crypto has its challenges. At the end of the laundering pipeline, "real" money emerges, with all the challenges of accounting for its source. In fact, since governments can hack the blockchain, crypto may not be as good a choice for long.

Bitcoin is an interesting case. As of writing, the total amount of Bitcoin out there is close to $1 trillion Canadian. Bitcoin is the preferred method of payment for ransomware criminals, an industry that, according to some, has cost the world $20 billion by the end of 2021. It is fair to guess that the upward pressure on bitcoin price is fueled by the "demand" for Bitcoin from ransomware victims. Coincidentally, the current "circulating supply" of Bitcoin is about $20 Billion.

Any coordinated attack on the ransomware industry would obviously involve killing off Bitcoin. I have no sympathy for those whose speculative Bitcoin fortunes would vanish as a result of such a campaign. These speculators are basically betting on the success of a crime that touches victims from the little old ladies losing their family photos to hospitals trying to treat the sick.

---------- PS ------

Crypto fans believe that Crypto is the future. To put this in perspective. The existing "money" system is fabulously successful and useful. Whatever you may think of, say, Bitcoin, it is not useful as a currency.

The foreign exchange or forex market is the largest financial market in the world – larger even than the stock market, with a daily volume of $6.6 trillion, according to the 2019 Triennial Central Bank Survey of FX and OTC derivatives markets.

To compare, crypto trades about 600 billion per day. That sounds impressive but it's a tiny fraction of "real" transactions. It's simply a measure of the size of crypto-crime activity boosted by speculation.

------ PPS -----

Basic reference about Bitcoin - 2 books by Saifdean Ammous

Commentary on Bitcoin (basic text) and Fiat Currency (deep dive) from the point of view of "Austrian Economics".

Bitcoin Standard

Fiat Standard

There are many fundamental criticisms of "Fiat" that are not obvious. For example, reconciliation is slow and inefficient. (Elon Musk).

Another (Ammous) is that inflation is built into fiat. The banks are effectively "mining" fiat.

Do Economists Understand Money?

I'm no expert, but I can see when "experts" are 180 degrees from each other.

For example, in an interview with New York Times "Daily", an expert economist is asked where all these trillions of dollars of the bailout money are coming from. He seems to think that all Federal funds are either collected in taxes or "borrowed into existence". The implications are that it will take generations to "repay" all these massive loans.

This seems factually wrong in several respects if you know "Modern Monetary Theory (MMT)". MMT is not exactly a "theory" needing proof. It is simply a description of how things work in the accounts of a sovereign nature when it comes to its sovereign currency.

For one thing, all government funds spent are materialized "out of the blue". This applies to all spending all the time and not just in times of crisis. The exception which is not really an exception is government borrowing that covers the gaps between outright cash expenditure and money acquired by the sale of bonds, T-bills, and the like. This is not really an exception since these bonds are serviced and/or repaid out of funds that are "materialized". There is no limit to how much money the Federal Government can "print". Some of it appears in the current year. More is sprinkled into future years in debt "service" and repayment. All of it appears magically by Government fiat.

Taxes are not in any way "revenue" for the Federal Government. They cancel out a tax obligation, likewise created "out of the blue". The effect is to remove currency from circulation, preventing the world from filling up with money printed by the government. The difference between "spending" and "Income" (the deficit) is a made-up number that nobody cares about except when opposing social spending and ranting to the general public about impending doom. For the Federal government, there is no such thing as a "balanced" budget any more than there is a "purple" budget. Of course, the situation is different with the levels of government that are forbidden by law from printing money.

So, where do the trillions come from? They just roll off the press, or, more precisely, they are keyed into a computer at the Federal Reserve (or similar institution). Congress (or the PM) simply orders up a number and voila, it exists ("borrowed" from the future or printed).

Why would a government borrow money it can print? This is an (often ineffective) way to steer the interest rates in the general economy. Banks and the "shadow banking system" actually create far more money than the Government. "Control" of interest rates is hopefully influenced by the bond market. But the government certainly doesn't "need" the money raised by bond sales. On the other hand, this method of control builds up a fictitious number that grows to frightening proportions, called the "national debt". This is "money" that can either be serviced or paid off with printed money or simply ignored. The size of this number is meaningless. Yet we find "expert " opinions on things like the dangers of allowing debt GDP rise to some number pulled out of an economist's nether regions. "Servicing" this debt has the effect of putting vast sums of printed money into the hands of the investor class, but this is beyond the scope of this essay.

So what seems to be the sensible view of injecting trillions into the economy to keep the lights on?

For one thing, we can see the catastrophe that results from not doing this in the horror of the '30s in Canada. Among the many problems in the Canadian depression was the simple lack of cash and the universally accepted gospel of the "balanced budget". Yet, when Canada entered the war against Germany, all of a. sudden there was no problem paying thousands of previously out of work young men and transporting them overseas at considerable cost. Obviously, there was a problem with our assumptions.

On the other hand, we can see some famous examples of governments attempting to print their way out of disaster, resulting in hyperinflation.

Let me give you a metaphor infested personal view of this.

When the government gives you $1, it's an IOU. The government is saying, I owe you $1. But the Canadian Economy is what stands behind this idea. They are saying, this piece of paper can be exchanged for any goods or services created or acquired by the Canadian economy. You can redeem the IOU by spending the $1 on what Canada has for sale.

So the trick is to have enough of these $1 floating around that they more or less track the amount of goods and services available. A dramatic increase in these IOU's will, all things being equal, lead to an over-supply - too many dollars chasing a fixed amount of goods and services, resulting in inflation. This is the classic objection to "printing money" even though that's the only way a Federal Government spends money. Note that the "same problem arises if money is created by the banking system - credit and debt. This leads to the conventional way of attacking inflation by raising interest rates - sometimes to painful levels - and why the government keeps its toe in the sea of debt by issuing bonds when it could just as easily print money. The effectiveness of this policy is questionable, but that's a subject for another time.

But what happens when there is a big drop in the amount of goods and services available, such as when the economy is locked down for months? People following the situation mostly hear about people's dwindling buying power and, in Canada at least, massive direct injections of cash are made (for example) to prevent people from losing their homes. But a more subtle danger is the loss of productive capacity in the economy, leading to a drastic reduction in the amount of goods and services for sale. The latter problem is far more complex and difficult than the first. You can't just throw money at it. For example, many small businesses constantly skate on the edge of. bankruptcy. Moving at "government speed", there is no way to save these businesses from disappearing - possibly forever. Moreover, mass failures of these businesses has an implication for creditors, including Federally-supported banks. The Government will presumably save the banks but not the millions of businesses whose loads went bad.

Put these together ("supply-side" and "consumption") and you see a drastic contraction in the amount of money needed in the economy and a serious risk of runaway inflation. From a monetary point of view, the task would seem to be interventions that recognize both sides of the issue. "Fortunately", the current situation results in contraction of both supply and consumption so, in theory, we can visualize a "balanced' intervention. In the current situation, the added problem of keeping people alive makes it a problem from Hell. One obvious long-term problem (especially in the US) is that direct subsidization of wages is laughably inadequate. Even if a low-wage person manages to keep a roof over her head, she will emerge with staggering debt. Similar situations will emerge in most of the "supply-side", where businesses will survive only by accumulating debt. Since all money is an IOU to somebody, we see the emergence of an even larger creditor class whose size depends largely on who gets the trillions of dollars being printed to deal with the current problem. It is the creditor class (the rich) who are deciding all this.

Sorry if you were expecting solutions...