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MMT and the Wealth of Nations, Revisited

March 23rd, 2018 Comments off

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 apprehensible 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.

Where MMT Gets Its Accounting Wrong — And Right

October 2nd, 2015 78 comments

Modern Monetary Theory has been revolutionary in economics, and its influence is — beneficially — ever-more pervasive. It has opened the eyes of a generation to a clear-eyed, accounting-based methodology that trumps dimensionless theory, and has brought a deep, nuts-and-bolts understanding of money, debt, and financial institutions to a discipline where that understanding has been inexcusably absent. Witness: a whole raft of papers from central-bank economists worldwide embracing MMT principles (though often not MMT by name), and eviscerating decades or centuries of facile and false explanations of monetary mechanisms.

But MMT’s terminology and associated accounting constructs remain problematic and contentious, even among some MMT supporters like the splinter group, the Modern Monetary Realists. Some of this contention results from the usual resistance to new ideas and ways of thinking. But some arises, in my opinion, because MMT terms and accounting constructs are indeed problematic. (The terminological confusion even causes some to object correctly, but for the wrong reasons — and vice versa!)

These difficulties are apparent when you consider one of MMT’s central and oft-repeated mantras and accounting identities, here in its simplified form for a closed economy ignoring Rest of World, courtesy of the redoubtable Stephanie Kelton:

Domestic Private Surplus = Government Deficit

This suggests an important truth, as far as it goes: public (monetarily sovereign federal government) deficit spending creates private assets out of thin air. The government spends new money, created ab nihilo, into private accounts. +Private Assets. No change to private liabilities. So: +Private Sector Net Worth.

But it doesn’t actually go very far. That “private surplus” (a term that is absent from the national accounts, and from MMT’s ur-text, Monetary Economics by Godley and Lavoie) is not defined in accounting terms, except circularly and tautologically: it’s the amount that private assets increase as a result of government deficit spending. That makes the identity true by definitional tautology.

But contrary to what’s at least implied by the equal sign, deficit spending is not the only way that private assets increase, or even the primary way. It’s not the only source of private-sector “surplus” or “saving,” as is often suggested in MMT discourse. Not even close.

Start by thinking in terms of Household Net Worth. This measure has the virtue of encapsulating and telescoping all private-sector net worth, because households ultimately own firms, at zero or more removes, but firms don’t own households (yet…). Citibank may own some GE shares, but Citibank is ultimately owned by households. Because: firms issue equity shares; households don’t. It’s an asymmetric, one-way ownership relationship.

Then take a look at this paragraph from MMTers extraordinaire Eric Tymoigne and Randall Wray:

MMT does differentiate between saving (in the flow of funds it is the change in net worth: ΔNW) and net saving (saving less investment). Net saving shows how the accumulation of net worth occurs beyond the accumulation of real assets. For the domestic private sector, this comes from a net accumulation of financial claims against the government and foreign sectors.

Some of the problems with this paragraph:

• Pace T&W, there is no “saving” measure in the Fed’s flow of funds accounts (FOFAs) that equals ΔNW — whether you’re talking net or gross saving (with or without consumption of fixed capital), including or excluding capital transfers.

• The “net saving (saving less investment)” bruited in that paragraph is confusingly at odds with the existing definition of the term as used in the national accounts — gross saving minus consumption of fixed capital.

• “Net accumulation of financial claims” does not appear anywhere in the national accounts, and has an uncertain relationship with a measure that the FOFAs do provide: “Net acquisition of financial assets.” Are these the same measures? If not, what is their accounting relationship?

I find here a set of terms that I’m unable to resolve into a coherent set of accounting statements — despite years of diligent and highly motivated efforts to do so. (I’m an ardent MMT supporter; I wouldn’t be thinking these thoughts if it weren’t for the MMT cabal.)

The core problem is these measures’ opaque relationship to net worth, and change in net worth. The problem exists because they don’t incorporate the primary way that net worth (wealth) is accrued: market revaluation of existing assets, a.k.a. capital gains. Market runups increase private-sector assets, without increasing liabilities. Voila: higher private-sector net worth. “Money” created, ab nihilo.

MMTers seem to have these conceptual, terminological problems for the same reason as more traditional economists (and due to MMTer’s efforts at speaking in those economists’ language): they’re still “thinking inside the NIPAs” — despite MMTers well-founded devotion to the FOFAs.

The BEA’s National Income and Product Accounts, pioneered by Simon Kuznets in the 1930s, are essentially income statements. They are one of the primary data sources for the FOFAs. But the NIPAs have a key failing: they don’t include balance sheets (the essential second component of a coherent accounting, which the FOFAs add). And the NIPAs completely ignore (with good reason) existing-asset exchanges and revaluations.

Absent balance sheets, and accounting for existing-asset revaluation, it’s impossible for balance sheets — and net worth, period to period — to…balance. Economists who don’t deeply understand that — and I will assert that few economists do, because they’re conceptually trapped inside the NIPA’s balance-sheet-free definitions of income and saving — cannot form a coherent understanding of an economy’s workings.

In Monetary Economics, Godley and Lavoie (G&L) do show a deep understanding of revaluation’s importance — they give extensive coverage to the Haig-Simons accrual-based mark-to-market accounting approach that I also favor. But you’ll be hard-pressed to search Google for top MMT names (Wray, Tymoigne, Kelton, Fullwiler) and find asset revaluation, capital gains, or Haig-Simons accounting incorporated into their discussions of income or saving.

This even though the FOFAs (presented in the Fed’s Z.1 reports) provide exactly that: balance sheets and income statements based on Haig-Simons  accounting — using accrual-based, marked-to-market revaluation of existing assets — wherein the sum of accounted flows totals to balance sheets’ period-to-period net worth changes. See for instance the Household tables B.101 (bottom line: net worth) and R.101 (top line: change in net worth).

Those FOFA tables are the source of the Integrated Macroeconomic Accounts for the United States (IMAs), which unlike the NIPAs, conform (mostly) to the international System of National Accounts (SNAs). See for instance Household table S.3.a, which includes the income statement and balance sheet on a single page (bottom line: net worth).

