#50 Phil Armstrong: Where Does Money Come From? (Part 2)
Patricia and Christian talk to PhD scholar Phil Armstrong about learning from and working with MMT founder Warren Mosler, and the revolution in the understanding of money brought about by his insights (Part 2 of the interview).
Phil and Warren Mosler’s paper.
Federal Debt and Modern Money by Steven Hail and David Joy.
Follow Phil on Twitter.
Info on Christian’s MMT show.
Listen to Part 1 of this interview.
Transcript for Opening Monologue
At the beginning there, you heard our guest this week, Modern Monetary Theorist and PhD scholar Phil Armstrong talking about what anthropologists call The Myth Of Barter, which is the idea that money is something that evolved spontaneously, through non-coercive human interaction to solve the inefficiency of barter.
Many economics textbooks still start with the proposition that once upon a time, there was such a thing as a barter economy, where people would take stuff that they’d made or food that they’d grown to some trading venue and have to wait for someone to come along who not only had what they wanted, but who also wanted what they had – economists call this the double coincidence of wants – and of course, it’s clunky and inefficient, so naturally humans must’ve invented money to solve the inefficiency, and it evolved from primitive forms, feathers, beads, shells, into pieces of metal, and then into the modern money systems we have today.
As many anthropologists have pointed out over the years, the problem with this story is that there isn’t any evidence that an economy like this ever existed. As David Graeber writes, in his excellent Debt: The First 5000 Years: “The story of money for economists always begins with a fantasy world of barter. The problem is where to locate this fantasy in time and space… For centuries now, explorers have been trying to find this fabled land of barter—none with success.”
This is not to say barter doesn’t exist – humans barter all the time – but what’s being said here is that there is no evidence that barter evolved into modern money systems as we know them today. It’s just a story.
When it comes to the invention of money all we can have is conjecture, as economist Randall Wray puts it, and I’m paraphrasing: “Nobody sat down and documented it – nobody sat down and wrote ‘today I invented money’”.
So given that all we can have are theories, I think it’s important to know this idea of barter evolving into modern money systems, this story which is the jumping-off point for many, if not most, macroeconomics textbooks, is one with no supporting evidence (or arguably any logical basis), and so it’s called “The Myth of Barter”.
A competing theory of the origin of money is chartalism, which is the idea that a government or a state needs to provision itself and so it creates money by fiat – it chooses what will be the money, the unit of account, that everybody under its authority will use by demanding taxes be paid in that unit of account, so whatever activity the private sector engages in, it will always have to do something to acquire some of the state-issued currency to settle its tax bill. The state could choose gold or seashells or feathers as currency, but then it would have to go to the inconvenience of acquiring those things in order to spend them, and so it chooses something that it alone controls the issuance of. And that’s why the goods and services wherever you live are priced in the state’s unit of account (pounds, dollars, yen) and not gold, feathers or seashells. As long-time listeners will know, this chartalist framework for understanding money is at the heart of MMT. All central government spending creates new money for the private sector and all central government taxation takes money out of circulation and destroys it as far as the private sector is concerned.
So given that fiat currency is issued into existence by a currency-issuer (usually a sovereign state, at this point in human history) what does it mean when we say our government is borrowing? Why would it need to do that?
I’ll use pounds for this example, but this explanation applies to the US, Japan Canada, Australia and New Zealand to name a few, but by no means all.
When the government borrows pounds from a holder of pounds in the private sector, for all intents and purposes, it puts those pounds into a savings account at its central bank. That private sector person or entity is now a bondholder – and they’ll get their money back plus interest when the bond matures, but they’ve given up some of their spending power in the meantime. So on top of taxation, what gets called government borrowing is another way for the government to influence the spending power of the private sector.
But also, deep in the plumbing of the banking system, when a person or an institution buys a government bond, it removes reserves from reserve accounts at the central bank. These reserves (sometimes called settlement balances) are the pounds that banks use to settle up with each other. They are current accounts that commercial banks have at the central bank. When the government sells a bond it moves pounds from reserve accounts to a securities account, said another way – it moves pounds from current accounts, to the savings account at the central bank. This is why insiders call bond sales a reserve drain.
So one explanation of why governments still do this thing they call borrowing is that they task their central bank with a thing called monetary policy, which is voting on, and targeting an interest rate, and they do this because they work with the idea that there is a perfect interest rate that will keep the economy growing in such a way as to achieve full employment and avoid inflation.
Of course the definition of “full employment” in this paradigm actually means plenty of unemployment, under-employment and lower-than-subsistence wages – but if you’re the policy maker rather than the person that has to live with the negative externalities of that policy, all those things are a small price to pay to not have inflation.
Anyway, central banks used to hit their interest rate target by draining reserves from the banking system, through bond sales, to keep banks short of reserves system-wide, which meant the banks had to lend to each other overnight and this would achieve an interest rate on bank reserves. Since the advent of QE, which added excess reserves to the system, meaning no system-wide shortage of reserves, and no overnight lending, central banks now achieve their interest rate target by paying interest on reserve balances, making bond sales for the purpose of targeting interest rates a complete anachronism.
This all as I understand it, I may have oversimplified it, but if you want to take a deeper look into central banks, commercial banks and government bonds you can listen to our episodes 13, 30, 31 and 43 in that order, and those episodes are with two of the best economics teachers in the world, and that should round out your understanding. And also I’ve linked to a recent policy note from the Global Institute For Sustainable Prosperity called “Federal Debt and Modern Money” which lays this out in a very clear way.
The reason I’m saying this is because this is part two of a two part conversation with Phil Armstrong, and we start the conversation talking about interest rates and the efficacy of monetary policy, just changing interest rates, versus spending the money where it’s needed – AKA fiscal policy targeted at alleviating unemployment and poverty. Just my opinion, but it seems to me the attraction of monetary policy for policy-makers is it gives them plausible deniability – they get to say “yes, the economy is not working for everybody, but we leave all that ‘economy’ stuff to the Bank of England and it’s so important to just leave them to it, anything else would be totalitarianism, sorry for all the dead people, that’s the price of freedom, please keep voting for us”.
Again, just me but the reason I want to understand all these dynamics is because the Bank of England is part of the government and the government work for us, or they should do in a functioning democracy.
So thanks as ever for the time you put into understanding these things, thanks for your continuing support, it means so much to us – if you’re able to support us financially, it starts at a dollar month (which is 80.7 British pence at the time of recording) and there’s a link to our Patreon page in the show notes. Your financial support helps keep the show going and makes it better – but your support in other ways and and your encouragement is the thing that keeps us going as humans, we really appreciate it, it’s hard to get by without that, so thanks again – let’s dive in!
