Tuesday, March 3, 2015

Steve Keen on how Money is Created

Steve Keen has a summary of what money is and how it is created here:
Steve Keen, “What Is Money And How Is It Created?,” Forbes, 28th February, 2015.
Steve Keen points to the work of Augusto Graziani, the Italian monetary circuit theorist, and gives an interesting, if perhaps a little idiosyncratic, perspective on what money is and the nature of a monetary production economy.

I think the whole discussion would benefit from distinguishing (1) high-powered money from (2) credit money. Any private-sector agent can create credit money, including negotiable bills of exchange, negotiable promissory notes, negotiable cheques, or bank money. The trouble is having your credit money (which is simply a promise to pay in a higher money that can finally extinguish debt at a later date) accepted as payment in a transaction, because that money creates a debt/credit relationship that almost always must be extinguished by high-powered money. High-powered money can be either (1) commodity money or (2) state-issued fiat money.

As an aside, one of Graziani’s most important books was The Monetary Theory of Production (Cambridge University Press, Cambridge, 2003).


  1. 'The credit/ debt must be extinguished by high powered money'
    I don't think this is necessarily true. Although govt chartal fiat is the ultimate liquidity in the system, I don't think bank customers require direct access to it to make final payment, only access to a point in the liquidity schedule determined by the central bank, most commonly another private bank credit. What makes a private promise to pay widely negotiable is the nature of its endorsement / underwriting within the overall liquidity schedule. In historical periods without central banks the credit of different private banks traded at discount to one another - the schedule was horizontal. With the advent of a central bank, those credits all trade at par with fiat - the schedule is vertical and the discount is now manifested in the pricing of the private asset used as collateral in the loan or repo from the central bank window when one private banker seeks to make net payment to another. Many of those assets were created by the same loans for which the original deposits were written. So, to conclude, in a hybrid chartal/credit system, demand for bank rationed credit is the endogenous driver of chartal component. It's all money, its all fully liquid and it's all good for final payment, it just costs individuals differently to access it because they have borrowing risks. Clear as mud??

  2. The indirection of trust is called a trust chain. It's a common security principle. "Any private-sector agent" doesn't have a government guarantee. Vertical money is a private sector credit and a government liability. It's just credit with certain legal privileges. Hugo Evans is also correct that it's not necessarily needed to settle payment within the banking system.

  3. Must first read Steve Keen's piece before I comment further, but please don't forget good old G.F. Knapp and his State Theory of Money. According to him (and I do believe he's right) there is only one version of what you term "High Powered money": state-issued fiat money. There is no such thing as commodity money: you either have a commodity (such as gold bars) or you have state-issued fiat money coupled with a promise by the State to keep the price of a commodity (most commonly gold or, ealier, silver) fixed in terms of the money that State issues. A promise the State may try to keep in a host of different ways, the most obvious of which is to stamp its IOU on quantities of the commodity in question (e.g. gold coins). And, fatefully, a promise the State may or may not keep.

  4. That is a valid distinction between credit and currencies, but
    It is not true that the credit/debt realitionships almost always have to be extinguished with high powered money
    , the vast majority of debt/credit relationships in Bank money are netted of in the clearing process without evertouching the provision of high powerd money.

    different topic

    What do you think about PayPal now offering PayPal credit,

  5. Hugo makes a good point.

    Banks don't use "state issued fiat money" they use Central bank deposits accounts.

    A lot of the the assets called high powered money nowadays since the Fed buying MBS are cretead by the same loan contracts that create commercial bank deposits.
    And MBS aside there is not a fundamental difference between the conventional central bank assets - government bonds , and any other loan contract, and so high powered money concept is an obscurification an unnessasay addition to the scrutiny of the subject.

    All deposits are backed by loan contracts including central bank deposits and the so the thing called called high powerd money is only another loan contract.

    Its just that central bank deposits have a particular soundness and so the commercial banks use them for clearing debt outstanding from the netting off of the clearing process.

    But it doesn't have to be that way, strictly from the principle of accounting a large commercial bank could do the same job in , Which was the case in the USA prior to the 1900's.

  6. Why do unit costs rise over time? Why do commodity prices rise over time? Is a Keynesian able to answer these basic questions?

    1. I've already answered this question on the previous thread here, but clearly you are too much of a halfwit troll to have noticed.

      So let me repeat for your benefit:

      What causes costs to rise? This depends on the sector that is producing the factor inputs for a given firm and how this accounts for its costs:

      (i) in the flexprice non-labour factor input sector it happens when demand exceeds supply, and

      (ii) in the mark-up pricing capital goods sector it is because firms often shun price reductions when demand falls or even when their total unit costs fall (so that they can enjoy a larger profit margin) and prefer price rises to price reductions, and

      (3) in the labour sector human beings often strongly resent and oppose nominal wage cuts.

      These 3 factors are major causes of the strong inflationary tendency seen in modern capitalist economies.