You will find a similar Haig-Simons approach in Armour, Burkhauser, and Larrimore 2013, an analysis that merits significantly more attention, and replication. (The authors, inexcusably, have not made their data set available.) The FOFAs and IMAs provide the necessary revaluation estimates for such a replication, estimates which Armour et. al. achieve by their own methods (somewhat different from the Fed’s, but using similar indices).

This is all important because the widespread MMT statement (at least implied, and frequently explicit) — that government deficits are the source of private saving (or “surplus”) — is at least a poor explanation of economic workings, and at worst just wrong. Government deficits are a source of private saving.

The two primary sources of private assets (hence saving) are:

  1. Surplus from production (how “surplus” is commonly used in the national accounts), monetized by the markets for newly produced goods and services.
  2. Revaluation of existing assets — assets produced in previous periods — realized in the existing-asset markets.

I would even go so far as to say that these are the primary mechanisms whereby “money” is created. Deficit spending is small beer compared to cap gains. Asset markets go up, and there’s more money. This eschews the widespread confution of money with “currency-like things,” suggesting rather that all assets — which since they exist on balance sheets are necessarily designated in a unit of account — embody “money.”

As an aid to untangling the confusion that I still find inherent in MMT discourse, I offer up the following taxonomy of sources for household income. It’s explained in detail here.

Household Income Sources
Comprehensive Income (gross contributions to net worth, before netting out expenditures) Non-Property Income (compensation for labor) Other Labor Income Social benefits and other transfers received (including employers’ social contributions)
Primary Income Primary Labor Income: Wages and salaries
Comprehensive Property Income (compensation for ownership) Primary Property Income: Dividends, interest, proprietors’ income, rental income, and operating surplus
Other Property Income Market asset revaluation (capital gains)
Other changes in asset volume

Here’s what that looks like in an accounting statement, here using IMA data:

Screen shot 2015-10-02 at 9.01.27 AM

Before you raise objections, I point you again to further explanation of this construct, here.

Like Armour et. al., I use a measure labeled “Comprehensive Income” that includes accrued, marked-to-market capital gains. I go a step further, however, and propose another measure based on that, a residual of sources and uses: “Comprehensive Saving.” That measure has a singular virtue: it equals change in net worth.

“Primary income” — the vestige of the NIPA’s “income” measure that is carried over into the FOFAs and IMAs (but properly labeled as “Balance of primary incomes”) — is given as an addendum measure. The measure here varies from the FOFAs/IMAs only in that interest paid is not deducted from income; it’s tallied under Uses.

Comprehensive Saving does not, of course, equal government deficit spending. (Nor does Primary Saving.) Such spending contributes to private-sector saving, but it’s not even vaguely identical.

Before concluding, I’d like to touch on private-sector bank lending. (Modern Monetary Realists, are you listening?) Its direct effect on net worth is zero. It creates new assets — bank deposits. But unlike government deficit spending, it also creates equal and opposite offsetting liabilities on both the borrower’s and the bank’s balance sheets. Both balance sheets expand, equally on the left and right sides.

Borrower: +Assets (new bank account deposits)  +Liabilities (new loan payable)

Bank: +Assets (loan receivable)  +Liabilities (customer deposits withdrawable)

So the act of private lending itself creates new assets, but it doesn’t directly, in accounting terms, increase private-sector net worth.

But: borrowers use many of those loans to create real assets — goods, capital — that are then sold at a higher value (or marked to market at a higher value). That markup increases private sector net worth, and private lending is a huge catalyst for that process. But that is an economic effect, not an accounting identity.

So yes: private bank loans create new private-sector assets, and they have the indirect economic effect of increasing net worth, but they don’t, directly and in and of themselves, increase private-sector net worth. Government deficit spending does. MMTers are right that it’s special in that way.

What they’ve missed — or caused many of their followers to miss — is that it’s not the only thing that’s special in that way.

Really, it’s not even close:

Screen shot 2015-10-02 at 10.21.20 AM

Runups in stock and real-estate markets create new wealth, net worth, “savings,” money, out of thin air — just like deficit spending, but by a different mechanism.

The markets create money too.

Cross-posted at Angry Bear.

Predicting Recessions The Easy Way: Monetarists, MMT, and the Money Stock

August 25th, 2015 Comments off

I have a new post up that has implications for stock-market investment, so I decided to try posting it over at Seeking Alpha, where they’re paying me a few tens of dollars for the post (plus more based on page views — not much luck so far).

The post argues that year-over-year change in Real Household Net Worth has been a great predictor of NBER-designated recessions over the last half century. (It’s either 7 for 7, or 8 for 7, over 50+ years, depending on the threshold you use.) If you were following this measure, you would have gotten out of the market on March 6, 2008, avoiding a 50% drawdown over the next twelve months.

But the post goes farther, offering a somewhat monetarist economic explanation but using total household net worth as the measure of the “money stock.” Short story: if households have less (more) money, they spend less (more). Not exactly a radical behavioral economic assertion.

If you’re wondering how recent days’ market events have caused billions (trillions?) of dollars to “disappear,” and are pondering how to think about that, you might find it an interesting read.

Cross-posted at Angry Bear.

An MMT Thought Experiment: The Arithmetic and Political Mechanics of Net Financial Assets

January 13th, 2012 63 comments

Imagine that over the next week (in a closed American economy — the rest of the world has never existed) everyone sold all their financial assets, paid off all their debts, and deposited the remaining money (and any currency they have) in their checking accounts. No money-market funds, even. Just banks with reserve accounts at the Fed, holding everybody’s money in “cash.”

All those other financial asset prices would dive to zero. Late sellers would sell for nothing.

Would the remaining money in all the bank accounts equal U.S. government debt? That seems to be the implication of MMT thinking, because the remaining money only exists because it got spent into existence by the government deficit spending — crediting bank accounts with that fiat, ex nihilo money in the first place.

Net financial assets = gross financial assets = government debt

(If the government had always just deficit-spent instead of borrowing to cover its deficits, “government debt” would be replaced by “cumulative to-date government deficit spending.”)

