Labor in the Twenty-First Century

Minsky in "Can 'It' Happen Again? A Reprise" (1982):

"Money is created as banks lend--mainly to business---and money is destroyed as borrowers fulfill their payment commitments to banks. Money is created in response to businessmen's and bankers' views about prospective profits, and money is destroyed as profits are realized. Monetary changes are the result, not the cause, of the behavior of the economy, and the monetary system is "stable" only as profit flows enable businesses that borrow from banks to fulfill their commitments."

In what follows, I will only loosely refer to the text above, and again simplify. I hope you can bear with me. My aim is to create discussion around this and find out where I make mistakes - I'm happy if you can help me with that.

In our economic system a certain "symbiosis" has made it necessary for the wage earners to spend their wages later on the products of the firms so that the debts could be repaid. This was because the wages in effect were paid in IOUs (bank-created money) which the workers could later switch for goods they desired. The whole idea was to produce these goods and then use them. These goods - not the IOUs - were the fruits of the labor. When the workers gave the IOUs to the firm as a payment for goods, and the firm forwarded them as loan repayments to the bank where the loan was originated, the IOUs (made by the firm) ceased to exist. Money was destroyed.

Here's my updated version of Minsky's text above:

Money is created as banks lend--mainly to households---and money is destroyed as borrowers fulfill their payment commitments to banks. Money is created in response to households' and bankers' views about prospective wages, and money is destroyed as wages are realized. Monetary changes are the result, not the cause, of the behavior of the economy, and the monetary system is "stable" only as wage flows enable households that borrow from banks to fulfill their commitments.

The very same "symbiosis" I described above makes it now necessary, if we follow this logic, for the firms to spend their profits later on the wages of the households so that the debts can be repaid. Many households have paid for the goods in IOUs (bank-created money). These IOUs are what the employees and the owners of the companies have received for the goods they produced. Again, money is an IOU. Many households have received the goods --the fruits of yet-to-be-performed labor-- already. These households can look forward to labor without (further) fruits. This is what "debt slavery" is.

All this means that the wages and profits of past decades are good only to the extent these IOUs are good. The money some people have accumulated is good only to the extent to which the debts will be repaid. And the debts will be repaid if there will be enough wages. The problem for the firms is that these wages paid to indebted masses will not be buying the goods the firms produce.

To sum this all up using a reference to my previous posts:

Money created out of nothing has a value, but the value is directly connected to the value of the promise to pay. If the promise to pay doesn't hold, like was obvious in the case of subprime loans (just to give an extreme example), then the money created and used for payment ended up having very little value. It was not "good" money. We need to remember that when money is destroyed, an IOU is destroyed, and so debt is made good.

Another Man's Asset

We know that a household can become over-indebted. The consequence of this over-indebtness - when it becomes apparent - is that the household loses its ability to take on new debt, and is asked instead to start paying back the existing debt. The household needs to lower its living standards, as it was financing those standards with debt in addition to income.

We also know that a whole nation can get over-indebted, through some combination of private and public debt it owes to foreigners. In this case, the general living standards of the population fall. In the absence of foreign aid (e.g. in form of fairly-priced loans), there's no other option than "austerity". (All this is of course a simplification, but one can't write about the economy without simplifying, especially if one has a point to make. So I hope you don't get too tangled in details I have omitted.)

What I write above about a nation must also be true when it comes to any group of nations (that doesn't consist of all the nations in the world), like the European Union.

But if one asks about the possibility of global over-indebtness, one usually gets to hear that it's not possible because "one man's debt is another man's asset". This point is often stressed by mentioning that for the whole world to get over-indebted, there would need to be an extraterrestrial creditor.

I ask myself a question: Can't a central bank be seen as an extraterrestrial creditor, in the sense that money coming from central banks comes from outside the economy and money going into central banks leaves the economy?

And another question: Can't commercial banks be seen as an extraterrestrial creditors, in the sense that the money they create out of nothing when they extend a loan (see my previous post) comes from outside the economy and money paid to the bank in the form of a repayment of a loan is destroyed from the economy?

I will come back to the first question in my future posts, but now I will dive a little deeper into the role of commercial banks as creditors (as holders of assets).

Two main types of "another man's assets"

I will put this very simply: If I have lent you cash I happened to have in my pocket when we last time met, and you have promised to pay it back later, I have an asset, an I.O.U. from you (I'm creditor and you are debtor). When I handed you the cash (an asset itself), it was replaced on my side by the I.O.U. and my wealth in form of assets remains the same as it was before the loan (assuming now that you pay me back). When the day comes that you repay me, I get back the cash and the I.O.U. as an asset ceases to exist. Your debt was my asset. Now my asset is the cash again. Just before you repaid me, you had an asset (the cash) and a corresponding liability (the I.O.U. you gave me). After you repaid me, you don't have that asset but you neither have the liability.

Let's call the I.O.U. the creditor held "another man's asset Type 1".

It should be obvious by now (especially if you read my previous post) that the situation is not as clear cut when we talk about commercial banks as creditors. Loans to households and businesses form the main part of the assets a typical commercial bank holds. These loans can be seen as assets in that they generate income for the bank in the form of interest payments. But these loans can't be seen as assets in that they don't represent any real wealth, as they are not a "store of value". The bank can lose this asset in a blink - sometimes against its own will - through (early) repayment of the loan. The money paid back to the bank is "destroyed", as it was created "out of nothing" by the bank when the loan was granted - so there is no cash that would replace the loan as an asset like there was in the first example (Type 1). Additionally, a non-bank lender can often sell the asset (loan) to someone else and keep the proceeds from the sale. A bank can sell a loan (through securitization) but doesn't get to keep the proceeds from the sale. The money is again "destroyed".

Let's call the loan the commercial bank had made "another man's asset Type 2".

