What I want to do in this blog is to argue that the reason both theory and policy get money “wrong” is because economists and policymakers fail to recognize that money is a public monopoly*. Conventional wisdom holds that money is a private invention of some clever Robinson Crusoe who tired of the inconveniences of bartering fish with a short shelf-life for desired coconuts hoarded by Friday. Self-seeking globules of desire continually reduced transactions costs, guided by an invisible hand that selected the commodity with the best characteristics to function as the most efficient medium of exchange. Self-regulating markets maintained a perpetually maximum state of bliss, producing an equilibrium vector of relative prices for all tradables, including the money commodity that serves as a veiling numeraire.
All was fine and dandy until the evil government interfered, first by reaping seignior-age from monopolized coinage, next by printing too much money to chase the too few goods extant, and finally by efficiency-killing regulation of private financial institutions. Especially in the US, misguided laws and regulations simultaneously led to far too many financial intermediaries but far too little financial inter-mediation. Chairman Volcker delivered the first blow to restore efficiency by throwing the entire Savings and Loan sector into insolvency, and then freeing thrifts to do anything they damn well pleased. Deregulation, which actually dates to the Nixon years and even before, morphed into a self-regulation movement in the 1990s on the unassailable logic that rational self-interest would restrain financial institutions from doing anything foolish. This was all codified in the Basle II agreement that spread Anglo-Saxon anything goes financial practices around the globe. The final nail in the government’s coffin would be to preserve the value of money by tying monetary policy-maker’s hands to inflation targeting, and fiscal policy-maker’s hands to balanced budgets. All of this would lead to the era of the “great moderation”, with financial stability and rising wealth to create the “ownership society” in which all worthy individuals could share in the bounty of self-regulated, small government, capitalism.
We know how that story turned out. In all important respects we managed to recreate the exact same conditions of 1929 and history repeated itself with the exact same results. Take John Kenneth Galbraith’s The Great Crash, change the dates and some of the names of the guilty and you’ve got the post mortem for our current calamity.
What is the Keynesian-institutionalist alternative? Money is not a commodity or a thing. It is an institution, perhaps the most important institution of the capitalist economy. The money of account is social, the unit in which social obligations are denominated. I won’t go into pre-history, but I trace money to the wergild tradition—that is to say, money came out of the penal system rather than from markets, which is why the words for monetary debts or liabilities are associated with transgressions against individuals and society. To conclude, money predates markets, and so does government. As Karl Polanyi argued, markets never sprang from the minds of higglers and hagglers, but rather were created by government.
The monetary system, itself, was invented to mobilize resources to serve what government perceived to be the public purpose. Of course, it is only in a democracy that the public’s purpose and the government’s purpose have much chance of alignment. In any case, the point is that we cannot imagine a separation of the economic from the political—and any attempt to separate money from politics is, itself, political. Adopting a gold standard, or a foreign currency standard (“dollarization”), or a Friedmanian money growth rule, or an inflation target is a political act that serves the interests of some privileged group. There is no “natural” separation of a government from its money. The gold standard was legislated, just as the Federal Reserve Act of 1913 legislated the separation of Treasury and Central Bank functions, and the Balanced Budget Act of 1987 legislated the ex ante matching of federal government spending and revenue over a period determined by the celestial movement of a heavenly object. Ditto the myth of the supposed independence of the modern central bank—this is but a smokescreen to protect policy-makers should they choose to operate monetary policy for the benefit of Wall Street rather than in the public interest (a charge often made and now with good reason).
So money was created to give government command over socially created resources. Skip forward ten thousand years to the present. We can think of money as the currency of taxation, with the money of account denominating one’s social liability. Often, it is the tax that monetizes an activity—that puts a money value on it for the purpose of determining the share to render unto Caesar. The sovereign government names what money-denominated thing can be delivered in redemption against one’s social obligation or duty to pay taxes. It can then issue the money thing in its own payments. That government money thing is, like all money things, a liability denominated in the state’s money of account. And like all money things, it must be redeemed, that is, accepted by its issuer. As Hyman Minsky always said, anyone can create money (things), the problem lies in getting them accepted. Only the sovereign can impose tax liabilities to ensure its money things will be accepted. But power is always a continuum and we should not imagine that acceptance of non-sovereign money things is necessarily voluntary. We are admonished to be neither a creditor nor a debtor, but try as we might all of us are always simultaneously both. Maybe that is what makes us Human—or at least Chimpanzees, who apparently keep careful mental records of liabilities, and refuse to cooperate with those who don’t pay off debts—what is called reciprocal altruism: if I help you to beat the stuffing out of Chimp A, you had better repay your debt when Chimp B attacks me.
OK I have used up two-thirds of my allotment and you all are wondering what this has to do with regulation of monopolies. The dollar is our state money of account and high powered money (HPM or coins, green paper money, and bank reserves) is our state monopolized currency. Let me make that just a bit broader because US Treasuries (bills and bonds) are just HPM that pays interest (indeed, Treasuries are effectively reserve deposits at the Fed that pay higher interest than regular reserves), so we will include HPM plus Treasuries as the government currency monopoly—and these are delivered in payment of federal taxes, which destroys currency. If government emits more in its payments than it redeems in taxes, currency is accumulated by the nongovernment sector as financial wealth. We need not go into all the reasons (rational, irrational, productive, fetishistic) that one would want to hoard currency, except to note that a lot of the non-sovereign dollar denominated liabilities are made convertible (on demand or under specified circumstances) to currency.