I ask not just for clarity, but because (as always), I’m struggling with the relationship between fixed assets and financial assets, between saving and investment.

It’s said that the true wealth of the nation — the “national savings” — consists of its real assets: stuff that can be consumed in the future through use and time/natural decay. The NIPAs only count “fixed assets” — hardware (equipment), software, and structures, so let’s pretend that those constitute all real assets (which they don’t in actuality — not by a long shot). Net investment — purchases/creation minus consumption of fixed assets — increases the stock of fixed assets/”savings.”

In theory, financial assets are just financialized, monetized representatives, proxies, for the real, fixed assets that underly them. And indeed over the (very?) long term, the quantity of fixed assets and net financial assets rise together. Both are much larger today in the U.S. than they are in Thailand, or the U.S. in 1910. Financial-asset values wander all over — even over decades — based on “animal spirits,” but again in the long term…

If that’s so, then in our thought experiment:

Net financial assets = gross financial assets = government debt = fixed assets

The quantity of fixed assets increases over time through net investment. But by MMT thinking, net financial assets can only increase through government deficit spending (or trade surpluses). What is the mechanism whereby government deficit spending is translated into more net financial assets that embody the increased stock of fixed assets?

I imagine a necessarily political mechanism something like the following:

1. People and businesses buy/create fixed assets, resulting in more economic activity — creating/consuming, buying/selling, spending/income.

2. Those increased quantities (both stocks and flows) create more demand for government services. Both individuals and businesses would be decidedly unhappy, I’m thinking, if today’s government were the same size it was, at least in absolute terms, in 1870. (Conservatives and libertarians may say otherwise, but they’re talking through their hats.)

3. Legislators and executives who don’t provide those increased services don’t get re-elected.

4. Taxation lags behind spending — resulting in deficits — because A) people hate taxes and vote against politicians who raise them, and B) if deficit spending is not sufficient to match the increases in fixed assets, depressions result, and the “fiscally responsible” leaders get voted out.

5. The new money from government deficit spending is used to purchase financial assets, driving their prices up to (roughly) match the value of fixed assets.

This is thinking of government and the Fed as one consolidated entity. If you think of them as separate, you can imagine a different mechanism, in which the Fed and the congress/president are engaged in a constant chicken game over inflation, unemployment, and GDP growth, to determine how and when to increase the amount of money/net financial assets (ultimately through deficit spending) to match the stock of fixed assets.

These mechanics would also explain how buying/creating a bunch of drill presses will — through a long, tangled, and messy political process, and in the long but not the short run — result in more “loanable funds.”

Cr0ss-posted at Angry Bear.

The Most Important Econoblog Post This Year: The Steve Keen/MMT Convergence

January 10th, 2012 1 comment

Neil Wilson has done yeoman’s duty to (perhaps) achieve a convergence that has been too-long delayed.

A Double Entry View on the Keen Circuit Model.

Steve Keen is, to my knowledge, the only person who is actually encoding a Godley-esque, MMT-style, accounting-based, stock-flow-consistent dynamic simulation model of how economies work. But many MMTers have been quite hostile or at least resistant to Steve’s work, based on some different concepts of endogenous/exogenous money, and — this may seem trivial but it isn’t, at least as it has played out over time — based on details of single- versus double-entry accounting.

The debate has been quite acrimonious at times, and that acrimony has greatly hindered a convergence that in my eyes would be the most salutary event possible in the development of economic thinking and practice.

You can read the details in Neil’s post, but in short he’s re-jiggered Steve’s accounts to make them conform better to (at least Neil’s view of) standard bank-accounting practices. I’m not qualified to evaluate his new formulation, but I am excited to read Neil’s comment on the post, replying to uber-MMTer Scott Fullwiler:

We need to get all this pulled together into a coherent overall model.

Steve’s up for it. I hope you are too.

I’ll just say: I’m very much up for watching it happen.

Also: run don’t walk to read Steve’s Debtwatch Manifesto, posted last week.

Cross-posted at Angry Bear.

Question for Market Monetarists and MMTers: What Happens if IOR Goes to Zero?

January 5th, 2012 21 comments

For the non-cognoscenti: “IOR” is interest on reserves. Banks keep money in their accounts at the Fed. In October, 2008 the Fed started paying .25% interest on those accounts.

The Fed’s also engaged in “quantitative easing,” a.k.a. open-market purchases on steroids, creating new money and using it to buy $1.6 trillion dollars worth of bonds from banks. The money is deposited in banks’ reserve accounts.

The result: banks have $1.6 trillion dollars in excess reserves (in excess of what they’re required to hold) sitting in their accounts at the Fed.

This is the heart of the “pushing on a string” argument — giving the banks more reserves (making their holdings more “liquid”) doesn’t (necessarily) increase real-economy transaction volumes (on consumption or investment), either directly through spending by the banks or via bank loans to people and businesses who will spend it. This $1.6 trillion in new money issued by the Fed is effectively stuffed in an electronic mattress.

So I’m curious what would happen if the Fed no longer paid IOR.

I asked Scott Sumner this a while back:

if tomorrow the Fed dropped IOR to zero or even negative, what would happen to:

o Excess reserves
o Inflation

He gave a somewhat less than satisfactory answer:

The IOR question is a good one, and at the risk of being annoying I’m going to slightly dodge the question. I do think it would be expansionary, but it’s hard to know how much, because it’s almost inconceivable to me that it would be done by itself, without any other policy changes. It could be slightly expansionary, or if accompanied by other moves, wildly expansionary.

Less than satisfactory (for me) because he often engages in these kind of simplified thought experiments. Change Variable X, ceteris paribus: what would happen?

I’m basically asking for a free education here (hoping others would appreciate such an education as well), but I’m also hoping to spur a discussion on a tightly focused question that has not been cogently discussed, as far as I can find. (I certainly could have missed it. Pointers welcome.)

Cross-posted at Angry Bear.

Actually, Only Banks Print Money

December 12th, 2018 2 comments

I’m thinking this headline will raise some eyebrows in the MMT community. But it’s not really so radical. It’s just using the word money very carefully, as defined here.