I have heard many times how one man's debt is another man's asset. I have never heard which type of asset (Type 1 or Type 2) it is, although the difference between these two types must be substantial as Type 1 represents wealth while Type 2 doesn't represent wealth?

I can now see why many banks offer "Asset & Wealth Management" services. One man's debt may reflect another man's wealth?

Schrödinger's Money

The latest Quarterly Bulletin from Bank of England has raised an always intriguing topic on the agenda: How commercial banks create money when they extend loans. Many commentators, Paul Krugman among others, have correctly pointed out that this is nothing new.

I must say there is something very assuring about a central bank saying that money is created "out of nothing" (ex nihilo); you can know it's true. I have never heard of a central bank trying to mislead the public to think that money is created out of nothing, but I can think of many cases when the exact opposite has happened - a central bank has said that money is not created out of nothing, even when it is.

I find it interesting that this truth about money creation comes as a surprise -even to many professionals- every time it is stated. Could there be something in it that just doesn't make sense to us even when explained?

We are often told how the money we deposit in a bank is actually lent out to borrowers, so that strictly speaking the money is not in the bank, and the bank only has a certain amount of money, a fraction of the total deposits, available for satisfying the requests from deposit-holders who want to withdraw their money. This is still today the prevailing explanation of how banking in a fractional reserve banking system works.

What has been so fascinating about the prevailing explanation has been the parallel between it and "Schrödinger's cat". The money simultaneously is in the bank and it is not. As depositors we act in the economy knowing that our deposits are available to us more or less whenever we need them, and deposit insurance schemes and central bank support to banks (as the "lender of last resort") have made it clear that this is the case. The money is in the bank. And as borrowers we have got, in the form of a loan, money from the bank that is said to be actually money belonging to depositors. So the money is with the borrower. It's not in the bank.

The prevailing explanation made more sense when we used currency, cash, to a larger extent. It was clear that not all the currency remained in the bank once we had deposited it there. But with electronic money this has got even more complicated. Money that is transferred to our demand deposit account is just 1s and 0s. No currency was involved in the transaction. And we can at any moment log into our Internet bank and observe that the 1s and 0s are still there. Therefore, as Bank of England explains, it's not really depositors' money that is lent to borrowers, but money created "out of nothing". This is comparable to revealing that Schrödinger's cat multiplied inside the box - so that there was one cat dead and one alive.

If the money for lending is created out of nothing, why does the explanation with its Schrödinger's money still prevail even among economically literate people? Isn't it time to finally get rid of it? Once that is done, someone of course needs to explain us how something can be created out of nothing...

On The Source

What I'm going to present in this blog is derived mostly from applying on the economy a certain perspective. This is a perspective on money and debt that my mind has, should I say, stumbled upon in my search for an understanding on how debt really works and affects the economy. First was the perspective. Then came, bit by bit, something that might look like an attempt at some kind of a theory, and it is the findings from this attempt that I'm going to present here. The findings are by no means final, and inevitably many of the initial findings turn out to be wrong. I'm refining the findings, and continuing my attempt, every day from morning till evening - and often in my dreams too. I've been doing this research for some years now, with increasing intensity.

So this is money and debt, and the whole economy, from one perspective. Money, debt and economy can't be viewed from only one perspective. If we do that, a lot of important things will go unnoticed. My attempt at a theory would never explain everything, not even close, even if it was a somewhat successful attempt. But it seems to me that by looking at the economy from this perspective I can explain a variety of economical phenomena, and some of it in a way that makes more sense than the prevailing explanations.

What I hope and believe is that my perspective makes you find out something new, something you never thought of. At least it has done that for me and for some people who have been unfortunate enough to be chosen by me as the audience of my "lectures". I can't promise you'll hear something no one else has ever said, but what keeps me working hard is the chance that it could be so.

I'm happy to discuss the subject, so feel free to contact me via e-mail.

Prologue

When there are two opposing camps (or schools of thought) with intelligent, knowledgeable people on both sides, we should treat any decision carefully. This is especially true in the case of monetary policy decisions, mainly due to the fact that they are made by a small committee and based on a majority vote. To me it seems it would always be wise to follow the rule "first, do no harm". Should the banks be encouraged, or even pushed, to lend more freely? And should households and firms be encouraged to borrow more? Not if that puts us in harm's way later. Does it? We just don't know.

Why is the Fed, or central banks in general, currently erring on the side of loose monetary policy and have been doing so since Greenspan, whenever we have been facing a small recession, or even a sign of it coming? Well, loose monetary policy is more or less the only weapon against recessions the Fed has at hand, and either a) it has been seen that we should avoid even a small recession whenever we can, or -and I find this more likely- b) any recession has been seen as a potential deep recession that should be fought decisively.

This is where we stand even today. Ultra-loose monetary policy for an ultra-long time is seen as the best option IF we want to avoid a deep recession. Why shouldn't we do everything we can to avoid a recession? Well, one could argue that we should take the recession now if fighting it with loose monetary policy would make matters worse in the long run. And, of course, we would still have the chance to look for other -albeit most likely less effective- "weapons" against the recession, or at least against the negative consequences of a recession (some kind of "managed decline" approach). But prevailing economic theory does not explain why loose monetary policy would lead to an even worse recession later, why it would be even worse than just "kicking the can down the road". Of course, very few things are inevitable (death and taxes?). Even if we got ourselves in trouble, a miracle can always save us. But if we are accumulating harm for the future through the current policy, then we will for sure need an even bigger miracle to save us?

This blog describes my (as) honest (as possible) struggle to understand if we are making matters worse in the long run -time before most of us, or if not us then our children, are dead- by continuing with the current monetary policy and monetary system. My understanding is that this is a systemic, not just policy, issue.