Originally published December 14, 2011 on the New Economic Perspectives blog.
Of course, I didn’t expect comments this week on the keynote talk. I know many will agree with the comment on Billyblog—I’m sure many of you found our site after following Bill’s posts.
There was one substantive and flawed comment, so I will deal with that here.
Comment: The “Sotty” principle. That’s twice Prof. Wray has used the term. Referring, it would seem unknowingly, to the radiochemist Frederick R. Soddy, who demonstrated that interest continues to compound on the books after the bank money that offsets it is destroyed. Directly contravening the MMT notion that inside debts net to zero.
The money sovereign isn’t, as financial institutions have the power of money creation and leverage. That’s the power imbalance — a mathematical and financial imbalance — this piece is futilely attempting to deny.
Response: Yes, sorry, Soddy not Sotty, Nobel Winner in chemistry who also wrote a lot on economics. Michael Hudson has used Soddy’s ideas in his own approach to debt and debt cancellation.
But the commentator is in way over his/her head on balance sheets.
First, here is Soddy’s idea:
Debts are subject to the laws of mathematics rather than physics. Unlike wealth, which is subject to the laws of thermodynamics, debts do not rot with old age and are not consumed in the process of living. On the contrary, they grow at so much per cent per annum, by the well-known mathematical laws of simple and compound interest … For sufficient reason, the process of compound interest is physically impossible, though the process of compound decrement is physically common enough. Because the former leads with the passage of time ever more and more rapidly to infinity, which, like minus one, is not a physical but a mathematical quantity, whereas the latter leads always more slowly towards zero, which is, as we have seen, the lower limit of physical quantities.
You cannot permanently pit an absurd human convention, such as the spontaneous increment of debt [compound interest], against the natural law of the spontaneous decrement of wealth [entropy]
And so the fundamental problem is that “real” economic growth cannot match compounded interest growth—so debts increase faster than ability to pay.
Now I don’t want to get into a debate about the links between “real” and nominal, laws of entropy applied to economics, and so on. The idea is rather simple: if the nominal interest rate is higher than growth of ability to pay debt, then we’ve got a problem. And there is indeed a tendency for that—it is hard to achieve income growth rates that are consistently above nominal interest rates. Problems are compounded as debt ratios grow, as they have done.
But to return to the Commentator’s claim that this violates MMT: at a point in time, inside debts = inside credits. Every financial I owe U is offset by a financial U owe Me. It is an identity that is violated only by an arithmetic error.
Any theory that holds that the two are not equal is just plain wrong. You do not have to accept MMT to accept identities—they hold regardless of theory.
Here is the Soddy claim: over time, those debts will grow faster than ability to pay. That does not mean that debts don’t equal credits. When one defaults on a debt, the credit is also written down. If IOU $100 but can only pay $50, your credit against me is no longer $100—it is $50.
Debt cancellation wipes out the debts and the credits; at the same time; by the same amount.
It is elementary, dear commentator. It does not violate MMT—or any other theory.
Nor does bank leveraging violate MMT. Indeed, MMT has much to say about banks leveraging the state’s high powered money. You have not been paying attention!