by Steve Roth (at Asymptosis)
I just had occasion, in replying to a correspondent, to reiterate much of the thinking in my recent MMT Conference presentation. I thought it might be a useful and comprehensible form for some readers, so I’m reproducing it here.
I’ve also explained this at somewhat painful length here.
Correct me if I am wrong but what you are saying extends MMT into the private sector. The govt boosts balance sheets with stimulative fiscal policy. The private sector boosts balance sheets through asset price appreciation. Each creates “money” out of nowhere.
That’s one way of saying it. It adds a mechanism for asset (money) creation beyond “outside” (gov) and “inside” (bank) money issuance.
I’d say: MMT largely and Sectoral Balances exclusively “think inside” the incomplete flow of funds accounting matrix, which ignores cap gains (and nonfinancial assets). So it misses the biggest asset (“money”) creation mechanism there is.
To be precise:
Gov def spending adds assets to PS balance sheets. No new PS liabilities added, so +PS NW.
Bank lending (net, new) adds assets to PS balance sheets. But adds equal new PS liabilities, so no ∆NW.
Market runups (cap gains) add assets to PS balance sheets. Like gov def spending, no new PS liabilities added, so +PS NW.
Key point though: unlike gov def spending, new assets from cap gains don’t “come from” anywhere, aren’t issued by any sector. There are no new liabilities added to any other sectors’ balance sheets. That’s why cap gains aren’t included in the closed-loop, balance-to-zero flow of funds matrix.
The thing is, the economy doesn’t balance to zero. It balances to net worth. (Wealth.) That’s the bottom-line balancing item that makes balance sheets…balance. Since the flow of funds matrix is missing complete balance sheets, total assets, net worth, and cap gains, it can’t represent that.
And what is money?
People use that word in three primary ways:
1. The market-priced value of balance-sheet assets or net worth (representing the value of ownership claims), designated in a unit of account. Wealth. Ask a zillionaire, “how much money do you have?”
2. Financial instruments whose prices are institutionally pegged to the unit of account. Fixed-price instruments. (The price of a dollar bill is always $1.) eg Checking/MM-account balances and physical cash. The instruments that are tallied in monetary aggregates. Finance types often refer to this as “cash.” A subset of (1).
3. Physical currency/coins. A convenient late invention that makes it easy to transfer assets from one (implicit) balance sheet to another. A different meaning for “cash.” A subset of (2).
Note that the stock of #2 can only increase if some sector (financial or gov) issues more. Ditto its subset, #3. And, market pricing can’t affect the total stock of this subclass of money because these instruments’ prices are…fixed! The stock can only increase/decrease, these instruments can only appear/disappear, through issuance and retirement by other sectors, which post equal liabilities to their balance sheets. (That issuance/retirement is tallied in the FFA matrix — inside and outside money.)
If I have money in my pocket, I have a right to claim some portion of of the worlds’ production, be it a cup of coffee or a beach house on a tropical island.
Right. In practice, you can also claim people’s labor. Cause they need money. A balance-sheet asset is a formalized, labeled numeric representation of the value of an ownership claim (generally embodied in a financial instrument, with the claim’s asset value always designated in a unit of account), which can be exchanged for A) goods and services and B) other ownership claims.
So where does this money come from?
Ignoring #3 as a distraction, and focusing just on the two financial mechanisms that increase net worth:
A. Gov def spending. (Creates #2 hence also #1.)
B. Existing-asset market runups. (Creates #1 but not #2.)
As technological progress increases our productive capacity, so does our wealth. We become richer, so we should have more money.
Can definitely look at it that way. Wealth could be:
1. The value of our existing stock of stuff — both tangible and intangible, both consumable and productive. (To the extent that those can be distinguished; productive “capital” is “consumed” through use, decay, obsolescence…)
2. The capitalized net present value of what we will be able to produce in the future (thanks in large part to our existing stock of productive stuff).
Either way, I’d say:
We steadily increase our stock of real stuff. Surplus from production, all that. There are three financial mechanisms for creating new $-numerated claims on that new stuff, new balance-sheet assets. In terms of magnitude, cap gains is the dominant mechanism.
Finally, to expound on the implications of fixed-price vs variable-priced instruments/claims/assets:
When government deficit-spends, it delivers new fixed-price assets (checking/MM deposits) onto private-sector balance sheets. Assuming portfolio preferences are unchanged, the private sector is overweight “cash.”
Collectively, wealthholders can’t get rid of that cash by spending; they can only trade/swap that money around. The total stock only changes via issuance/retirement (caveat below). So they do a bunch swapping/trading of existing assets, driving up the prices of variable-priced instruments(mainly bonds, equities, and titles to real estate), with everybody marking their balance-sheet assets to market, until the market achieves its preferred portfolio balance.
The relatively fixed stock of fixed-price “money” is sort of a fulcrum around which portfolio rebalancing pivots.
So there’s some portfolio “multiplier” to government def spending. It immediately adds assets (cash) to private-sector balance sheets, but it also causes price increases in variable-priced instruments through portfolio rebalancing. Voila: even more assets.
This, by the way, is exactly how the portfolio mechanism works in the more advanced Godley-Lavoie-style models (which do encompass complete balance sheets, and include holding gains in “income.” See Haig-Simons.) Though I would suggest that the precise portfolio reaction-functions in these models might be improved.
The caveat: wealthholders can remove cash from their asset portfolios and from the private-sector balance sheet by paying down bank debt — shrinking their balance sheets, and the banks’. Likewise they can create cash by borrowing. (Again: private-sector assets and liabilities change, but net worth doesn’t.) They’re instigating the retirement/issuance of those fixed-price assets and associated bank liabilities. Think: reflux.
I hope folks find all this useful, or at least interesting.