Starting with the big picture: 

You can compare the magnitude of these asset-creation mechanisms here. (Hint: cap gains rule.)

The key concept: “money” here just means a particular type of financial instrument, balance-sheet asset: one whose price is institutionally pegged to the unit of account (The Dollar, eg). The price of a dollar bill or a checking/money-market one-dollar balance is always…one dollar. This class of instruments is what’s tallied up in monetary aggregates.

A key tenet of MMT, loosely stated, is that government deficit spending creates money. And that’s true; it delivers assets ab nihilo onto private-sector balance sheets, and those new assets are checking deposits — “money” as defined here.

But. Government, the US Treasury, is constrained by an archaic rule: it has to “borrow” to cover any spending deficits. So Treasury issues bonds and swaps them for that newly-created checking-account money, reabsorbing and disappearing that money from private sector balance sheets.

If you consolidate Treasury’s deficit spending and bond issuance into one accounting event, Treasury is issuing new bonds onto private-sector balance sheets. It’s not printing “money,” not increasing the aggregate “money stock” of fixed-price instruments.

This was something of an Aha for me: If you look at the three mechanisms of asset-creation in the table above, only one increases the monetary aggregates that include demand deposits (M1, M2, M3, and MZM): bank (net new) lending.

Arguably there might be one more row added to the bottom of this table: so-called “money printing” by the Fed. But as with Treasury bond issuance, that doesn’t actually create new assets. The Fed just issues new “reserves” — bank money that banks exchange among themselves — and swaps them for bonds, just changing TheBanks’ portfolio mix. That leaves private-sector assets and net worth unchanged, and only increases one monetary aggregate measure: the “monetary base” (MB). 

I’ll leave it to my gentle readers to consider what economic effects that reserves-for-bonds swap might have. 

Wealth and the National Accounts: Response to Matthew Klein

March 8th, 2018 Comments off

I’m both abashed and delighted that the truly stand-out econ writer Matthew Klein has offered wonderfully fulsome praise of one of my pieces, Why Economists Don’t Know How to Think about Wealth, and some very interesting discussion as well. Some responses here. Please excuse me if I repeat some of the points from the first article.

>His key point is that changes in net worth caused by asset prices fluctuations are just as important as standard measures of income and saving.

That’s important, but there are really three key points I’d really like to come through:

1. Wealth matters. Net worth and total assets. Those are absent from the Flow of Funds matrix, because it ignores: A. Nonfinancial assets — the (L)evels tables aren’t balance sheets — and B. Holding gains. Yes: changes in wealth measures also matter a lot (see below), and they’re of course also invisible and largely unexplained in the FFA matrix.

2. Accounting statements are economic models, based on deeply-embedded assumptions that are largely invisible except to accounting-theory adepts. The FFAs’ closed-loop construct depicts, promulgates, and validates the whole factors-of-production worldview (each according to its contribution…) which underpins travesties like Greg Mankiw’s “just deserts” claptrap. See in particular national-accounting-sage Robert Hall’s discussion of the accounts’ implicit “zero-rent economy.”

3. The dumpster fire (@noahpinion) of terminology that economists rely on to communicate — and really to think (together) — is (or should be) rigorously defined based on accounting identities. But that requires deeply understanding #2 above: what those measures and identities mean. To repeat: accounting classes don’t even count as electives for econ degrees at Harvard and U Chicago. (Really, the situation is more like the sub-basement of Fukushima Three. One word: “saving.” Many economists vaguely think that more individual saving results in some larger stock of monetary “savings.” Sheesh.)

>Roth’s presentation…is not new. Alan Greenspan wrote about these ideas back in the 1950s

Johnny-come-lately. Haig-Simons, who I refer to repeatedly, bruited their comprehensive accounting definition of income in the 20s and 30s. (Dead-cat bounce. I’m thinking the rich hate this idea. The political implications of fully revealing wealth and wealth accumulation could be…revolutionary?)

Wikipedia informs me that a German legal scholar named Georg von Schanz was on it somewhat earlier. (Modern Money Network, are you listening?)

>Roth ends up downplaying the importance of the liability side of the balance sheet.

Perhaps. At least three reasons:

1.The FFA matrix does an excellent job of accounting for (inevitably “financial”) liabilities. Nothing to complain about there. That’s where the IMAs get most or all of their liability accounting from. And economists have made very good use of that data.

2. Looking at households as the “buck stops here” balance sheet, liabilities are surprisingly (to me) small percentage of assets. Yes, a long secular trend with one big spike (not much for sample size…). Click for Fred.

3. For the economic import of (change in) assets versus liabilites, I’ll just point to one economic factoid which I find darned significant:

Post-1960s (post Bretton-Woods?), every time you see year-over-year decline in real household net worth or assets, you’re just into or about to be in a recession. (There are two bare false positives, just after the ’99 and ’08-’09 market dives; they look to me like blowback, residual turbulence, if that suffices as cogent economic terminology…)

Notice: The two measures are equally predictive; including liabilities (in net worth) adds no predictive power. These two measures move closely together. This especially makes sense for declines; asset markets dive, while liabilities are much more sticky downward. (They tend to climb together over time.)

So yeah, I’m with Roger Farmer about stock-market declines “Granger-causing” recessions, though 1. I cringe at that faux-statistical usage, and 2. at least for the GFC, I’d say the real-estate crash caused the stock-market crash. In any case, overall, it sure looks to me like wealth (asset) declines (proximate?) cause recessions. I’d say high debt levels amplify the effects when that does happen.

So yeah of course, net worth is not some kind of tell-all economic measure. You gotta deconstruct it. But it’s a bloody-well-necessary measure that economists (and national accountants) have largely ignored, like forever.

>defining “saving” as the “change in net worth”, as Roth does, is that this obscures as much as it clarifies

Note that I use a particular term for that, Comprehensive Saving, while leaving what I call Primary Saving (largely) intact. (The IMAs’ measure of primary income hence saving is after “Uses of property income (interest paid)” are deducted, which seems crazy (and politically pernicious) to me. I’ve moved it from it’s sort-of-hidden position in Sources, to appear explicitly in Uses, so my Primary Income and Primary Saving measures are a bit higher than the IMAs’.)