Since government is the only issuer of currency, like any monopoly government can set the terms on which it is willing to supply it. If you have something to sell that the government would like to have—an hour of labor, a bomb, a vote—government offers a price that you can accept or refuse. Your power to refuse, however, is not that great. When you are dying of thirst, the monopoly water supplier has substantial pricing power. The government that imposes a head tax can set the price of whatever it is you will sell to government to obtain the means of tax payment so that you can keep your head on your shoulders. Since government is the only source of the currency required to pay taxes, and at least some people do have to pay taxes, government has pricing power.
Of course, it usually does not recognize this, believing that it must pay “market determined” prices—whatever that might mean. Just as a water monopolist cannot let the market determine an equilibrium price for water, the money monopolist cannot really let the market determine the conditions on which money is supplied. Rather, the best way to operate a money monopoly is to set the “price” and let the “quantity” float—just like the water monopolist does. My favorite example is a universal employer of last resort program in which the federal government offers to pay a basic wage and benefit package (say $10 per hour plus usual benefits), and then hires all who are ready and willing to work for that compensation. The “price” (labor compensation) is fixed, and the “quantity” (number employed) floats in a counter cyclical manner. With ELR, we achieve full employment (as normally defined) with greater stability of wages, and as government spending on the program moves counter cyclically, we also get greater stability of income (and thus of consumption and production)—a truly great moderation.
I have said anyone can create money (things). I can issue IOUs denominated in the dollar, and perhaps I can make my IOUs acceptable by agreeing to redeem them on demand for US government currency. The conventional fear is that I will issue so much money that it will cause inflation, hence orthodox economists advocate a money growth rate rule. But it is far more likely that if I issue too many IOUs they will be presented for redemption. Soon I run out of currency and am forced to default on my promise, ruining my creditors. That is the nutshell history of most private money (things) creation.
But we have always anointed some institutions—called banks—with special public/private partnerships, allowing them to act as intermediaries between the government and the non-government. Most importantly, government makes and receives payments through them. Hence, when you receive your Social Security payment it takes the form of a credit to your bank account; you pay taxes through a debit to that account. Banks, in turn, clear accounts with the government and with each other using reserve accounts (currency) at the Fed, which was specifically created in 1913 to ensure such clearing at par. To strengthen that promise, we introduced deposit insurance so that for most purposes, bank money (deposits) functions like government currency.
Here’s the rub. Bank money is privately created when a bank buys an asset—which could be your mortgage IOU backed by your home, or a firm’s IOU backed by commercial real estate, or a local government’s IOU backed by prospective tax revenues. But it can also be one of those complex sliced and diced and securitized toxic waste assets you’ve been reading about. A clever and ethically challenged banker will buy completely fictitious “assets” and pay himself huge bonuses for nonexistent profits while making uncollectible “loans” to all of his deadbeat relatives. (I use a male example because I do not know of any female frauds, which is probably why the scales of justice are always held by a woman.) The bank money he creates while running the bank into the ground is as good as the government currency the Treasury creates serving the public interest. And he will happily pay outrageous prices for assets, or lend to his family, friends and fellow frauds so that they can pay outrageous prices, fueling asset price inflation. This generates nice virtuous cycles in the form of bubbles that attract more purchases until the inevitable bust. I won’t go into output price inflation except to note that asset price bubbles can fuel spending on consumption and investment goods, spilling-over into commodities prices, so on some conditions there can be a link between asset and output price inflations.
The amazing thing is that the free marketeers want to “free” the private financial institutions to licentious behavior, but advocate reigning-in government on the argument that excessive issue of money is inflationary. Yet we have effectively given banks the power to issue government money (in the form of government insured deposits), and if we do not constrain what they purchase they will fuel speculative bubbles. By removing government regulation and supervision, we invite private banks to use the public monetary system to pursue private interests. Again, we know how that story ends, and it ain’t pretty. Unfortunately, we now have what appears to be a government of Goldman, by Goldman, and for Goldman that is trying to resurrect the financial system as it existed in 2006—a self-regulated, self-rewarding, bubble-seeking, fraud-loving juggernaut.
To come to a conclusion: the primary purpose of the monetary monopoly is to mobilize resources for the public purpose. There is no reason why private, for-profit institutions cannot play a role in this endeavor. But there is also no reason to believe that self-regulated private undertakers will pursue the public purpose. Indeed, as institutionalists we probably would go farther and assert that both theory and experience tell us precisely the opposite: the best strategy for a profit-seeking firm with market power never coincides with the best policy from the public interest perspective. And in the case of money, it is even worse because private financial institutions compete with one another in a manner that is financially destabilizing: by increasing leverage, lowering underwriting standards, increasing risk, and driving asset price bubbles. Unlike my ELR example above, private spending and lending will be strongly pro-cyclical. All of that is in addition to the usual arguments about the characteristics of public goods that make it difficult for the profit-seeker to capture external benefits. For this reason, we need to analyze money and banking from the perspective of regulating a monopoly—and not just any monopoly but rather the monopoly of the most important institution of our society.
* Much confusion is generated by using the term “money” to indicate a money “thing” used to satisfy one of the functions of money. I will be careful to use the term “money” to refer to the unit of account or money as an institution, and “money thing” to refer to something denominated in the money of account—whether that is currency, a bank deposit, or other money-denominated liability.