Now it’s true that I relegate Primary Saving to an addendum, favoring Comprehensive Saving as the more important measure. This imparts how deeply rhetorical all accounting presentations are. But I think this privileging makes sense give the relative magnitudes we see. (Net Lending + Capital Formation here is traditional primary “saving”).

This is J.W. Mason’s recent graph, which I was delighted to see, showing the same measures (the IMAs’ ∆NW decomposition) that I’ve also graphed in the past.

>asset price appreciation generally leads to proportionally tiny increases in spending.

The linked study, like others of its kind, in my opinion gives too much weight to marginal propensities, based on one-time changes. So I question how good a guide they are to determining economic reaction functions. This is too much of a subject to address here, so I’ll only suggest that more straightforward, long-term propensity-to-consume measures by wealth/income classes might be more illuminating. Also velocity of wealth. (I’m a monetarist! As long as “money” means “wealth”…)

Whether or not you consider these figures illuminating, they are the kind of figures you can derive from a complete accounting construct that tallies total assets and net worth. Note that both are also dependent on data from Zucman/Saez/Pikkety’s magisterial Distributional National Accounts (DINAs). What I’d really like to see is Distributional IMAs (DIMAs). I corresponded with Gabriel Zucman on this a bit; he’s given me permission to quote him:

You are correct that there can be pure asset valuation effects in the long run (i.e., capital gains in excess of those mechanically caused by retained earnings). These pure valuation effects are not part of national income, hence not included in our measure of income and our distributional series. However, they could be included down the road by computing income as delta wealth + consumption (i.e., Haig-Simon income). We have wealth in our database so we’re not far from being able to do this.

To conclude on a decidedly accounting-dweeby note, here’s the key accounting identity for Haig-Simons (which I call Comprehensive) Income:

∆ Net Worth + Consumption = Primary (traditional) Income + Holding Gains (+ Other Changes in Volume)

Subtract taxes, and you’ve got Comprehensive Disposable Income. Subtract Consumption, and you’ve got Comprehensive Saving. Equals…change in Net Worth.

Accounting identi-tists, have fun!

(For those who prefer this kind of thing in slide-deck form, here’s a PDF of my presentation from the recent Modern Monetary Theory conference.)

“In the Beginning…Was the Unit of Account” – Twelve Myths About Money

November 19th, 2017 39 comments

Jan Kregel presented a great dinner speech at the recent Modern Monetary Theory Conference, touching on some of the fundamental ways we think about money and economics. (Sorry, no recording or transcript available.) I had a brief conversation with him afterwards, and we followed up with a few emails.

The quotation in the title of this post is condensed from the final line of one of his emails — a line that made me laugh out loud:

“So I guess we start from that — in the beginning was the word, and the word was the unit of account?”

Okay, yes: money-dweeb humor. But the implications are kind of profound.

The Word. LogosIndeed. I’ve written about this before — how writing in its earliest forms emerged from tally sheets, accounting. Even, that its emergence was the first step on the road to outsourcing our memory onto iPhones, maybe even (only somewhat tongue in cheek) causing human brains to shrink over millennia.

Jan’s great line, and our conversations, prompt me to set down some thoughts on this ever-vexed subject. Herewith, twelve widespread usages and conceptions that, in my experience, tie our money discussions in knots. Please assume that anything you don’t like here is mine, not Jan’s, and apologies to those who have heard some of this from me before.

(A proleptic response to an inevitable digression: I’m assuming a closed national or world economy for simplicity. The “rest of world” sector, and the exchange rate with Martian currency, are not considered.)

#1. Money was invented around 700 BCE. No. That’s when coins were invented — handy physical tokens making it easy to transfer assets from one person’s (implicit) balance sheet to another’s. Money existed on something like balance sheets — tallies of who owns what and who owes what — long before that; those tallies go back thousands or tens of thousands of years. Mentions of monetary values in written documents — designated in staters, drachms, whatever — were widespread long before anyone thought of using coins for asset transfers.

The earliest coins, by the way, may well have been badges of honors and offices issued by religious authorities. Somehow people started exchanging them, and voila: physical currency. This had little or nothing to do with butchers and bakers or convenient time-shifting of purchases. That’s a made-up armchair myth (though the convenience benefit is real). Wampum, likewise, wasn’t used for trade exchange until Europeans captured that “money” system and transformed it.

#2. Money is a “medium of account.” (Whatever “medium” means in that phrase…) Money was invented when some clever tally-keeper, totting up cows and horses and bags of grain, invented the arbitrary unit of account — a unit that allows those heterogenous goods to be tallied on a single sheet, in a common unit of value. We find price lists of assorted goods on some of the earliest Sumerian tablets, for instance, and price lists can’t exist without a unit of account. It’s hard to know, but it seems like this clever technology might have been invented multiple times over the millennia.

If this historical tale holds water, the earliest forms of money were just…the value of tallied (balance-sheet) assets, with the value designated, denominated, in a unit of account. In the beginning…

By this thinking, an “asset” is a labeled balance-sheet entry, designating the value of an ownership claim — again, designated in a unit of account. These “asset” things only exist on balance sheets. The claims themselves may be informal — you own the apple on your kitchen counter by norm, convention, and common law. Or they may be formal, inscribed in one or more legal instruments and a supporting body of law and norms. The forms and terms of these ownership-claim instruments are myriad and diverse.

Money in this sense is the UofA-designated value of an ownership claim (perhaps formally recorded in an asset entry).

Ask a real-estate zillionaire, “how much money do you have”? The answer has nothing to do with physical dollars in wallets, or any particular class of ownership claims/assets that are tallied up in “monetary aggregates.” It’s about total assets or net worth — necessarily, designated in a unit of account.

The problem arises when we confute these two common meanings of the word. Start watching: you’ll often see it happen even within a single sentence. This ubiquitous muddle — trying to talk about two different things using the same word — has engendered unending confusion.

Both uses of the word are perfectly valid and useful; they just mean completely different things.

#3. There is such a thing as non-fiat money. Nope. (A better description is “consensus” money. The consensus is usually enforced by the fiat powers of a government, temple authorities, etc.) The consensus exchange or “face” value of precious-metal coins must always be higher than the market value of the metal substrate. If the reverse were true, people would just melt them down. Outside the fiat/consensus purview of the issuer, those coins many only retain their substrate value. So they’re still valuable for far-flung trade, or if authority breaks down, because the commodity may still retain consensus value. (That security in itself can contribute to holding up their consensus face value.)

Ditto cigarettes in POW camps. There are physical things called cigarettes, but there’s also this conceptual thing that emerges when people start using them in general trade: a cigarette.” Or “the cigarette.” It’s a unit that can be used to designate the value of other things.

The consensus value of coins and currency is based on the stability of the unit of account. (See: Brazil.) The coins are just physical tokens representing a unit of exchange — an asset that can be transferred, and that’s designated in the unit of account. In the beginning…

#4. Money “is” debt. Or, “you are paying with liabilities.” Money, by any definition, is always and everywhere an asset of the holder. The $5 bill in your pocket or the five dollars in your checking account are assets on your balance sheet. Paying, spending, is transferring assets to someone else — from the lefthand side of your balance sheet to the lefthand side of theirs.

Now of  course money issuance is often associated with the creation of new balance-sheet liability entries — think government deficit spending — but those liabilities are posted to the money issuer’s balance sheet. The recipient gets an asset: the credit half of the tally stick. That’s what gets passed around in spending and payments. The debt side is generally held on the balance sheet of large, powerful creditors or institutional authorities.

This isn’t just true of “cash”; government bondholders are obviously holding assets. The debt is on the government balance sheet. “Holding debt” is a handy shorthand for finance types, but considered even briefly, it makes no literal sense at all. How could you hold or own something you owe?

Ditto “paying with liabilities.” If you transfer a liability from the righthand side of your balance sheet to the righthand side of another’s, you are unlikely to receive much thanks, or any value in return.

These usages can be useful, stylized ways of referring to particular economic, financial, and accounting relationships. Which is fine as long as users are perfectly clear on how the thinking is stylized. But on their face they don’t make sense, and they engender great confusion. Money is always an asset of the holder.

#5. People “spend out of income.” Spending, payments, always come from asset balances. That’s what payments are — asset transfers. When you write a check, you withdraw from your checking-account balance. When you buy a bag of Doritos at 7-11, the money’s coming out of your wallet. It’s impossible to “spend out of” the instantaneous event of somebody handing you a five-dollar bill. Once it’s in your hand, once it’s an asset you own, you can spend it.

“Spending out of income” is another of those common usages — a useful shorthand way to talk about spending more or less than you receive over a period. It’s an unconsidered commonplace that deeply confuses our conversations about money.

#6. There’s a difference between “inside” and “outside” money. After new money is issued, its origin is immaterial in the particular. Where did the $100 in your checking account “come from,” originally? Say I borrowed it, or got it in a tax refund, or whatever, then paid it to you. It’s impossible to say, and it doesn’t matter, where it came from.

New assets appear in account balances from 1. government deficit spending, 2. bank lending, and 3. holding gains. Then people swap them for other assets, or transfer them to pay for newly produced goods and services. Whether the money came from “inside” or “outside” sources (or holding gains), once it’s circulating among accounts, it’s just…money. As we all know, money is fungible.

Certainly, newly created liability entries associated with money issuance can be economically significant. And some particular financial instruments retain a meaningful and influential financial or economic (ultimately institutional) relationship to particular liability entries. But in the big picture once the money’s out there, it’s disconnected from its “inside” or “outside” origins.

#7. Monetary aggregates tell us how much “money” we have. The various monetary aggregates so beloved of monetarists (M0, M1, MZM…) share a common, unstated definition of “money”: financial instruments whose prices are institutionally pegged to the unit of account — physical coins and currency, checking account and money-market deposits, etc. Remember the 2008 headlines: “Money Market Fund ‘Breaks the Buck.’” The institutional powers and practices of pegging are diverse, and institutional pegging can fail.

This particular subset of assets — fixed-price, UofA-pegged financial instruments — comprise only about 9% of U. S. households’ $111 trillion in assets. They play a particular role in individual and aggregate portfolio allocation (more below), they’re quite handy for buying new goods, and they’re a necessary intermediate holding for most asset swaps. But their stock quantity is swamped by even the price-driven change in other assets; capital gains on variable-priced instruments added $7 trillion to household balance sheets in 2013 alone. Monetarists’ fetishization of these “currency-like” financial instruments, and their aggregates, is…misplaced.

#8. If people save more money, there is more money (or “savings,” or “loanable funds”). Obviously, if you save (spend less than your income over a period), you have more money. But we don’t. Just, the money’s in your account. If you spent it instead of saving it, it would be in somebody else’s account.

Spending — even spending on consumption goods that you’ll devour within the period — is not consumption. The money isn’t, can’t be, “consumed” by spending. It’s created and destroyed by other, financial, mechanisms. If you eat less corn, we have more corn. If you spend less money, we have no more money.

#9. Saving “funds” investment. Investment spending, like all spending, comes from asset balances. “Funding” from flows is harder to nail down: If a firm this year has $1M in undistributed profits (saving) and borrows $1M, spends $1M on wages and buys $1M in drill presses, which inflow “funded” which outflow? Firms borrow to make payroll all the time. (Don’t even get me started on stock repurchases.)

I can’t resist quoting one of the best financial and economic thinkers out there (read the whole thread):

Individual money-saving isn’t even really a flow; it’s a non-flow — not-spending — just an accounting residual of income minus expenditures. (Though of course it’s a flow measure: tallied over a period of time, not at a moment in time.)

#10. Portfolio allocations — and spending — are determined by “demand for money.” The relatively small stock of monetarists’ “money” — instruments whose prices are pegged to the unit of account — is sort of a fulcrum around which portfolio preferences and total asset value (wealth) adjusts. But the vague gesture toward the unmeasurable and dimensionless notion of “demand” is not illuminating. Here in more concrete terms:

Suppose government deficit-spends $1 trillion into private-sector checking accounts. The market’s portfolio is overweight cash (assuming portfolio allocation preferences are unchanged). But the market can’t get rid of those fixed-price instruments — certainly not by spending, which just transfers them — or change their aggregate value (their price is fixed, pegged to the unit of account).

So people buy variable-priced instruments — stocks, bonds, titles to real estate, etc. — bidding up their values competitively until the desired portfolio allocation is achieved. (This, by the way, is exactly how things work in the more advanced Godley/Lavoie-style, “stock-flow consistent” or SFC models.)

The economic implications of this: A trillion-dollar deficit-spend results in $1T more in private-sector assets (the “cash”), plus any asset-value runups from portfolio adjustments triggered by that cash infusion. (This is before even considering any effects on new-goods spending — the so-called “multiplier” — or the proportion of spending devoted to investment — Keynes’s particular fixation.)

Sure, if wealthholders are feeling nervous — more concerned with return of their wealth than returns on their wealth — they may prefer instruments that by their very nature guarantee stability, non-decline relative to the unit of account. They’ll sell variable-priced instruments, running down their prices until the market reaches its preferred portfolio allocation. “Liquidity preference” is one rather strained way to refer to this straightforward idea of portfolio allocation preferences.

Likewise, “demand for money” is a cute conceptual and verbal jiu-jitsu, flipping straightforward understandings of portfolio preferences on their heads. Demand is supposed to influence price and/or quantity. But it can’t influence the “price of money” or the aggregate stock of fixed-price instruments — only the prices, hence aggregate total, of variable-priced instruments. This notion does far more to confuse than to enlighten.

Takeaway: holding gains and losses — which are almost universally ignored in economic theory even though they’re the overwhelmingly dominant means of wealth accumulation — are the very mechanism of aggregate portfolio allocation. If you’re only considering “income”-related measures (which ignore cap gains), there’s no way to think coherently about how economies work.

#11. The interest rate is the “price of money.” This is like saying a car-rental fee is the price of a car. The price of a dollar (a unit of exchange) is always one, as designated in the dollar (the unit of account). The cost of borrowing is something else entirely. Like “demand for money,”  “the price of money” is just verbal and conceptual gymnastics, inverting the very meaning of the word “price,” and trying to shoehorn money-thinking into a somewhat inchoate notion of supply and demand (that’s constantly refuted by evidence). It’s not helping.

#12. Central bank asset purchases are “money printing.” Not. Sure, the Fed magically “prints” a zillion dollars in reserves to purchase bonds. But then it just swaps those reserves for bonds, which are “retired” from the private sector onto the Fed’s balance sheet. Private-sector assets/net worth are unchanged; the private sector just has a different portfolio mix: more reserves, less bonds.

Ditto when the Fed sells the bonds back (as it’s now doing and promising to do, a bit); it re-absorbs the private sector’s reserve holdings and releases bonds in return, disappearing the reserves back into its magic hole in the ground. (As Milton Friedman observed, banks have both printing presses and furnaces.) Again: no accounting effect on private-sector assets or net worth.

QE and LSAPs do have some asset-price, hence balance-sheet, effect, at least while they’re happening; the central bank has to beat market prices by a smidge to play the whale and buy all those bonds. Bond prices go up and yields go down. Which will push investors’ portfolio allocations more into equities and other “risk assets,” driving up their prices some. But the first-order accounting effect is just to change private-sector portfolio allocations.

So there: twelve conceptions about money that have made it difficult or impossible for me, at least, to think coherently about the subject. Here’s hoping these thoughts are useful to others as well.


I’d like to end this post with the same question for my gentle readers that I went to Jan with. Units of account are very odd conceptual constructs indeed. They’re not like other units of measurement — inches, degrees centigrade, etc. — which generally have some physical objective correlative: “length” or “warmth” or suchlike. Units of account tally “value,” which basically means value to humans, a function of human desire. And human desires, of course (“preferences”), vary.

So my question: what’s a good metaphorical or figurative comparison to help us understand and explain this strange conceptual thingamabob? Is money an invention like algebra? Are there other conceptual constructs that are similar to units of account, comparable mental entities that can help us think about what these things are? I can’t think of any good analogies. It’s vexing.

Extra points question: what is “the bitcoin”?

Yes: In the beginning was the word. Words are one of the main things, maybe the main thing, that we use to think together. All thanks to my gentle readers for any help in doing that.

The Mysterious Stock of “Loanable Funds”

October 26th, 2017 5 comments

This Twitter thread between Ryan Cooper and Joe Wiesenthal prompts me to do full-spectrum explanation of some thinking that I’ve been meaning to get to for a while. (Thanks for the inspiration.)

What follows is very unorthodox thinking even among the heterodox. It’s well beyond and different from MMT’s utterly convincing takedowns of “loanable funds” notions, for instance.

So take it as the ravings of an internet econocrank, if you will. But here it is FWIW.

First off, nobody can ever point to these so-called “loanable funds,” or mostly even say if they’re talking about a stock measure or a flow measure. It’s one of those unmeasurable, actually dimensionless, concepts that econs are so fond of, like demand and supply (desire and willingness).

It’s often used synonymously with “savings” with an “s”, at least implying some stock. (The national accounts use the term “saving”; there is no stock measure labeled “savings” therein.)

The only measurable stock of “loanable savings” I can think of is wealth: balance-sheet assets, or net worth. (The national accounts, by the way, only started tallying those comprehensively a decade ago.) Household-sector assets or net worth are probably the best measures of this, because they incorporate the value, telescoped in, of the household sector’s wholly-owned subsidiary, firms.

On the idea that household saving “funds” lending and investment by providing more loanable funds: individual saving increases your assets/net worth. It doesn’t increase our assets/net worth. Your savings are just held in your account instead of — if you spend — someone else’s account. They can be intermediated into investment from either account.

Likewise “saving” by firms — retaining earnings instead of distributing them to shareholders as dividends. In either case those funds are in accounts that are intermediated (and re-re-re-“hypothecated”…) by the financial system. If a firm uses those funds for actual, real investment, that’s…spending! (“Investment spending” as opposed to “consumption spending” — the two sum to GDP.)

Individual saving doesn’t create any extra “loanable funds” — stock or flow. When you eat less corn (save), we have more corn. When you spend less money, we have no more money. Spending — even “consumption spending” — is not consumption. Transferring an asset (spending) doesn’t “consume” that asset, make it disappear. This error of composition pervades economic thinking. Think: Krugman/Eggertsson’s whole “patient savers”/”impatient borrowers” construct. Individual saving doesn’t create collective savings.

Individual saving is actually a non-flow, an accounting residual of two actual transaction flows — income minus expenditures. (Though it is a flow measure as opposed to a stock measure — it’s measured over a period, not at an instant.)

Sectoral saving actually consists of two (or three) things, as revealed by the accounting derivation in the Integrated Macroeconomic Accounts (IMAs): capital formation + net lending/borrowing + capital transfers. For households, capital transfers is mostly estate taxes; it’s a small number. Capital formation is the creation of actual new (long-lived) stuff within a sector, whose value is posted to the asset side of balance sheets. Net lending/borrowing is the accumulation of claims against other sectors’ balance-sheet assets.

These two are utterly distinct and different economic mechanisms, crammed together into a single accounting measure labeled “saving.” It’s no surprise that nobody understands saving. In the grand scheme of wealth accumulation, these two saving mechanisms are pretty small change. Here, the derivation of change in private-sector net worth, again from the IMAs.

Real investment in the creation of newly produced, long-lived (productive) stuff — capital formation, investment spending — is overwhelmingly “funded” by churn within wealthholders’ $100-trillionish portfolio. Sell treasuries, buy into an IPO or a real-estate development deal. A zillion et ceteras. The “flow” of saving is small by comparison.

At the macro-est level, that “investment impulse” is driven by collective portfolio preferences, the markets’ risk/reward/yield calculations. (“Jesse Livermore” delivered the Aha for me on this; his measure of equities as a share of outstanding financial assets on Fred here. Pace market monetarists, it sure doesn’t look the market is crowding into “safe assets.”)

Swapping checking-account deposits for Apple shares is not investment in the economic sense of paying people (spending) to create new long-lived (productive) stuff. Collectively, it’s just portfolio allocation. If people are (confidently) optimistic, they bid up risk assets, expanding the total portfolio (wealth) pie.

Monetarists’ obsession with financial instruments like checking and money-market deposits whose prices are institutionally pegged to the unit of account (“cash” — only about 5% of household assets) blinds them to that collective portfolio adjustment mechanism. If government deficit-spends $100 billion in cash onto household balance sheets, the market is overweight cash (if portfolio preferences are unchanged). It re-allocates by competitively buying variable-priced instruments (bonds, stocks, land titles), driving up their prices. There’s more cash and more other assets.

Market asset pricing doesn’t — can’t — influence the total stock of fixed-price, UofA-pegged instruments. Their prices are fixed! (That’s the thing that makes cash, cash.) They can only be created by bank lending and government deficit spending (see next para). Those instruments are largely just a pool of intermediates in portfolio churn, in any case: sell treasuries, get cash; swap cash for IPO shares. As long as there are enough “cash” instruments for transactions to clear (and the peg holds), you’re cool. The transaction system doesn’t bind up. Collective portfolio reallocation is almost all via price changes in, duh, variable-priced instruments.

There are three economic mechanisms that create new private-sector balance-sheet assets ab nihilo: government deficit spending, bank lending, and asset-market price runups/capital gains. (Bank lending creates simultaneous private-sector liabilities, so it doesn’t create new private-sector net worth; the other two do.) These mechanisms create new “loanable funds” a.k.a. wealth. (Fed asset purchases with newly-“printed” “money” — reserves — create no new private sector assets or net worth — they just swap reserves for bonds, changing the private-sector portfolio mix; the market then adjusts its portfolio allocation in response, as described above.)

Of these three ab novo asset-creation mechanisms, capital gains utterly dominates:

Especially since the 80s/90s, as revealed here in corporate equity performance (this in inflation-adjusted dollars):

Think Amazon: essentially zero profits, saving, change in book value over two decades, while delivering half a trillion dollars onto household balance sheets.

This (plus similar or larger cap gains effects in real-estate valuation) gives rise to some very perplexing trends — perplexing for me at least:

This depicts what Sri Thiruvadanthai calls a “structural break,” some kind of seeming phase shift in how markets are working, or how we perceive and report on those markets, in accounting terms. Or both. Earnings and P/E, for instance, are becoming increasingly problematic as predictors of total return. What’s the capitalized present value of future cash flows from a firm that…will never deliver any cash flows/”profits”?

The asset markets seem to think that all our stuff is worth a lot more than it sold for in the new-goods markets.* One of those markets is getting prices “wrong.” Either this is the mother of all multi-decadal asset bubbles, or we’ve been vastly understating GDP for decades. (Or something else, maybe accounting, measurement-related.)

The creation of real, long-lived goods (“capital”) is the ultimate driver of wealth accumulation. But the economic mechanisms of wealth creation and accumulation — creating new claims on all our goods and future production (claims whose market-priced value is tallied up as balance-sheet assets) — are something else entirely.

In any case I agree with Joe: within what I think is a great article, Ryan’s rather rote recitation of standard-issue “loanable funds” truisms merits some careful rethinking.


* The national accounts don’t even come close to tallying all that “capital,” by the way, or the investment in creating it. Consider the massive, lasting productive value, for instance, of widespread knowledge, skills, and abilities imparted through education and training and deployed over lifetimes, or broadly experienced health and well-being delivered through health-care spending. Those expenditures aren’t tallied as “investment” (spending on long-lived goods), nor are the resulting “assets” depreciated as humans age, sicken, and die.